How can companies reap the full benefits of netting and quickly set up efficient cross-border netting structures in China? This article outlines four major considerations for achieving the maximum efficiencies.
In the wake of China’s rapid economic growth and the gradual easing of cross-border fund movement controls, the issue of trapped cash is no longer as big a concern for corporate treasurers as it once was. Indeed, over the past two years several new regulations have been issued by the People’s Bank of China (PBoC) and the State Administration of Foreign Exchange (SAFE) specifically to promote cross-border cash and liquidity management in the renminbi (RMB) and foreign currencies. This has given rise to various schemes in the Shanghai Free Trade Zone (SFTZ) and across China, from which corporates can cherry pick those most suitable for their requirements.
Of the new additions to the cash and liquidity management framework, the introduction of netting has attracted considerable attention. Chinese regulators have allowed corporates to leverage the concept of centralised payment and collection to manage their working capital better, including pay-on-behalf-of (POBO), receive-on-behalf-of (ROBO) and the netting of transactions between inter-companies and third party companies.
The benefits of netting are obvious: it not only simplifies settlements between internal and external trading partners but also helps reduce funding costs significantly, since it eliminates the short term borrowing needs of companies who are net creditors. In order to reap the full benefits of netting and quickly set up the right structures, corporates will need to take into account the following factors:
- The design of netting structure:
The key question to ask is “Do you plan to leverage your global netting centre (GNC) located overseas to implement netting, or appoint a China-based leading company to settle transactions with your GNC?”
Initially, corporates were only allowed to appoint a China-based leading company that would centralise all netting positions before settling with overseas companies. With this structure, there is only one transaction per month between a corporate’s China entities and its GNC, thereby streamlining inter-company settlements and reducing funding needs for its China entities. However, this structure also adds another layer of complexity as corporates will have to consolidate the monthly net positions of all their China entities before settling with the GNC
To alignment with international best practices, the PBoC recently authorised China entities to net inter-company transactions directly with their GNC, thereby eliminating the need of setting up a China-based leading company as the middleman.
Companies that have already established global netting processes should opt for direct netting with the GNC for ease of implementing netting without having to modify global standard processes. For companies with a limited number of cross-border counterparties and no standard global netting processes, appointing a China-based leading company can help quickly capture the benefits of netting.
- Technology as an enabler
With the sophisticated “netting centre” functionality offered by technology vendors, companies can leverage their treasury management system (TMS) or enterprise resource planning (ERP) system to execute netting transactions. Nearly all industry-grade TMSs are equipped with this module to help group companies efficiently implement netting, which can be bilateral or multilateral.
Netting can also be payables-driven or receivables-driven, which provides companies with another way to use the “leading and lagging” technique to optimise working capital. A payables-driven netting process can be initiated by companies that have accounts payable, and this method is suitable for sales companies to enable payment “lagging”. On the contrary, a receivables-driven netting process can be initiated by companies with accounts receivable, and therefore more favorable for manufacturing and supplier entities as it enables payment “leading”.
While some clients may expect their banks to provide a ready-to-implement netting system, a majority of banks lack any that are readily available. Even for those with available netting systems, these are often legacy systems from a treasury service business that have already been sold or spun-off. It is therefore recommended that clients use their own TMS or ERP to implement netting, as the platform is comparatively more sophisticated and allows clients to take ownership of the data and benefit from increased efficiency.
- Regulatory reporting requirement
Even as the netting process simplifies cross-border settlements, regulatory reporting can be a challenge, as companies in China participating in cross-border netting are required to provide monthly balance of payments (BOP) reporting on an original transactions basis. This means that if a group of companies has one monthly netted transaction comprising 10,000 original transactions, they are required to file the BOP reporting for both the netted transaction as well as the 10,000 original transactions. This is where automated reporting will help increase efficiency and streamline the process. As an example, Standard Chartered provides an automated BOP reporting solution that enables clients to automatically file the reporting once the BOP data is populated on the bank’s reporting module. The straight-through solution also enables the data feed process to be automated from a client’s ERP system to the bank’s system, resulting in an efficient, hassle-free reporting process.
- Liaison with local Tax Bureau
China’s tax bureaus require cross-border transactions be verified against the original sales contracts or invoices. This requirement creates operational complexity when participating entities leverage a netting centre to pay or receive funds on a netted basis. It is necessary for companies adopting cross-border netting to explain their processes to the relevant local tax bureaus and verify that netted transactions are essentially the same transactions that are settled under a different scheme.
To do this, companies need to provide their local tax bureaus with relevant simulated netting reports, together with the original transaction details before implementing netting processes to provide the tax bureau with a clearer understanding of the process. It is important for corporates to engage their tax bureaus before implementing netting to avoid any potential impact on their tax claims, such as export tax refund.
Given the opportunities, China’s growing role in global trade has brought about cross-border netting -which has recently become one of the biggest market trends, with corporates regularly combining netting with POBO/ROBO and cross-border two-way sweeping in order to move funds to where it is needed. For corporates looking to set up efficient netting structures in China, having a strong understanding of the legal, tax, accounting and technology issues and keeping abreast of the latest regulatory developments will be critical to successful implementation.
By Philippe Tian, executive director, treasury solutions, Standard Chartered.