The expected introduction of two-way sweeping in the newly launched Shanghai free trade zone (FTZ) could mark the next phase of rates convergence between the onshore and offshore markets. As corporates adjust to the freer flow of money, transaction bankers think that onshore/offshore borrowing rates may begin to converge by as much as 100 basis points (bp).
State Administration of Foreign Exchange (Safe) and People’s Bank of China (PBoC) are expected to announce a two-way automated sweeping pilot programme in the coming weeks, allowing China-based companies to shift excess renminbi in and out of the country automatically, say bankers with knowledge of the FTZ regulation.
The pilot would follow regulators’ recent decision to allow select companies to automatically sweep funding in a one-way direction, offshore.
A sweeping mechanism allows a corporate to set up a bank account – a sweep account – that would automatically transfer cash that exceeded or fell short of a certain level into higher-paying investment options at the close of each business day. At the moment, the excess is typically swept into money market funds.
“Two-way sweeping will hopefully be possible soon because there was discussion that this could be done as a pilot scheme in other areas of the country,” said a senior renminbi-focused banker. “This means the scheme should be extended first into the zone. This would be exciting for a lot of corporates because under the PBoC’s Circular 168, companies are still a bit limited on what they can do to leverage their idle cash in China.”
While transaction bankers say that automated sweeping does not directly relate to interest rate liberalisation, the act of giving multinational corporations (MNCs) greater ability to access funding will impact overall borrowing rates – if activity within the FTZ grows.
As it stands, most MNCs in China are able to shift renminbi cash overseas under the provisions of Circular 168, which was released in July to simplify cross-border renminbi-denominated transactions. The rules state that MNCs are only able to sweep renminbi offshore if the transaction is classified as an intercompany loan, which must be repaid in renminbi, with interest.
This means that the MNCs’ mainland treasury functions cannot receive much more money from their offshore units than was originally lent out.
A new option
Intercompany lending has become the cheapest form of renminbi borrowing for corporates. Onshore branches of global companies tend to lend renminbi to their offshore branches at an average rate of 2%-3%, in line with what they would earn in an onshore deposit or money market account.
The next cheapest borrowing option for MNCs comes from bank loans in the offshore renminbi market. Because of the low demand for renminbi-denominated loans – it is more cost efficient for corporates to borrow in US dollars and swap the proceeds into renminbi – borrowing from banks in this way tends to cost 3%-4%.
The most expensive option for MNCs is borrowing onshore, which must be based on the PBoC’s one-year lending benchmark of 6% and means that most MNCs pay about 5%-6%.
In the FTZ, this financing hierarchy could disappear if enough corporates participate in two-way sweeping, alleviating much of their liquidity pressure. “It’s just another component that provides liquidity in the market, and that can impact rates in other areas just given how controlled the currency is now,” said the senior renminbi banker.
If cheaper funding becomes available offshore or through other means, transaction bankers expect loan pricing in the FTZ to begin to drop to reflect this, perhaps by 100bp or more.
“If this is really an open market, this may have an impact on the onshore [FTZ] rate because if you can create a two-way flow you have a better source of liquidity to fund your needs,” said Carmen Ling, global head of renminbi solutions, origination and client coverage, wholesale banking, at Standard Chartered.
“Companies will use the lowest cost of funding and if those funds are cheaper in the free trade zone than in the onshore market, the FTZ interest rate would mimic the offshore rate, which is freer. It’s a market supply and demand implication.”
Bankers reckons FTZ rates could fall by as much as 200bp to meet the 4% cost of offshore borrowing.
But not yet
However, bankers admit that falls in lending rates are still a way off. Chinese regulators have not clarified their plans regarding automated sweeping, or other goals for the FTZ, for that matter. And corporates and banks will find it hard to set up shop in the zone without having that certainty.
Furthermore, even with two-way sweeping available in the FTZ, MNCs will still have to use intercompany loans to funnel renminbi from Shanghai to other parts of the country.
“Certainly corporates’ cash won’t be trapped in the FTZ. However, the two-way automated sweeping processes between the FTZ and the Mainland aren’t not yet allowed, and you can expect that the corporates will continue to rely on intercompany loans,” said Shirley Chan, head of transaction services at RBS. “It’s definitely positive to see two-way sweeping to be adopted, but the regulators still need to provide further clarification on what exactly this will mean before companies set up their headquarters in the FTZ.”
Twenty-five companies have been approved to be the first entrants into the FTZ, including the subsidiaries and joint ventures of CITIC Securities, Chia Tai Group, Microsoft, Porsche, SAIC, Shengda and State Grid. Eight Chinese banks and two foreign banks were also approved to set up offices in the zone.