China’s announcement in November last year that cash management and currency rules would be relaxed has encouraged interest from international firms who have until now struggled with the country’s verbose exchange rules. Treasurers and risk managers at some of those firms welcomed the announcement.
“If the changes they’ve suggested actually go ahead, this could be huge for us,” says a Singapore-based risk manager at a multinational energy firm. “We do some business with China, naturally, but if the laws are relaxed even slightly, this would be an absolute game-changer.”
As things stand, banks, financial services firms and international companies must set up international accounts in Chinese banks, and transactions are scrutinised a lot more than domestic deals. That can add days – and in some instances weeks – to the settlement process.
“There’s a lot of opportunity in this for us, if it goes ahead we can expect to see a lot more capital flows coming into and out of the country,” says the head of research at a Chinese bank. “We’ve had a lot of queries from foreign customers on our expectations for it to happen. It could really stimulate the economy.”
“There’s a lot of opportunity in this for us, if it goes ahead we can expect to see a lot more capital flows coming into and out of the country”
In mid-October, the country’s president Xi Jinping delivered a speech at the 19th National Congress of the Communist Party of China in which he spoke of plans to open up open the domestic financial system to international market participants. As well as pointing to the need to build competition and transparency, Xi said foreign exchange rules needed to be modified to better attract international players to China’s thriving investor marketplace.
Subsequently, the country’s financial market regulator, the China Banking Regulatory Commission (CBRC) issued a notice in late December in which it outlined a number of plans to make things easier for foreign banks and firms providing financial services. As well as easing license requirements, the CBRS said it will make it easier for foreign banks and joint ventures to perform treasury bond underwriting and financial advising services. The changes will allow foreign banks to offer a range of these services before obtaining approval from the regulator. While it could provide foreign firms with access to the country’s substantial financial service market and make doing business with China much more appealing on the surface, not everyone is convinced the reforms will go ahead as expected.
“The regulators have made similar announcements in the past, only for new managers to come in and completely change things,” says the Singapore-based risk manager. “Of course, because some of the direction has come from the very top that creates a lot more confidence that they will indeed go ahead, but it only takes a slight change in the country’s economic outlook for leaders to change their direction on things. I’ll believe it when I see it, basically.”
Further, he adds that should changes to the way that international players engage with yuan and yuan-denominated products come into play, some market participants may be wary of the government’s instructions to regulators on how rates are set – which will be motivated by the country’s economy.
Hot growth
“We’ve seen it in the past. If certain commodity markets look to be overheating, the government will intervene, change the rules or play with the rate of exchange to slow things down,” he says. “Companies that are considered getting more involved in China because of these changes will be smart to realise that the yuan is not about price discovery, it is about price setting. It’s just how Beijing likes to control things and if a firm has great exposures in a high growth sector don’t be too surprised if regulators lean in to manage whatever risks they feel are getting too hot.”
And state intervention based on factors that impact the country’s economy could be in the offing. In a recent working paper, the International Monetary Fund (IMF) outlined systematic risks to China’s financial markets and suggested that downward policy action may be required to stop the certain aspects of the economy from overheating. Focusing on the country’s booming credit market – which has been growing since the financial crisis – the IMF says the sector is on a “dangerous trajectory”, and is at threat of encountering a slowdown to which China’s financial regulators will be forced to make policy adjustments.
“Every country in the world has gone through extreme reform in the past few years,” says the Chinese bank’s head of research. “It would be undue for treasurers operating in the international marketplace to turn their noses up at the Chinese economy because of something that might happen in the future. The world has been on a knife edge for years – why ignore an opportunity if you can take advantage of it?” he asks.
“It would be undue for treasurers operating in the international marketplace to turn their noses up at the Chinese economy because of something that might happen in the future”
The proliferation of regulatory changes across the world over the past decade has led multinational firms to reassess their exposure to certain markets. In the US, the 2010 Dodd Frank Act has weighed heavily on banks and financial institutions to restructure their balance sheets and liquidity ratios. In Europe, the Markets in Financial Instruments Directive, now in its second iteration, with its slew of technical standards aimed at encouraging transparent and responsible markets have threatened to curtail business. The bank’s head of research says that’s lead to many companies looking eastward for arbitrage and risk management opportunities.
“There’s definitely been a lot more companies considering how to get out of these markets and move to Asian markets,” he says. “A lot of these firms are know feel under new, serious pressure to try to keep up with the regulations and naturally some are looking to China and India to see what opportunities lie in the east.”
However, while China’s regulators may be looking to liberalise the country’s foreign exchange systems, they have – like their counterparts in the US and Europe, taken aim at different parts of their financial system. President Xi, while attempting to encourage international market participants to the country’s domestic markets, has also led calls to identify and curtail systematic risks. In regulators’ sights currently is the so-called shadow banking system – where unregulated or under regulated organisations provide lending or other financial services. According to Moody’s Investor Services, in April of last year China’s shadow banking sector accounted for a whopping $8.5 trillion. Now, regulators have moved to block a number of the ways in which market participants conduct shadow banking activities.
Of concern to international players considering entering China’s market will be the veracity with which the country’s regulators turned on cryptocurrencies. In September last year, the People’s Bank of China (PBOC) imposed a ban on fundraising for cryptocurrency launches, or initial coin offerings (ICOs). With the cryptocurrency market in China growing markedly, the ban had a huge impact on the market and swallowed six percent of bitcoin’s value. Shortly after the ban, large, Shanghai-based bitcoin exchange BTCC shut down its Chinese operations. In a statement in early February this year, the PBOC issued a statement that it would “block access to all domestic and foreign cryptocurrency exchanges and ICO websites.”
The Singapore-based risk manager says not only does this point to a risk-sensitive, over-active regime, but also to one that will be quick to change rules should it believe markets are not in line with the government’s policy line.
“The changes to the way the country decided to deal with bitcoin weren’t exactly unexpected, but it does show that if the government decides it doesn’t like something it’ll just get rid of it – no matter what benefits we might be seeing elsewhere,” he says.
“One of the benefits of having an international mode of exchange is that you get rid of foreign exchange risk, which is exactly what the Chinese now say they are trying to do. Who’s to say treasurers won’t really prefer to deal in cryptos?”
“And we don’t know where we’re going to be in the future with cryptocurrencies. Bitcoin and others have had their ups and downs but they’re still sizeable markets, structured and with their own derivative products. Who is to say that the larger financial players won’t want to use them to trade cross-border in the future? One of the benefits of having an international mode of exchange is that you get rid of foreign exchange risk, which is exactly what the Chinese now say they are trying to do. Who’s to say treasurers won’t really prefer to deal in cryptos?”
With regulators discussing such huge changes to how companies interact with the yuan, much depends on how the economy performs – and the government isn’t afraid to step in should things not be running according to plan. The country’s economy grew by 6.9 percent in 2017, according to state figures, representing the fastest rate of growth since 2015. That could prompt policy makers to reconsider their agendas.
“If the PBOC and the CBRC start to think the economy is running away from them, they’ll toy with markets, set the exchange rate and if things overheat they’ll dampen them,” says the multinational’s risk manager. “That’s why when assessing the risk of going into the country, you have to be aware that how the foreign exchange system works could look very different in just a few months’ time.”