act 2014 - managing excess liqudiity in china

Surplus Liquidity Management in China

Tony Lam, Asia Treasurer

March 2014

Agenda

Part Topic

1 About Valspar Group and China

2Surplus Liquidity Repatriation Channels

(Traditional vs New Options )

3 Investment Options in China

4 Lessons Learned

VALSPAR Group

Established in 1806, headquartered in Minneapolis, USA

Fifth largest Paints and Coatings Company in the World

Over US$ 4 billion Turnover in 2013

9,500 employees in over 25 countries

China Treasury Reform Roadmap

Fully centralized Treasury Centre in Shunde.

Cash management (pooling, investing excess cash,

fund transfer to ensure sufficient cash for payment ,

forecasting ).

Full range of treasury support to China entities such

as daily payments, trade finance (Bank Acceptance

draft , LC, DA, bank guarantee etc…), custom duty ,

FX etc.

Regional support to other Asia countries (Singapore,

Malaysia, Indonesia, Thailand, Vietnam, etc.)

Tianjin

Shunde

Shanghai

DongguanHong Kong

Centralized

Treasury

Operation

Business case SSC /

Bank bidding SSC projectSite / BU finance

Mid 2012 to date

Set up shared services /

Upgrade Cash pool / H2H

2011/2012

Valspar in China

1996 - 2010 2010/2011

2008

First China

Cash pool

Totally 6 manufacture plants. Located in

Shanghai, Dongguan, Tianjin and Shunde.

Regionally headquartered in Shanghai.

Treasury Operation

Surplus Liquidity

Repatriation Channels (Traditional vs New Options )

Roadmap of China open-up in Cross-border Liquidity SolutionsMore flexible alternatives are now available

Before July 13July13

onwards

Feb14 onwards

Limited ways for cash repatriation

Global liquidity solutions on pilot base

Cross border RMB Cash pool

Cross border RMB Pay & Collect on behalf Expansion of RMB Cross-border Usage in SHFTA, PBOC SH Yin Zong Bu Fa [2014] 22, 20 Feb 2014

Cross border FX Cash pool / Cross border FX Pay & Collect on behalf (Open-up)Implementation Rules of Foreign Exchange Administration Supporting China (Shanghai) Free Trade Zone

SAFE SH Hui Fa [2014] 26 , 28 Feb 2014

PBOC opinion on

providing financial

support for the

development of the

China (Shanghai) Free

Trade Zone (SHFTA) , 2

Dec. 13

http://www.google.com.hk/url?sa=i&rct=j&q=&esrc=s&frm=1&source=images&cd=&cad=rja&uact=8&docid=F09hMpLy8DQVuM&tbnid=TNpZuDBHuZidvM:&ved=0CAYQjRw&url=http%3A%2F%2Fwww.edsaplan.com%2Fen%2Fnode%2F99&ei=98sjU4fAKuTn2QW-7IHIBQ&psig=AFQjCNGwLfs_JcO7K5BWp2d-tXyijuXfdQ&ust=1394941290690109






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Surplus liquidity onshoreMore flexible alternatives are now available

PledgeRMB Standby Letter

of Credit

Onshore deposit Offshore loan

Dividend payment /

Royalty / Service fee

Credit Facility

Payment from China to offshore entitles

Cross border loan/

Cross-border cash pooling

Offshore Loan on pledged local

deposits

(内保外贷)

2

3

(1) Dividend / Royalty/ service fee payments are subject to withholding tax, the rate for which varies from country to country.Once paid, cannot flow Back .

(2) Offshore Financial Guarantee is subject to limited resources of China banks’ foreign debt quota. (3) Interest charged on cross-border loan/physical pooling balance on arm’s length base and subject to China income tax

1

Onshore liquidity

Intra-Group Loan

Proceeds received offshore

Participation in global liquidity structure

Incre

asin

g f

requency

Bank XYZ -

Onshore

branch

Bank XYZ -

Offshore

branch

2 way sweeping

Onshore Offshore

Cross-Border Cash Pooling Via Shanghai Free Trade Zone

Sub

1 **

SFTZ leading

company’s RMB

special account

(Daily Zero balanced)

