WISH LIST GRANTED?
MULTINATIONAL TREASURERS HAVE REASON TO APPLAUD A RECENT EASING OF CASH MANAGEMENT RESTRICTIONS IN CHINA
By Arthur Clennam

Like many regional treasurers in Asia, Brian Leung sometimes imagines out loud just how good it could be - if only China eased its cash management restrictions. "You'd be able to lower the cost of moving money around," says Leung, the Hong Kong-based regional treasurer of Lucent, the telecom-equipment company. "You'd be able to use less cash to support the same level of operations," he adds. "You'd reduce the amount of bank borrowing overall, and you'd also improve your administrative efforts, because you'd be controlling cash in a single system, rather than in different cash pockets."

This is no dream of the gift of idle hours, pace poet Robert Frost, and certainly not for a busy man like Leung. Lucent has substantial operations in China, representing 11 percent of its global revenues, and employs 3,500 people there. It is the third-largest employer in Tsingdao, Shandong province. With such a large chunk of the company's business in China, a thorough integration of treasury between China and the region would provide tangible benefits in cost control and liquidity management. Yet incorporating Lucent's regional and global best practices with the company's China treasury operations is still more a catalyst for wishful thinking than practical application.

For most multinationals with a substantial business in China, it's the same. "It is still frustrating for corporates and their bankers," says Jimmy Yap, Asia Pacific head of global cash management for Deutsche Bank, "because companies cannot use the same sort of techniques they would use elsewhere in the world. These include notional cash pooling."

General Easing

When CFO Asia last checked in on the topic (see March issue, 2002), we wrote: "The development of cash management in China is hamstrung by government regulation. Inter-company lending, as well as alternatives such as notional pooling, are illegal É as far as cash management is concerned, related companies are very much unrelated." In addition, no pooling of foreign currencies was allowed inside of China. Cross-border notional pooling, allowing for companies to repatriate some of that China cash pile outside of China's borders - the way companies can do it in, say, Singapore - was just a dream. Because of foreign currency controls, netting was forbidden.

The bad news is, most of this is still true. The good news is that it's getting a little easier day by day, with regulators recognizing the need to accede to demands from companies and their bankers to loosen the reins. Progress is appearing in crucial areas:

Inter-company loans are almost certainly not to be allowed in the near future, but the entrusted-loan structure, which requires banks to act as an intermediary between separate entities, has become so efficient that it allows for traditional cash concentration that, inside China, sufficiently mimics notional pooling. There are costs attached, of course, such as a stamp duty on each transaction. According to Stephan Levieux, senior vice president and head of global payments and cash management, Asia Pacific at HSBC in Hong Kong: "This does not necessarily impact the efficiency of the structure, as some banks are now able to provide fully automated solutions." Yap agrees, but cautions that the entire structure itself still imposes a nuisance tax on treasurers. Says Yap: "You end up having many multiple bank accounts with Chinese banks." Nevertheless, the banks appear to be operating with greater scope in entrustment lending.

Now, to add to their momentum, the State Administration of Foreign Exchange (SAFE) has published a new regulation providing a framework for foreign-currency entrusted loans. This new regulation covers not only loans to be arranged between entities incorporated in China, but also allows for cross-border structures, or loans from Chinese entities to companies incorporated and operating outside of China. According to Levieux: "I do consider this as a significant step. It certainly demonstrates the intention of the regulators in China to make incremental steps to improve the attractiveness of the business environment in the PRC." He adds: "However, the attractiveness of this new regulation will likely be limited to businesses with a significant export activity and therefore with significant sources of foreign currency income." Levieux says the regulation was published for Beijing, and it is not yet clear when it will be green-lighted for Shanghai. And, of course, companies that operate primarily in local currency and have renminbi surplus will not benefit from this development.

Cross-border netting is a no-go for the immediate future, still made impractical because the government requires foreign-invested enterprises to match each receipt for a shipment of goods on a standalone basis, both for goods sent and received. But regulators seem to be experimenting with easing here, too. Two large multinationals with large investments in China were approved by SAFE to operate a gross-in and gross-out mechanism, allowing their Chinese subsidiaries to participate in their global netting structures. Sources say it's too early to judge the success of the experiment, and whether the government will be encouraged to open further.

Another area that has seen some greening is rules governing China holding companies. In the past, foreign enterprises were allowed to set up a group holding company only if they had invested a tremendous amount of money in China. New rules published in September reduce the amount of money required drastically. The advantage that holding companies offer the multinational is the ability to create a de facto cash pool, and the ability to manage funds at the operating-subsidiary level through leading and lagging intercompany payments. However, the new rules still leave in place several onerous restrictions on holding-company activity. The treasurers and bankers CFO Asia interviewed for this article seemed uniformly unexcited by the prospect of greater powers via a holding-company structure, perhaps because easier cash management via banking intermediaries is looking more likely.

Making your Case

Certainly, the new openness is regarded as an encouraging sign. "The regulators are increasingly open," says Shirley Chan, head of cash management for Greater China at Deutsche Bank.

