China, the Renminbi and Liquidity Management

China officially the People's Republic of China (PRC), is a sovereign state located in East Asia, with a population of over 1.35 billion. According to the IMF, China's annual average GDP growth between 2001 and 2010 was 10.5%. Between 2007 and 2011, China's economic growth rate was equivalent to all of the G7 countries' growth combined. Its high productivity, low labor costs and relatively good infrastructure have made it a global leader in manufacturing and allowing Multinational companies to make a base in China. In the early 2010s, China's economic growth rate began to slow amid domestic credit troubles, weakening international demand for Chinese exports and fragility in the global economy.

From Liquidity Management perspective, China is a highly regulated market with direct influence over Interest rates governed by People's bank of China. There are strict restrictions governing intercompany lending among corporates to practice an Optimized liquidity Structure.

However, few foreign banks and local banks (JP Morgan Chase, HSBC) have been providing Liquidity Structure solutions through Entrust Loan framework (People's Republic of China Lending Principles prohibits direct inter-company lending, a common treasury technique in most developed markets. Direct funds movement from one legal entity to another is not allowed unless it is a trade related transaction, payment of service or royalty fee).

Framework was introduced way back in 2003, with two major differences w.r.t to Liquidity services being offered around world.

1. For Cash Pool , funds are physically swept to and from participant companies to pool header account which are regarded as entrust loans where in Multi –lateral and Bi-lateral agreement are setup and swept amount is tracked as loan.
2. Cost of setting up and running Cash Pool are very expensive and two components drive this high running cost.
   • Stamp Duty:  Stamp duty is charged 0.005% of the contract amount for each party per agreement.
   • Business tax: Interest Rate can be freely negotiated among borrower and Lender; However Business tax of 5 % is levied on interest income earned by lender. This tax will be applied on fund movement from participant to pool header or vice versa (applied on both cases). 

However for Multinational to operate Cash Pool structure in China need to have

1. Either a China holding company or a regional headquarters in China that allows to temporarily lend excess foreign currency funds up to a maximum of two years) to related group entities domestically within China or overseas prior to formal declaration and payment of dividends.
2. There must be at least three or more domestic subsidiaries for the foreign multinational in China and the domestic subsidiary acting as the lender in the transaction must also have injected its registered capital in full as scheduled. Cross-border borrowing and lending of foreign currency is structured as direct lending and regulator (State Administration of Foreign Exchange, SAFE) pre-approval is required for every transaction

In October 2005, the SAFE together with the Shanghai Pudong City government relaxed foreign currency restrictions for select multinational companies having regional headquarters domiciled in Pudong district. This pilot program provided the ability to do foreign currency daily cash concentration among subsidiaries of the multinational company in China.

SAFE approval is required and special accounts must be opened to facilitate the sweeping. Surplus RMB balances may also be converted to foreign currency and the resultant foreign currency proceeds extended via a cross border foreign currency entrustment loan to related offshore company to meet their funding requirements. Thus reducing taxes and cost of running Cash pool Structures.

This experiment led PBOC to lift the ban on Cross-border Forex cash pooling in the Shanghai FTZ in Feb, 2014. This will further open up China’s other locations for cross-border RMB cash pooling which will benefit corporates and multinationals.

Another reason of opening of China market is Internationalization of RMB. RMB is reported to be the eighth or ninth most traded currency worldwide. Today, offshore RMB centers have been established in Hong Kong, Singapore, Taiwan, London, Paris, Frankfurt and Luxembourg, and at least 40 central banks from around the globe have allocated partial reserves to the currency. Recently, the People’s Bank of China signed a high-profile currency swap agreement with its European counterpart, the European Central Bank, adding to the list of 23 territories with such agreements in place with China.

So, what’s next in China’s arsenal to offer corporates and multinational? Is it notional pooling?

Answer is probably yes, since regulations are moving towards liberalization, Notional Pooling* is the next advanced liquidity management tool being offered in China with RMB capabilities.

However, interest rates are governed by PBOC under arms length principle which is put in use in Notional Pooling structures which may still not be favorable towards corporates currently

* Citi is the first bank to offer Multi-Currency Notional Pooling with RMB Capability