CASH MANAGEMENT
China's Evolving Liquidity Management Environment
June 23, 2006

"There are many shared service centres established in Shanghai and Beijing (seen here) but increasingly we are seeing other cities being viewed as potential locations" —Ernest Mak ARTICLE TOOLS Print Version Reprints RECENT ARTICLES Different cities, same customers China is the region's top stop for exporting Improving wire transfers Quantifying your banks' performance

Regulatory changes in the past year have introduced a wider choice of cash management instruments for company treasurers in China. Although restrictions still remain, both foreign currency entrusted loans and repatriating renminbi earnings are now possible.

Keeping up with Regulatory Changes

Treasurers of multinational corporations (MNCs) operating in China are still facing challenges in cash management, both in terms of cash concentration within the country and repatriation of funds out of the country. Techniques such as inter-company loans and cash pooling are restricted by regulations from the central bank (People's Bank of China/PBoC) or the State Administration for Foreign Exchange (SAFE). According to Ernest Mak, who heads the multinational group at Bank of America Global Treasury Services in China, it is vital that cash managers in China are aware of the rapidly changing regulations. He says: "One of the biggest challenges for corporates in China is to keep up to date on the regulatory changes."

There have been two main regulatory changes in China in the past year that have had an impact on how companies based there are allowed to manage their cash: the Pudong District Nine Measures and the PBoC's Six Measures. The Pudong District Nine Measures, introduced in October 2005, are a pilot reform scheme of the foreign exchange administration of MNCs and they have made it possible for companies operating in the Pudong area of Shanghai to set up a foreign currency entrusted loan structure.

The PBoC's Six Measures, introduced in April 2006, have relaxed regulations regarding China-based companies or individuals investing in wealth management products outside China. This will make it much easier to invest cash generated in China in overseas wealth management products. The six measures mean that foreign banks can apply for qualified domestic institutional investor (QDII) status, which will enable them to offer overseas investment products (such as fixed income instruments, bonds and equities) to their customers. Other financial institutions have already begun the application process for QDII status and, according to China Knowledge, a business information website, Hua An Fund Management Co became the first QDII in China on 6 June 2006.

These two sets of regulations have given cash managers considerably more choice in the way they manage company liquidity and have had far-reaching implications for two of the main liquidity tools in China: entrusted loans and repatriation of cash. These are discussed in more detail below.

Entrusted Loans

Regulations in China do not allow direct inter-company loans in the form used in Europe or the US. However, cash can be loaned between companies through the structure of an entrusted (or entrustment) loan, whereby a bank acts as intermediary and trustee for the loan between one company and another. According to Mak: "The only way to lend money between companies is by entrustment loans, which are, in the main, quite straightforward." Entrusted loans fall into two categories: local currency and foreign currency.

Renminbi entrusted loans
The most commonly used form of entrusted loan is done in local currency (renminbi/RMB). Brian Tsang, head of payments and cash management at HSBC in China, says "Local currency entrusted loans have already been in the market for several years and it is a mature product in terms of the technology used and its level of popularity in China." There are different structures for RMB entrusted loans:

• One-to-one entrusted loans (between two entities of the same group of companies).
• Group entrusted loans. According to Tsang, some banks in China have added other services onto the basic one-to-one entrusted loan structure. "For example, we offer a product called a group entrusted loan, which means that a group of companies can participate in an entrusted loan without going through the process of arranging and registering, drafting a loan agreement or paying stamp duty for each drawdown, which is often necessary under an individual one-to-one entrusted loan arrangement." Group entrusted loans are based on a streamlined version of the entrusted loan documentation.
• Group liquidity solution, which is a fully automatic sweeping of RMB funds within an entrusted loan structure. Group entrusted loans need to be initiated by the group companies themselves, but with a group liquidity solution, a zero balance account is set up and, at the end of the day, any excess funds will automatically be swept into the head account within the entrusted loan framework. This structure can work with a large number of subsidiaries in the group.

Foreign currency entrusted loans
Mak explains that the focus of liquidity management in China is moving from local currency to foreign currency. He says: "Foreign currency liquidity management structures, such as bilateral onshore US dollar entrusted loans and direct cross-border loans to related entities are being carried out. The SAFE Pudong nine measures pilot guidelines allow qualified companies in the Pudong district of Shanghai to do even more on the foreign currency liquidity management front and we believe that, over time, this guideline will be extended to more cities."

Foreign currency entrusted loans (which are most commonly done in US dollar) have only been available in China since 2005 and are relatively new compared to RMB entrusted loans. The decision to allow this structure was originally announced in 2004, but it did not come into force until October 2005 when the Pudong Nine Measures were announced. More detailed guidelines of the Pudong Nine Measures were announced in January 2006 and these explained how to construct a US dollar cash pool in China.

One of the main aspects is that for any foreign currency loan, corporates have to set up a special loan account as well as their current account. Tsang says: "So companies need two accounts: a normal foreign currency settlement account and a foreign currency special loan account in order to join a foreign currency pool. This requirement is more complex compared to a RMB entrusted loan arrangement." Setting up a special loan account is not difficult in terms of documentation, but it is a requirement of China's foreign exchange regulations. Although no additional fees are involved in setting up a special loan account, it does pose an additional challenge for corporates, which is reflected by the fact that few corporates have set up functioning foreign currency cash pools.

Repatriation of Cash

Dividends
The main method for a corporate to repatriate cash is to pay a dividend to its parent company. This is considered a laborious process, as extensive documentation is required. To make the dividend payment, the corporate needs to meet a number of criteria: they need to show that they have accounting profits; they need to present audited statements by a certified public accountant (CPA) and they also need to have paid all relevant corporate taxes in China. The dividend is officially paid just once a year, although the authorities can be flexible on this point, and companies can apply for permission to pay the dividend in stages.

Cross-border entrusted loans
Using a cross-border entrusted loan structure is also possible if the company fulfils certain requirements. Tsang explains that previously, the cash involved in the cross-border transfer has to be from the company's foreign currency retained earnings. He says: "However, the recently announced Pudong Nine Measures stipulate that companies can now also use their RMB earnings, which is a positive development."

Trade payments
Using trade payments as a means of moving money outside China has also been mooted by some market participants. However, Tsang feels that this is dangerous territory for any corporate. Although it can be done if a company has a lot of cross-border intra-group trade transactions, with methods such as transfer pricing and leading-and-lagging techniques, a company could be transgressing on China's strict regulations on tax and repatriation of earnings. Tsang says: "Without good planning and good measures such as proper transfer pricing documentation, a company could attract unnecessary attention from relevant authorities."

The Future of Cash Management in China

There are a number of trends in cash management in China and the gradual liberalisation of its strict FX regulations is making Chinese cities more attractive as bases for operating units and regional treasury offices. As a result, an increasing number of MNCs are bringing China into their regional cash management and banking structure. Mak says: "We are seeing more shared service centres being implemented in China where the accounts payable function is centralised, which lends itself to a more efficient means of delivering payment information to banks. There are many shared service centres established in Shanghai and Beijing but increasingly we are seeing other cities being viewed as potential locations particularly if they have the infrastructure and language skills, and for cost reasons. Some of these cities include Tianjin, Dalian, Wuxi, Hangzhou, Shenzhen and Guangzhou."

Other trends in cash management are the increasing adoption of ERP systems, which lends itself to more robust forms of payment origination. There is also an increase of companies investing in host-to-host links with banks. Although the development and liberalisation of China's regulatory restrictions on corporate cash management has been gradual, China is moving in the right direction and more cash management techniques are becoming possible with each set of measures that is introduced.

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