She adds: "If you have a good case, you can approach regulators and make it. We're seeing this more and more." Chan says that the process usually starts with the company and the bank service provider discussing a possible solution and approaching regulators together. One reason for the loosening of restrictions is that a growing number of Chinese companies are seeking multinational status themselves. Improving the environment for cash management both for operations within and without China would benefit these ambitious companies as much as the multinationals.

Those benefits are clearly not lost on multinational treasurers. "If you take a look at the broader picture of the MNC activity," says Ricky Kaura, regional MNC team head, treasury services at JPMorgan, "historically the difficult countries in the region were left out. Now there's been a step change, an effort to utilize the same sort of global discipline and bring it to China."

Desmond Lim, Honeywell's vice president for finance and treasury, Asia Pacific, is keeping an open mind about the new leeway to practice cash management in China. He has fielded a request for a proposal to foreign banks but has not decided what kind of structure he ultimately wants. Asked if he'll opt for multi-entrusted loans, he said he wasn't sure. Why? "The market is developing quickly," says Lim, "and there could be an even better structure." He adds: "Multi-entrusted loans are only a small step away from a notional and zero balancing account type of structure that you see in markets such as Singapore."

Another element that is giving treasurers a healthy sense of their options is an improvement in that long-standing bugaboo: the disparity in sophistication between foreign banks and local banks. Local banks have edged forward slightly. At least for now, before full foreign competition is allowed in the banking sector in 2006, the local banks and the foreign banks are forming a broad symbiosis, picking up a few of each other's tricks. Mostly, it's the Chinese banks that are benefiting from the knowledge-sharing that has emerged in banking partnerships between local and foreign banks. Says Lucent's Leung: "The foreign banks are miles ahead of the local banks in terms of the technology. Because the foreign banks are so far advanced in cash management knowledge, local banks have formed partnerships with them. Together, they can approach full solution for corporates, at least in the context of what's allowed in China."

But local banks are also beginning to use that knowledge to compete. Says Lim: "Local banks are certainly becoming more aggressive. They are making a certain push into the transactional side as well, in gaining visibility. They're pulling up their socks."

Framing these changes are the larger economic shifts experienced in the past two years. China's banks will face full-bore foreign competition by the end of 2006, and yet they are hampered both by over-capacity in their branch network and a payload of an estimated US$295 billion in non-performing loans. The health of the banking system underlies all economic concerns of the government, and fears of direct competition from foreign banks shape policy even to the degree of holding tight the reins on basic operations such as cash management. The local banks realize that there's a relatively short time to catch up and the government's gradual easing of controls may be a mildly protectionist way of complying with the World Trade Organization timetable for reform while still giving the local banks wiggle room to shape their strategies.

"Over the next few years foreign banks will be competing in an increasingly deregulated environment," says Kaura. "Both foreign and local banks will adopt strategies based on pronounced segments. In fact, the rubber has already hit the road and it's happening now."

Kaura says that JPMorgan is not looking to set up a branch network in China, but to serve as a whole banking partner. "I've always maintained the viewpoint that we're hardly at cross-purposes. They bring a lot to the table in terms of operating scale," he says.

He adds: "In emerging markets anywhere in the world, global banks still need to partner with local institutions. This is no less true of China. There's a lot to be said for a tripartite strategy between multinationals, a local bank, and a foreign bank partner."

Deutsche Bank's Yap also sees benefits in a partnership arrangement. "Because of the strong partnerships that we struck up with many of the Chinese banks," he says, "we get all the service levels in almost all places. You can open accounts with us, and yet this also gives you distribution across the country." Although Yap adds the caveats that monitoring the service throughout the vast network of Chinese banks can be a challenge, and basic elements such as ERP systems lag behind. HSBC's Levieux says that partnering with a Chinese bank also involves setting up a thorough and extensive system of controls, to determine whether service standards are met. For its part, HSBC has made the most tangible move by any foreign institution to form a partnership with a Chinese bank. In August HSBC bought a US$1.75 billion, 19.9 percent stake in Bank of Communications, the fifth-largest in China. Levieux says he's currently in the process of gauging what the partnership will mean to HSBC's cash management services.

India Ho

For now, the partnership approach is bound to yield dividends for the global banks, as the local Chinese institutions are still struggling to gain experience and expertise in what for them is a relatively new discipline (see box, below). It's no wonder that regional treasurers and their bankers are talking more glowingly of improvements in the cash management environment in India, and in Indian banks. Yap says India provides more promising ground for cash management innovation - at least for now.

"You have to take into account something about India: there's a mastery of logistics in the blood there," says Yap, recalling how astounded he was to learn of the mass delivery of 2 million home-cooked meals in India every working day via the local train lines, bicycles, and by foot. He explains: "In cash management, there isn't a single bank that covers the whole country. So the banks have been forced to collaborate with each other, and they've refined things to a high level." He adds: "Also, the local private banks have become quite innovative in recent years. They're terrific banking partners."

Next issue, CFO Asia takes the temperature of cash management in India.

Arthur Clennam is a writer specializing in back office operations. He is based in Hong Kong.