Sun Tzu’s Lessons for Treasury Management in China
With the development trend of globalisation, multinational corporations in the global economy face new challenges. China is still a socialist country, but its banking sector has consistently grown and is undergoing a historical and cultural transformation.
Chinese banks have continued their expansion abroad, particularly in the Asia-Pacific region. This expansion is mainly through organic growth by establishing new branches and subsidiaries, as well as through some mergers and acquisition (M&A) activity. Meanwhile, European and US banks have increased their stake in Chinese banks.
All Chinese national commercial banks have launched their own cash management services to compete with international banks. They provide corporate clients with standard solutions including collection, payment and account management.
Business Tactic and Strategy: Know Your Business Model
Sun Tzu’s famous treatise ‘The Art of War’ is applicable not only to war but also to Western business management. The book inspired many ideas as to how to succeed in competitive business situations. We believe that it can also be applied to the field of treasury management.
International companies willing to do business in China should take a long look at certain parameters in their home country before setting up a subsidiary in China, in order to evaluate the type of organisation and its characteristics in terms of:
Once these details are clear, then a gap analysis between the parent company and its subsidiary can begin. Initially, it is important to establish the structure of the company in relation to its subsidiaries.
In a centralised organisation, the parent company is responsible for financing subsidiaries. The treasury team based in the home country regulates the financing activities and maintains the banking relationships. On the other hand, transmission of information is slower between the parent company and its subsidiary (e.g. account statement or reports) than if the organisation was decentralised.
In a decentralised organisation, local treasury teams have the power to make decisions as they are more financially independent and able to more quickly respond to market changes. However, the treasury team in the home country must anticipate lack of supervision and have risk awareness policies in place.
Our best practice recommendation is to set up a flexible and homogenised treasury management culture, with flexible working processes and smooth communication between home and host country. An ideal scenario becomes reality when home country and subsidiaries share a homogenised IT system, the same banking communication process and an enterprise resource planning (ERP) system.
A mixed combination of centralisation and decentralisation organisational structure is highly recommended to obtain effective control and avoid situations of imbalance. It is important to develop regular information flows (e.g. intraday alerts).
Restricted access to credit
Banks are required by the China Banking Regulatory Commission (CBRC) to maintain a loan-to-deposit ratio of less than 75%. However, with total bank deposits on a downward trend due to the negative real interest rate environment, the loan-to-deposit ratio of banks has been forced up, reducing the amount of available credit. As a consequence, companies often face difficulties in obtaining credit.
Our best practice recommendation is to reinvest and avoid trapped cash or repatriation of cash. For example, a French fashion retail company manufacturing clothes in China has set up a wholly foreign-owned enterprise (WFOE), where involvement of a mainland Chinese investor is not required. The home country company can buy clothing material in euros from the host country subsidiary or WFOE. The Chinese WFOE converts euros into renminbi (RMB). As access to credit is complex, most of the converted RMB amount is reinvested locally.
Working capital management (WCM) is very important for those corporates that cannot afford to keep excess cash in some entities while funding other entities, due to the gap between the lending rate and the deposit rate in China.
Changing regulatory environment
The regulatory environment in China is changing and can generate unexpected situations. Deposits are regulated and loan rates are subject to limited variability. Local banks attach much importance to deposits because China’s banking authority, the CBRC, monitors their loan/deposit ratios. Another factor is that the interest rate is regulated, so the margins are more or less guaranteed. This renders business for local Chinese banks more secure than hedging transaction banking fees.
Our best practice recommendation is to be aware that handling unexpected shifts in government policy is a challenge for corporate treasurers in China. And it is almost impossible for corporations to foresee the changes. Deposit management is key to meeting preventive daily business needs. Therefore, it is best to have local and flexible treasury management teams able to face change in regulatory environments.
Increasing RMB internationalisation
In its July 2012 RMB Tracker SWIFT detected a 40% to 60% increase in the number of countries and institutions processing RMB payments from June 2011 to June 2012. The top RMB payment banks increased the number of RMB relationships by 68% in that same period, from an average of 91 to 153 correspondents.
Over this same period, the international adoption of the RMB grew significantly, as the number of countries and institutions processing RMB payments expanded from 65 to 91 (40% increase) and from 617 to 983 (60% increase) respectively. These figures are a good indication of the fast growing RMB international adoption.
Our best practice recommendation is that both foreign and domestic companies that wish to raise RMB for business development should adopt a foreign exchange (FX) strategy. Multi-currency cash pooling can manage investments and revenues in multiple currencies in order to hedge FX risk.
Increasing mobile payment
With one billion mobile phone users, China is the world’s largest mobile phone market, driving the global development of mobile banking services. Chinese telecommunications companies and banks have already expressed their ambitions to grow in this market by joining together. Given the banking dynamics in China and the need to provide access to financial services to people across a vast country, mobile-based banking services will be considered as a strategic development.
Our best practice recommendation is that both foreign and domestic companies that wish to do business in China should consider mobile payments for collection and receivables.
China is changing quickly. Three potential developments that could change business approaches include:
In addition, a number of national and regional government initiatives are already being rolled out.
In August 2012, China extended a nationwide trial of simplified procedures to pass foreign currencies between banks and companies in goods trades. Companies no longer need to carry out the procedures for verification and settlement of their FX received from exports. Instead, the State Administration of Foreign Exchange (SAFE) will regularly check export/import transactions and FX receipts/expenditures derived from trade of each enterprise. SAFE’s FX monitoring system for trade in goods replaces the former FX payment and collection verification system. As a result, foreign trade will be more convenient and increase trading firms’ global competitiveness.
China is pushing for an upgraded national payment system, with the China National Advanced Payment System (CNAPS) to migrate soon to CNAPS 2. The enhanced system will have a wider functionality and will also allow large amounts of RMB to be cleared across regional borders. However, China’s network of fragmented local clearing systems remains in place.
China is also extending connectivity between the RMB clearing system and other capital markets systems, such as the stock exchange or the central clearing system for bonds. CNAPS is now being connected with the bond clearing system in Hong Kong. Customers can buy and sell bonds in RMB via an automated cross-border payment. The whole operation is automatically processed in RMB.
Shanghai and Beijing have launched schemes for multinational companies (MNCs) to establish regional treasury centres (RTCs) in China. As they offer preferential policy treatment and streamlined approval processes, many MNCs looking to establish RTCs for Asia are now interested in these locations.
All of these developments means that the operating environment in China is becoming more attractive to MNCs and their treasury departments.