China focus: Renminbi internationalisation

It might be the most important financial development of the century, but for company CFOs and treasurers, the implications of renminbi internationalisation are not yet clear.

If you are a treasurer or financial controller, you should be taking a step back from all of the hullabaloo surrounding the rapid development of offshore Hong Kong renminbi, or CNH in bankers’ parlance, and you should be asking yourself: what does it mean for my company?

That is because for financial officers who operate in the unforgiving world of numbers and the bottom line, the currency represents a step into the unknown.

While you might understand the implications of renminbi reform as it stands today, you should anticipate further reforms from the mainland Chinese authorities. The introduction of onshore FX options this April, for example, is another indication if any were needed, of how Chinese authorities are trying to prepare financial and corporate institutions for greater currency volatility.

Global multinational corporations (MNCs) operating under strict treasury policies have mostly limited their renminbi activities to opening renminbi accounts in Hong Kong and Singapore, and only recently have they ventured further afield in the US and Europe. Even if you are more willing to make active use of renminbi, you may find that it is hard to find trade partners willing to settle in the currency. So like other companies, you may be forced to play a waiting game before you feel ready to use the currency more widely.

Your hesitation to go further is understandable. For all the renminbi’s potential, and for all the impressive growth of the trade settlement scheme, getting too involved in what is still a heavily-regulated currency that will almost certainly be subject to further near-term reform is a step many are not yet prepared to take.

“Are global clients in Frankfurt and Munich watching renminbi developments? Yes. But are they changing value chain payment processes? No,” said Venky Vishwanathan, co-head of capital markets and treasury solutions, Asia at Deutsche Bank. “What they are asking is if this currency picks up, can they use it to further centralise their treasury operations, and does this become a currency that they can slot into their treasury operations in Munich, Hamburg or New York?”

Settlements so far

According to the mainland’s central bank, the People’s Bank of China (PBoC), cross-border renminbi trade settlement reached Rmb530 billion ($82 billion) in the first four months of 2011. This amounted to about 5% of China’s total foreign trade in the same period, and exceeded total trade settlement in renminbi of Rmb506 billion in 2010 and Rmb3.58 billion in 2009. This rapid growth followed the mainland’s decision to increase the number of export pilot enterprises qualified under the scheme to 67,724 from an original 365. Basically, 90% of the country can now take part in the programme. But given that China accounted for 8.8% of global trade in 2010, worth about Rmb20.1 trillion, even a modest percentage increase in trade settlement would have generated massive growth in CNH liquidity.

Most observers think the increase going forward will be anything but modest, even if treasurers are sceptical of jumping into the fray.

HSBC, for instance, projects that as much as half of China’s trade will be settled in renminbi by 2015. In other words, what is now a trickle of receivables could soon turn into a flood. “Renminbi is certainly of great interest to us, and we have just commenced receiving renminbi remittances,” said Moe Yamin Tun, finance manager at ACE Insurance. “The amount that we have invested in dim sum bonds [Hong Kong issued renminbi-denominated bonds], is relatively immaterial for the moment, but we expect to receive more renminbi receivables in the future and will look at what we can do with them then.”

The businessmen most likely to take advantage of the new flexibility are small and medium-sized enterprises (SMEs). That’s because they can use the currency. “Smaller companies will be more nimble when it comes to settling in renminbi,” said Craig Millar, Standard Chartered managing director, strategic client coverage group, Hong Kong. “They have fewer transactions with mainland counterparts, but will use renminbi if they see an opportunity to increase their sales base or lower their costs. We see some MNCs using the currency but only on a small scale at the moment.”

Investing renminbi

Greater access to offshore and onshore renminbi-denominated assets will certainly encourage use of the currency. After all, there is not much point in holding a currency in the longer term if there is nowhere to invest it. And if the pace of reform and trends in CNH liquidity up to this point are anything to go by, renminbi convertibility should be expected sooner rather than later, though macro events could yet have a say. “Straw polls I’ve taken from our corporate clients show that estimates for the timeframe for renminbi liberalization have been falling, so now few believe that it will take longer than ten years,” said Vishwanathan. “But neither does anyone believe it will take less than three years, so the range is three to ten years. But what everyone does agree is that it will be attempted in at least the medium term.”

