Companies operating in China should monitor carefully the People’s Republic of China’s financial and foreign exchange (forex) regulatory landscape.
The treasury operations and their traditional liquidity management tools usually employed in other regimes, such as intercompany loans, have not been permissible under Chinese law.
China’s regulatory framework is a fragmented system that is based on a bifurcation between foreign and local currency movements, with greatest importance given to control of the renminbi (the local currency), foreign currency flows, and the maintenance of the exchange rate.
Since 2005, China’s financial and forex regulators have increased their liberalization momentum, following a path that is meant to entice multinationals; this deregulation has been rolled out in a series of pilot programs.
In volatile market conditions it is unclear how a global liquidity crunch will affect China’s momentum towards policy relaxation.
The best advice for treasurers coping with cash and liquidity management in China: Keep close track of the large foreign and local banks since they are in the best position to monitor regulatory intentions.
A company’s paramount asset in challenging liquidity times is its treasury talent—a treasurer should be able to anticipate and interpret the effect of the regulatory changes on the mechanics of cash management.
Efficient cash and liquidity management in China is a multifaceted challenge—a treasurer has to scrutinize China’s regulatory environment constantly. In the past regulation has been “lyrical” at best and arbitrary at worst. Up to recent market events, it had been tending towards liberalization. The treasurer has to match various limited and unique “China-derived” treasury solutions with the capital structures of his China entities. He has to anticipate the next direction of the regulators on both the financial and the forex fronts. In turbulent global credit conditions, the mandate becomes challenging but will create, we believe, a more robust set of treasury solutions for the China market.
Understanding China’s Regulatory Environment
A China treasurer has to understand the fragmented yet punitive nature of the regulatory framework in which financial transactions and forex are regulated. A good rule of thumb is that the capital structure of an entity in China will determine what liquidity and repatriation tools are possible. If the company entered China operations fairly soon after China’s market opening, the relevant capital structures –such as equity joint ventures, cooperative joint ventures, wholly owned foreign enterprises (WOFEs), and representative offices—have varying levels of restrictive regimes for the movement of local and foreign currencies. Structures sanctioned later by the government have more favorable regulatory treatment regarding the types of liquidity tools that can be employed. For example, from July 2006, the holding company and the regional headquarter (RHQ) structure was approved in order to encourage multinational companies (MNCs) to establish their regional operations in Shanghai. Since the move was to promote MNCs, the measure might not be useful to smaller companies operating in China.
China’s regulatory backdrop for cash management is best viewed as a dual system that is designed to maintain the nonconvertible nature of the renminbi, ensuring that the renminbi forex level is maintained within a band of a basket of currencies. There are regulatory nuances to an entity’s holding, movement, and account opening of foreign currency and renminbi, as well as cash repatriation. Foreign currency accounts within China, which require the State Administration of Foreign Exchange (SAFE) approval, are designated for certain capital injection exercises and for loan proceeds. Local currency is controlled in a number of ways, including physical flow of notes, control of local currency interest rates, and mechanisms for moving funds from corporate to individual accounts.
Renminbi currency accounts have more flexibility, and are used for daily operational needs, such as payroll, payables and receivables, and trade-related activities. The capital structure of the China entity determines the types of account the treasurer may open: For example, a representative office can only open one type of renminbi account, the basic account, which covers physical cash withdrawals and payroll.
Forex control and the maintenance of the renminbi-forex rate within a designated band is controlled by SAFE. SAFE, at the time of writing, has 34 branches and 807 sub-branches, a vast improvement over the previous centralized bureaucracy. SAFE oversees foreign currency-related matters in three main areas: (1) direct investment, in which case the nature of the investment must be examined for Department of Commerce approval (is the foreign direct investment “promoted,” “restricted,” or “prohibited”?); (2) SAFE also checks that transactions involving the use of foreign currency are “genuine”—the company must submit invoices, sales contracts, receipts and/or tax certificates to the appropriate SAFE subbranch for verification; and (3) SAFE oversees the limit on an entity’s foreign debt, including foreign guarantees—for example foreign debt cannot exceed “total investment” (“registered capital” as defined by the Chinese). SAFE also provides the approval mechanism for foreign currency short-term debt levels, while a sister agency (the National Development and Reform Commission) oversees mid-term debt.
Relaxation of regulations in 2005–07 included the following: encouragement of MNCs to set up in China via the RHQ provisions; support for large Chinese corporations to set up outside China, thereby allowing renminbi flows to “temporarily” exit China; and implementation of deregulatory efforts via pilot programs. These “Nine Measures,” promulgated in December 2005, were released to allow more flexibility for both foreign and Chinese qualified MNCs to manage their liabilities, including foreign currency cash pooling for domestic group entities, establishment of offshore accounts for overseas liquidity management, lending of foreign investors’ surplus renminbi to overseas investors, execution of renminbi–foreign currency forward and renminbi–foreign currency swap transactions, and simplification of non-trade-related (or services-related) payment processes. In April 2006 the “Pudong Nine,” as they became known, allowed certain companies to open multiple foreign currency accounts and liberalized foreign currency movements. In July 2006 a portion of the “menu” of forex reform measures for holding companies with RHQ status and SAFE approval was at the very beginning of its rollout phase—just as the liquidity crisis started to become apparent on a global basis.
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