RMB Cash Pool

Leading entity **

Master Account

of Domestic

RMB Cash Pool

SFTZ Lead Entity

Sub

2 **

Sub

3 **

China

Singapore

HK

USA

Global Notional Pooling

Etc…

Subject to :

Total Available foreign debt quota =

Foreign debt quota – “registered” mid/long term Foreign borrowing –

“unpaid short term foreign borrowing

IFMA – International Foreign Currency Master Account

DFMA – Domestic Foreign Currency Master Account

** Entities can be inside or outside SHFTZ

RMB

FCY

RMB

FCY IFMA Domestic

Particpiant ** -FCY Account 1

SFTZ Lead Entity

DFMA Domestic

Particpiant **

FCY Account 2

Pay Receipt

on behalf/

Netting

Traditional channels to repatriate surplus liquidity

Channels Pros Cons

Dividend Permanent repatriation of funds

of large sum at once

Once a year (maybe twice)

Withholding tax (10% or 5% for tax

treaty location)

Audited financial report is required

Royalty

Permanent repatriation of funds

with standard tax treatment (Vs

service fee)

Simplified document requirement

after Sep13

Withholding tax (10% or 5% for tax

treaty location)+ 6% business tax

Service fee

More flexible payment timing

Simplified process after Sep13 (<

USD 50,000)

Ongoing

CIT 25% on deemed profit 20-30% of

charging entity (effective tax rate

around 5% - 7.5%)

Needs to negotiate with Tax Bureau

on a case by case basis

Cannot do a lump sum transaction

Flexible Cross border liquidity solutions ….

Channels Pros Cons

Offshore loan on

local pledged

deposits

(内保外贷)

Cash able to remain in China

Net gain on investing holding cash at higher

onshore rate & borrowing at lower (CNH/FCY)

offshore rate

To be renewed annual

Complex tax consideration if the borrower is US parent

Increase external loan balance of whole group

In RMB - No limitation for foreign debt quota of bank Offshore CNH lending rate higher than FCY loan.

Limited use of RMB overseas (offshore notional pooling

may help)

In FCY - Lower FCY offshore borrowing rate than CNH Need negotiate with banks for banks’ foreign debt quota

being limited resources

Cross-border

loan to offshore

affiliates

Only bank approval required, easy & quick

Flexible – allow auto sweeping & multiple draw-down

(up to the initial RMB loan amount)

Opportunity cost : loss of higher RMB onshore return

Limited to onshore groups with overall net positive profit

& operation cash inflow

In RMB – Higher quota limit than FCY loan, No regulatory

filing required (FCY cross border loan required)

Limited use of RMB overseas (overcome by offshore

notional pooling)

In FCY - Funding can come from external borrowing

(mainly used by local-capital entities without oversea bank

relationship).

Lower quota limit than cross border RMB loans

2-way cross-

border Physical

Cash pooling

via SHFTZ

Most flexible liquidity solution for global companies

Draw cheaper oversea funding to meet China needs

(inside & outside SHFTZ)

Limited to onshore groups with overall net positive profit

& operation cash inflow

More time & effort to work with bank on initial control

cap limit setup for fund inflow to China

In RMB – Higher quota limit than FCY cash pool Limited use of RMB overseas (overcome by offshore

notional pooling)

In FCY – more common than CNH for use overseas

“Available Foreign debt quota” on inflow funding for

usage outside SHFTZ & lower quota for outflow to

oversea

Need register foreign debit with SAFE for each

oversea fund inflow to SHFTZ

FCY cross border

pooling via SHFTZFCY cross border loan

RMB Cross border

pooling via SHFTZRMB cross border loan

Approval

process

Filing with SAFE(SH) **(If no objection from SAFE

within 20 days, then start…..)

SAFE approval

(SHFTZ – filing with SAFE)Bank approval Bank approval

Lender

Eligibility

MNC with entity at FTZ

No breach in last 3 yrs

Grade A enterprises

No special requirement

MNC with entity at FTZ

(Unofficially - Capital fully

injected + financial

requirements same to RMB

cross border loan)

No official requirements.