The principal outlay for offshore renminbi investments remains Hong Kong’s dim sum bond market. The range of issuers has expanded from what were originally mainland government and local financial institutions to include supra-nationals such as the Asian Development Bank, Chinese corporate such as China Resources and foreign firms including McDonald’s and Hopewell. Chinese state owned-enterprises (SOEs) are now also actively issuing dim sum bonds. Sinotruk, a leading producer of heavy-duty trucks in China, paved the way. It was the first SOE to issue a dim-sum bond in October last year. “Chinese banks are also raising money and they will send that out as working capital to companies,” said Vishwanathan. “This then plugs the currency into the global trade flow and you will see two-way flow, which will in turn lead to global MNCs seeing changes in their supply chain invoicing. This is when their payment processes start to change.”

Another factor driving the renminbi trade settlement scheme includes the foreign debt quota that applies to any foreign or domestic bank lending renminbi in China. “The foreign debt quota has also encouraged exporters to invoice in renminbi and importers to seek renminbi import financing,” said Neil Daswani, Standard Chartered managing director and regional head transaction banking for North Asia. “US dollar interest rates may be at an all time low, so firms would generally want to borrow in dollars.  Exporters need to also consider their funding strategies, as borrowing in US dollars in China involves utilising the foreign debt quota, which means that US dollar funding is not unlimited.”

On the face of it, settling invoices in renminbi means the FX risk moves from seller to buyer. But this may not be bad news for companies buying from mainland Chinese firms. “There could also be significant cost savings for the exporter as renminbi is much more easily absorbed into their working capital cycle,” said Daswani. “This improves their working capital cycle by several days and some of these savings could be passed back to the buyer. So for buyers and sellers it’s not a zero-sum game by any means.”

Opportunities for FX hedging

Significant growth in the number of FX hedging instruments could also benefit companies doing business with Chinese firms. These developments provide additional hedging options to companies concerned about renminbi appreciation and its impact on their renminbi payables, acquisitions or capital expenditure.

“Corporates are now looking for solutions such as onshore and offshore spots, CNH deliverable forwards and non-deliverable forwards (NDFs), among others. And as the market continues to develop, we are seeing a number of new instruments, including FX options, in the pipeline,” said Mark Wuscher, segment head for corporates, Asia Pacific for J.P. Morgan treasury services.

These range from hedging CNH in the spot market and placing the proceeds in a CNH demand deposit account if they have excess cash, or hedging using CNH forwards if excess cash is limited.

“With the new CNH deliverable forwards, not only is it less expensive than NDFs, but it also qualifies under hedge accounting and hence there is no impact on profit and loss,” said Wuscher.

For the time being, banks say their corporate clients are primarily focused on the benefits of holding excess renminbi or converting to renminbi in expectation of the further appreciation of the currency. But as the market matures and investment opportunities grow, demand for renminbi denominated assets will grow.

“Overall, we are positive and optimistic about the development of offshore CNH,” said Ben Ho, vice president finance and control, Henkel Asia-Pacific. “Trade flows are increasing, not by three or fourfold but by far more, which will help a lot of Hong Kong and Chinese companies manage their FX risk exposure. This is one of the most important implications of the development of offshore renminbi for treasurers. Henkel has opened a renminbi account in Hong Kong, and plans to start trading internally in renminbi with internal counterparts in other countries to minimise currency exposure. We are also considering offering our customers the opportunity to trade in CNY as well.”

In the meantime, firms are looking at how they can integrate the currency into their treasury processes and how they can best use the trade settlement scheme, all the time waiting to see how quickly China intends to push the currency reform process. It looks like they won’t be waiting too long.

 

This story was first published in the Corporate Treasury Yearbook 2011 supplement to the June 2011 issue of FinanceAsia magazine.

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