In the last few years, China’s booming economy has led to a surge in foreign companies’ cash balances and with global market uncertainty still looming in the background, entities are looking for ways to maximise returns on excess cash and reduce liquidity risk.
Banks are now looking to help these multinational corporations (MNCs) manage the pool of cash that is trapped in a web of interlocking regulations that govern investments, lending, currency exchange and cash repatriation both locally and domestically in the Chinese market.
“For the vast majority of the clients that we deal with, probably 90% plus, their issue in China is that they have too much cash as opposed to not having enough cash in the country,” said Victor Penna, a Hong Kong-based head of solutions and advisory sales for Asia Pacific at J.P. Morgan to Asiamoney PLUS in a telephone interview on February 28. “The issue with this, is that a significant portion of this is trapped cash.”
“Right now the main concern would be that they are not able to efficiently utilise their surplus cash in China to help finance their operations elsewhere, especially when the global liquidity situation is getting tight,” said Frank Wu, a Shanghai-based head of trade and cash management corporates for Greater China at Deutsche Bank to Asiamoney PLUS in a telephone interview on February 29.
J.P. Morgan highlights that between the years 2000 to 2008, the accumulation of cash in Asia surged more than two-folds from approximately US$40 billion to US$90 billion.
In the past, many MNCs operating in mainland China viewed the nation as a manufacturing base rather than a potential market to develop and expand their presence into. But in the last five to 10 years, China transformed into one of the largest consumer markets, growing at an average rate of 10% every year.
“Some of that cash is going to be redeployed to support their domestic growth in China, because more of those sales will be happening in China itself rather than just manufacturing in China and shipping product to the rest of the world,” declared Penna. “A greater percentage of those sales are going to occur within the country itself because the domestic market is now growing.”
In the automobile industry, Chinese consumers bought 2.1 million SUVs last year, up 25.3% from 2010 and representing 11.6% of light vehicle sales, according to J.D. Power and LMC Automotive. That is about half of the 4.1 million SUVs sold in the United States, where SUVs were 32% of the light vehicle market.
The increase in sales illustrates that China's car market is maturing, analysts say, and presents another opportunity for foreign makers to expand their presence in China.
“With the global financial crisis, China is one of the bright spots for many of the MNCs operating globally,” added Wu. “If you look at the car industry for example, the profits generated by the some German auto giants would probably be larger than that generated back in their home country. A lot of trapped cash can then be ploughed back as a form of reinvestment into their China business.”
The International Monetary Fund (IMF) and the World Bank have both advised Beijing to relax its tight investment controls. By trapping money in China, the closed capital account has fuelled soaring property prices and generated inflationary pressures.
Maximising returns on spare cash
Direct borrowing and lending between two commercial entities within the same group is strictly forbidden under China’s regulations.
As a result, many MNCs have been actively looking into entrusted loans, which is a form of intercompany lending that enables these entities to redeploy funds from a cash-making subsidiary to another in need of financing at a minimum cost. These instruments have become more popular in the last few years, said analysts.
“This is a very effective way in ensuring that you have enough working capital without necessarily injecting additional cash into the country,” said Penna.
The entrusted funds are administered by banks according to target borrowers, usage purpose, amount, duration and rate. These banks, which act as intermediaries of entrusted loans from a depositor or principal, collect handling charges and will not undertake any loan risk.
There are two types of entrusted loan: intra-group and third party entrusted loan.
Source: Société Générale
In Deutsche Bank’s case, the biggest cash pool that they are managing in China comprises of more than 60 entities from the same MNC group. These subsidiaries, that have access to the pool of funds, are able to manage their cash positions efficiently and optimise intercompany cash balances on a fully automated basis.
“Banks will step in to be the agency to bridge the cash gap between the companies,” said Wu. “Intercompany cash transfer is possible but if it is not real buying and selling activities, then it has to go through the banks in the form of entrustment loans.”
For those companies who do not plan on expanding their business domestically, spare cash is then placed into time deposits – for those seeking for higher yield pickup – or basic deposits – for those who are conservative – of various maturities. This is more common for foreign entities that seek to receive stable returns on their yearly cash buildups and look to repatriate cash back to their home country once a year, said analysts.
Most MNCs use a mix of banks – both local and international – in order to diversify and reduce counterparty risk.
“The companies may be placing more emphasis on counterparty risks rather than investment returns, especially when the overall China interest rate is generally better than many of the other currencies,” added Wu. “For example, if you place a one-year renminbi deposit with a bank, you get 3.5% in interest rate.”
On the other hand, Chinese money market funds (MMFs) could be an alternative investment instrument as well but is not popular among larger MNCs because there is additional market and investment risk linked to these products. Fund houses also pose another layer of counterparty risk for corporate clients.
However, as previously reported by Asiamoney PLUS, MMFs are expected to attract institutional investors driven by need for efficient cash management solutions other than bank deposits.
Preventive measures for trapped cash
While the loosening of restrictions over the past few months in China is encouraging, the best approach for handling cash investments in local markets is to avoid getting trapped in the first place. In the past, foreign investors, who were so keen to tap into the Chinese market, overcapitalised and as a result accumulated a hefty amount of trapped cash within the country.
“Companies might inject more capital than they really need to make sure they have a buffer and that they are properly covered,” noted Penna. “The only problem is, over time those businesses become very profitable and you end up with a lot of trapped cash.”
Nowadays, MNCs have become more cautious in terms of injecting capital into a growing business in a country where regulations that govern capital movements, currency exchange and cash repatriation are limit. These entities have also reduced their level of buffer that they hold as a result.
Moreover, by drawing up specific investment policies for local markets, companies can retain control in overseas markets and ensure that their investment standards are maintained. To determine the most appropriate investment strategy, treasury teams should assess how much cash is available for investment and how soon it will be required by the local business or whether it can be repatriated as dividends, said analysts.
“For corporate treasurers, the working capital management is always on top of the agenda,” said Wu. “In a tight credit environment, what changes the corporate treasurers’ role is that they have to think more about the whole supply chain.”
Accessibility into China’s capital market has eased and investors can now participate in the onshore market via Renminbi Qualified Foreign Institutional Investors (RQFII) scheme, with an initial quota of Rmb20 billion (US$3.2 billion). This scheme is expected to make way for more investment into mainland.
Investment inflows into China surged in the years after it joined the World Trade Organisation (WTO) in 2001, and have rebounded strongly after being hit hard by the 2008 global financial crisis.
China's foreign direct investment shrank for the third consecutive month in January as firms in crisis-embroiled Europe slashed spending by over 40%, casting another pall over the outlook of the world's economic growth engine. The gloomy trend was augmented by China's trade ministry, which warned of grim times ahead and promised action to help struggling local exporters cope with lackluster demand abroad.
Investment from the United States rose 29% to US$342 million while that from 10 Asian countries including Japan edged up a mere 0.8% to US$8.6 billion.
China weathered Europe's festering debt crisis last year to draw a record US$116 billion worth of foreign direct investment, giving the Commerce Ministry confidence to target an average of US$120 billion in inflows in each of the next four years.