Local PBOC interpretation -

Positive profit;

Positive net assets;

Positive cash inflow (Ex

financing)

in last preceding year.

Participants Related companyOversea Parent Co /

subsidiariesRelated companies Related companies

Lending

Limit

50% of equity (Net

assets) of all

participants

Lower of 30% equity & Share

of undistributed profits +

dividend payable (SHFTZ

Lender - 50% of equity)

No formal quota

(PBOC SH interpretation:

consolidated income from

operation & investment)

No formal quota (norm is

Net equity subject to city-

specific guideline)

Lending

TenorFlexible 2 years (renewable) Flexible

No official limit – matching

the loan purpose

Lending

fund sourceNo formal restriction Borrowing or self funding

Self generated operating

fund ; Not from bank loans

Self fund from Cash pool

members (or one entity)

Borrowing

limit &

tenor

Available foreign debt quota

=All participants‘ foreign debt

quota – (registered) mid/ long

term foreign borrowing –

(unpaid) ST foreign

borrowing ; Tenor : flexible

Foreign debt quota

Tenor : can be > or < 1 yr

No official quota ; bank’s

Interpretation : meet real

business needs , cap limit

at consolidated expenses

Tenor : flexible

• Foreign debt quota

• SHFTZ borrower - can

select Paid-in capital x

adjustment factor (now 100%)

but tenor need be > 1 yr &

use of fund limited within

SHFTZ for operation or

oversea project )

Cross border liquidity solutions - lesser restriction / Openness

Changing China Regulatory environment

Different approach in New rules of SHFTZ SAFE (FCY)- Clear quota limit, although relaxed, still strong control, close monitoring

PBOC (RMB) – No official quota & flexibility, Encourage cross border RMB

Trend on the role of regulators & banks - More rely on banks’ “Know your client”, “Know your business”, “Due diligence”

Regulators : Pre-Transaction approval control => Post-transactional monitoring

Flexibility on Cross border RMB loan /cash pooling – Invisible rule behind

Enterprise can get different answers on quota limit etc… for :

Different interpretation of PBOC at city level

Different understanding of banks on training / oral guidance from PBOC

Different Risk aptitude of banks

Regulator may step in if any abuse (Principle is to serve real economy)

Implications & future developments : Principle-oriented guidance will likely evolve into a “norm” of more clear cap limit

Still flexible to over cap limit if any justifications (Enterprises to prove it), as more

practical and executable to the banks & clearer to enterprises

Large MNC banks of closer relationship with regulator may have advantages, before

new rules become mature

Setup entity in SHFTZ now or wait…. Rules on Cross-border cash pool still new / May

have more FTZ coming…

Cross Border RMB Loan

A ready-to-use tool to share surplus liquidity in China Fast implementation time : 2-3 months

Post pilot stage - Quick approval by banks

Many live cases since July 2013

Allow multiple drawdowns and repayments

A breakthrough of open-up reform Enterprises with profit and positive cash inflow generated from operations &

investing activities is free to share liquidity with offshore

Allow sharing of onshore liquidity to a very deep extent

Bank assessment bases on audited report of preceding year

Unofficial quota limit of Net equity

Illustration…...

Cross-border loan Vs dividend Re-think rationale for annual dividend …

Can improve annual bottom-line to foreign MNC

Illustration…...

Impact to MNC banks’ deposit Faster & more cash repatriation of MNC client

Illustration I : Depth of liquidity sharing with offshore

Interestingly, in certain scenarios, there is chance to reduce cash balance to a

level less than capital.

For profitable entities, may be used for faster capital funding withdrawal upon

exit from China market, instead of idle capital funding sitting in China during

long liquidation process.

Illustration II : Cross Border RMB Loan VS Dividend

For those corporations holding long-term strategy & interest in China market, may

consider cross border RMB loan to share surplus liquidity / cash generated from

China business in replacement of annual dividend. Can benefit with a net tax

saving. For example :

Annual Dividend US$ 50 million

Dividend Withholding Tax = US$2.5 million (5% preferential tax treaty rate)

Tax on Interest income of cross border RMB loan

= US$50 million x 3.4% Int’** x ( 5% business tax + 25% EIT)

= US$50 million x 1% approx.

= US$0.5 million** assume use oversea CNH loan rate as transfer price

Entrustment loan bank commission = 50 million x 0.1% = US$0.05 million(PS: Trend of bank commission is once off, lower or even free. Talk to more banks ! )

Net saving at bottom line / ST cash outflow for tax = US$ 1.95 million

Re-think : If cash can really be moved freely & easily cross-border at arm’s length

interest now, re-consider rationale to pay out dividend payout annually.

Other considerations : eg. Uncertainty in China policy in tax, banking &

monetary policy ; sovereign risk ; chance to exit China market etc…

Investment Options in China

Regional Perspective - Investing Surplus Cash

YIELDLIQUIDITY

Rating by

International credit

agents (MMF / Banks)

Principal guaranteed

by banks

Diversification

Meet Business &

operation needs with

certainty

Redemption

frequency / Length

of Notice

Cash pool supported

by OD line

Maximize yield on

condition of

Security & liquidity

Principle

AVAILABILITY

Easy to subscribe

E-platform/ paper

based

Money Market

Collective

Investment

scheme need

subscribe via local

banks

Referral from corporate HQ

Local banks need establish relationship with HQ to enhance understanding

CORPORATE POLICY /

RELATIONSHIP & COMMUNICATION WITH HEADQUARTER

Secure support of Bank Acceptance Draft facility and on-site services from local banks

LOCAL BANK RELATIONSHIP / FACILITY SUPPORT

SECURITY

Investment Options for Corporate Treasury

Instruments TenorYield **

(p.a.)Comments

Bank deposits

1 day call

Contract deposit,

7 days call

3 mth, 1 yr etc.

0.8%,

1.15%

1.35%

2.6%

3%

• Regulatory ceiling limit of deposit rates

• Bank can offer max. 10% up from ceiling rate

Wealth

Management

Products *

3-7 days, 1 mth, 3

mth, 6 mth, 1 yr

etc.

2.2% to

slightly

over 5%

• Commonly offered by Local banks

• Differentiate Principal-protected or Non-Principle-

protected low risk Products

• the later is not transparent off-balance sheet products

• Return % normally is certain at the time of subscription.

Structured

deposits *

7 days, 14 days, 3

wks, 1 mth, 2 mth,

3 mth, etc.

2.2% to

4.5%

• Offered by foreign banks and local banks

• Return subject to outcome of “event”.

• Principal and minimum return guaranteed.

Money Market

Fund MMF

Daily

(T+1 or T+2)

3.0% to

5% +Rated by local credit rating agency only or

also by international credit rating agency.

* Only low-risk Principle-protected products are discussed here

* * Being market indicative rates obtained via 3 foreign banks and 3 local State/commercial banks only at late 2013

China Wealth Management Products (WMP) Should differentiate WHP which are …..

Principal guaranteed by banks :

• Subject to monitoring of bank regulations like provision charges, capital weighting etc.

• Nature similar to Principal-protected structured deposits – tie to banks’ ability of repayment

Non-Principal guaranteed by banks or Products of trust companies sold via

banks’ retail channel :

• Off balance sheets of Banks

• A large portion of such WMP invested in interbank and monetary markets according to

Government source

• Certain WMP invest in risky non-standard debt-based instruments (NSD), utilized as

channels to escape regulatory controls upon financing projects restricted by the Government

(e.g. property development) or to medium-size enterprises which hardly to obtain loan from

banks via trust companies, finance companies etc..

• Certain WHP form part of China shadow banking system - This segment of WHP poses

major risk to banking system

China Wealth Management Products (WMP)

Regulatory controls tightened in 2013 :

Both the industry and China regulators realized the loopholes and

potential risk caused to the country financial system since 2012

CBRC New Circular Yin kan fa [2013] No.8 issued at early 2013

• All new WMP need be separately accounted for with own BS, P&L, cash flow

• Banks need to make risk assessment and provision for existing issued WMP

like other balance sheets assets by end of calendar 2013

• To cap investments of WMP fund in risky “non-standard” credit assets (less

liquid and not publicly traded) at the lower of 35 % of all funds raised from

the sales of wealth-management products, or 4 % of total assets.

• To stop pooling assets and to isolate the risks of such investments from their

own operations.

China Wealth Management Products (WMP)

Views and Recommendations….

Government tightened control is good news to ensure healthy development of WMP

sector, stability of country banking system and avoid systematic risk

For MNC that have to keep certain level of deposits in local banks (eg. For securing

issuance of Bank Acceptance Draft and other services) –

Principal-guaranteed & liquid (redeemable) WMP is a choice, instead of deposits.

Both bear the same counter-party risk

Value of local / regional treasury : Provide insight to headquarter for wiser

decision and facilitate communication between local banks and oversea HQ

Proper risk management :

Stick to principal-protected products

Select products from top-tier banks that are too large to fail to China

Structured Deposit

Nowadays, it’s a common products offered by Foreign banks and some

local commercial banks

To some extent, being foreign banks’ version of WMP to broaden deposit

base

Typical Terms to MNC clients :

Principal-guaranteed

Minimum Interest return guaranteed

Bonus rate if the linked index or commodity price stay within a

specified range during the deposit tenor

Linked with 1 mth USD LIBOR, 3 mth USD LIBOR etc..

.

Money Market Funds (MMF) in China

First choice to corporate treasury for major benefits of MMF :

Highly liquid (T+1 or T+2), transparent and hence ideal for cash

management

Lower counter party risk : Invested asset units kept under

separate assets custodian, separate from fund manager &

custodian assets. Risk depends on invested instrument.

Diversification and convenient access to a variety of low-risk

investment instruments in interbank market and financial markets

with potential higher return than normal deposits & counter-party

risks diversified.

High quality China MMF typically invested in high concentration of low risk

& liquid Central Bank notes, Policy bank bonds, Ministry of Finance bonds,

Repo etc…

Money Market Funds (MMF) in China MMF with AAA rating from Fitch / CCXR Moody's AAA in China: (As at Nov 13)

• Goldman Sachs / Gao Hua Sheng Yu Money Market Collective Investment Scheme

(CIS);

• MMF with foreign capital JV -

• Deutsche Bank / Harvest Prime Liquidity Money Market Fund;

• BNP Paribas/HFT Liquid Money Market Fund;

• JP Morgan / China International Fund Management Money Market Fund (CIFM);

• HSBC / Jin Trust Money Market Fund;

• Invesco Greatwall

MMF VS CIS in China

• Legal status: CIS is under a Security Company while MMF is under a Fund management

company.

• Subscription process: CIS needs a local bank but MMF does not. (Lower availability)

• Tax treatment of income : MMF is under new Fund Law and income is exempted from

tax . No regulation of tax covers CIS. Tax treatment not 100% certain for CIS and need to

check with local tax bureau.

• Publicity : CIS can’t promote publicly

Observations on the 2014 China market liquidity and

implications ….

2014 year starts with very tight liquidity compared to 2013 same period

Foreign banks – Note possible impact from cross border RMB loan

SHLIOR O/N & 1 week dropped after the end of Chinese new year (Early Feb14 ) but

discounting rate of Bank Acceptance Draft at local banks is still at a quite high level

(most 6 – 8%), although there is also some relaxation.

Local banks – With more regulating on shadow banking, higher demand for official

bank loans and very limit quota for private enterprises.

China MMF performance in 2014 will likely be better than 2013 – Local banks take

time to correct the mistakes of past mismatching in financing long term project with

short term WMP and continue to make “Repo” with MMF

Both banks and enterprises need to exercise stricter credit control

Lessons Learned…..

For MNC , insist on benchmarking with Market upon negotiation

with relationship banks for proper products – Talk to more banks .

To some banks, cash management division may not be

keen to sell MMF as not count its performance.

Communication with corporate HQ & get trust is crucial -

Direct communication of local banks with oversea HQ

where possible

Guideline, Interpretation and risk appetite can vary largely

among cities SAFE/PBOC and even among banks – Talk to more

banks & try different locations

Importance of strong integrity to Treasury Team under

China environment. Clear and transparent internal guideline on

investment.

Appendix

Comparison of annual returns on MMF Vs deposits

Movement of China MMF

Key consideration for MMF selection

.

Money Market Funds (MMF)

0.35%

1.35%

2.30%

1.60%

2.50%

0.47%

1.46%

3.28%

2.77%

3.41%

0.48%

1.47%

3.45%

2.88%

4.17%

0.35%

1.35%

3.00%

3.48%

4.46%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

4.50%

5.00%

Bank current rate Bank 7d calldeposit rate

Bank 1y rate High quality localMMF*

Local MMF*

2010 2011 2012 2013

• Source: WIND. Bank Rate: PBoC. High quality local MMF* are money market funds rated as AAA by one or more international

ratings agencies. Local MMF* referred herein not include high quality local money market funds.

•2010-2013 data is averaged yield of relevant year.

•Yields quoted are gross and do not reflect the deduction of any fees.

Source of MMF: Wind (Chinese version of

Bloomberg for MMF)

The above figures relate to the past and past

performance should not be seen as an indication of

future performance.; Settlement : T+1 Net return

Source of BADD : www.chinacp.com.cn中国票据网

Movement of China MMF

MMF movement in

2014 likely

continue at a level

better than 2013

after CNY

0.0000

1.0000

2.0000

3.0000

4.0000

5.0000

6.0000

7.0000

8.0000

9.0000

10.0000

%

SHLIOR - O/N SHLIOR - 1W HSBC Jintrust MMF

SHLIOR dropped to a low

level after CNY

Bank Acceptance Draft

Discounting (BADD) rate

still maintained at a high

level after CNY, despite of

slightly adjusting

downwards

http://www.chinacp.com.cn/

Key Consideration for Money Market Funds What are the underlying assets of the fund? Which guideline does it follow?

CSRC* CCXR** (Moody JV in China) US 2a-7 *** FITCH Chinese AAA MMF****

Maximum WAM ^ 180days 120 days 60days 75days

Maximum WAL^^ None 120 days 120days 120days

Maximum Asset

Maturity 1 year for Deposits, Repo, Gov bills ;

397 days for Bonds

1 year for Deposits, Repo, Gov bills ;

397 days for Bonds

397days&45days for tier 2 securities

& no limit for government FRN397days&36months for qualified FRNs

Minimum Credit

Rating

Minimum AAA local currency rating

(not equivalent to a global AAA

rating)

Minimum AAA local currency rating

(not equivalent to a global AAA

rating)

1st tier security

(‘F1+’/‘F1’,‘A1+’/‘A1’,P1 or

equivalent)

2nd tier security (‘F2’,‘A2’,‘P2’ or

equivalent) if security maturity

<45 days and total 2nd tier

exposure <3%. Max individual

exposure is 0.5%

A- /F2(global rating)

Maximum assets

weighting

30% for licensed custodian bank,

5% for non-custodian bank

No limit for Agency bank bonds,

repos

20% for floating rate notes

30% for licensed custodian bank,

5% for non-custodian bank

No limit for Agency bank bonds,

repos

20% for floating rate notes

No limit for government securities

100% for MOF, PBoC and Exchanges

exposure

50% of NAV for any single policy bank issuer

35% of NAV for single issue by MOF or PBoC

25% of NAV for single exchange repo

(exchange as counterparty)

15% of NAV for single issue by any policy bank

Stress test None Detailed guidance Monthly No Specific Requirement

* CSRC – The China Securities Regulatory Commission, the main securities regulator in China.

** CCXR - China Chengxin International Credit Rating Company Limited , of which 49% shares owned by Moody (CCXR website Nov 13)

*** The descriptions above for “US 2a-7” are based on the U.S. Securities and Exchange Commission’s (SEC) Investment Company Act of 1940.

**** The descriptions above for “Fitch Chinese AAA MMF” are based on information from Fitch as of April 2013

^ Weighted Average Maturity ; ^^ Weighted Average Life

Disclaimer & Contact

The views here represent personal opinions of the speaker and does not

necessarily reflect those of Valspar. All information is for reference

purpose and please consult your banks to verify regulatory requirements

and latest market situation.

Any comments and wish to obtain further information in this presentation

can contact via [email protected]

Thank You

act 2014 - managing excess liqudiity in china

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