Cash management in Asia: extracting signal from noise
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| Authors | |
| Tony Mclaughlin | Regional Cash Product Head, Asia Pacific, Treasury and Trade Solutions, Citi |
Please note that this article was last updated for 2015 and is awaiting an update.
Introduction
In Asia, as in the rest of the world, the macro-economic context in which treasurers operate is balanced on a knife edge. Will the global economy emerge from the global financial crisis into a period of self-sustaining recovery based on concerted stimulus? Or, are we on a never-ending treadmill where each increment of GDP growth depends on ever more debt, and round after round of stimulus until finally the gunpowder runs out? At this stage, nobody knows, but the answer will determine whether central banks will be able to step back from being the dominant economic actors in the global economy. The path of interest rates, currencies, and asset prices will follow in the wake of the outcome.
Treasurers do not have the luxury of waiting for a “new normal” to emerge: the wheels of treasury turn every day. The challenge for treasurers in Asia is to manage the financial risks of corporate expansion while moving ever closer to global best practices, a task often made more challenging by the realities of operating in a dense information environment.
Some of the information is signal, and some is noise. In Asia, treasurers are tuned into a broad sweep of external developments that either hinder or enable their company’s core mission:
- Political developments – Ripples are felt around the region as China exerts greater influence across a number of fronts. Stable governments are sought in Thailand and Indonesia. There is a new optimism in India that a new government will herald a wave of FDI and increased investment. Japan is making a herculean effort to rise from 20 years of underperformance. ASEAN countries seek to establish themselves as an integrated trading bloc with the AEC launching in 2015.
- Taper tantrums – 2013 saw kneejerk reactions to the prospect of withdrawal of stimulus. Capital flew and currencies plummeted. As a lesson to central banks around the world, in 2014 the Swedish Rjksbank raised rates too early and quickly had to reverse course. Treasurers will be watching developments carefully, seeking to manage the attendant interest and currency rate risks.
- Tax environment – In an era when governments are in deficit they seek ways to augment tax revenues. While corporate tax rates in the region may drift downwards to attract investment, there are multiple developments with governments attempting to plug tax holes. Of relevance to treasury are moves to tax “permanent establishments” on their activities and to capture more income by modifying transfer pricing rules. Another area that has attracted attention is “beneficial ownership”. This concept of who is entitled to interest payments is important to create a sound footing for both target balancing and notional pooling arrangements.
- Impact of new bank regulation – A set of new rules is about to affect banks’ short, medium and longer term funding and capitalisation. In particular, the Liquidity Coverage Ratio (LCR) is being progressively implemented from 1 January 2015, with Australia choosing to fully implement a 100% LCR requirement from the starting date. Banks will need to maintain High Quality Liquid Assets (HQLA) against the expected run-off of deposits that can happen within a 30-day stress scenario. Treasurers should expect LCR to affect bank transfer pricing (and therefore deposit pricing) and have an impact on the relative attractiveness of different kinds of deposits.
The discerning treasurer distils signal from noise, and then takes action. From Citi’s experience working with treasurers from the top multinational corporations, we see a common focus on four signals that are key to successful treasury management in Asia – managing currency risk; capturing RMB internationalisation opportunities; achieving global treasury standards; and keeping pace with Asia infrastructure developments.
| 1. Identifying the company’s risk exposures |
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| 2. Quantifying the risk |
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| 3. Setting a risk target |
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| 4. Constructing an optimised hedging strategy |
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| 5. Back testing chosen hedging strategy |
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The rise of RMB as a trading and treasury currency is worthy of particular attention. This is a subject where local knowledge is a must to understand exactly what is permissible within the rapidly developing rules. While there is rightly a great deal of focus on RMB developments, USD in Asia continues to play a decisive role.
Parallel lives: RMB and USD
RMB internationalisation is of great importance to multinationals with significant investments and sales in China. The following table gives a flavour of RMB significance. The $18trn worth of RMB money supply in China is approximately the same as US market capitalisation! We may well ask what happens when that magnitude of currency becomes freely convertible, given what restricted outflows have already done to prices in selected property markets around the world.
| Country | GDP in USD | Money Supply (M2) in GDP |
| UK | 2.4trn | 2.4trn |
| USA | 15.5trn | 11trn |
| China | 8.5trn | 18trn |
From a treasury perspective, the rules are relaxing so that the familiar range of treasury practices are gradually coming on stream in the China context. For example, it is now possible to have RMB as part of a cross border pool, giving companies with large sales in China the ability to use the proceeds as part of their regional funding. Netting rules are also relaxing. The progressive liberalisation of interest rates will see a sharper competition for loans and deposits, while widening of foreign exchange bands and the end to one way appreciation will lead to increased currency hedging.
USD and RMB lead interesting parallel lives within the region. Asia’s export champions have generated huge dollar surpluses in the region. US multinationals also have very substantial USD balances in the region. These balances mount up on the balance sheets of local and international banks, leading to plentiful dollar liquidity in the region at competitive prices, albeit with pricing spikes from time to time. With US interest rates expected to rise and political rumblings in Washington about the huge cash balances held by US corporates offshore, treasurers watch USD in Asia as carefully as developments in RMB.
The ability to fold RMB into global liquidity structures is a microcosm of a broader trend in Asia – it is becoming more possible to operate global standards in Asia. If we benchmark the best practices, then we can pinpoint where treasurers are able to act themselves with their partner banks, and where market liberalisation is required to facilitate a more efficient model.
Achieving global treasury standards in Asia
The extent to which best practice can be implemented in Asia can be illustrated through a selected list of benchmarks. Companies can ask themselves how they score on each dimension, and in which markets progress is hindered by local practices, rules and regulations.
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| In Scope | Policy Coverage | Control | Working Capital Management |
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Asia consists of broadly liberal and restricted markets. The liberal markets have open capital accounts, freely convertible currencies, developed clearing infrastructure, and transparent regulatory and taxation environments. In these markets the implementation of global standards is largely achievable.
In restricted markets embedded treasury solutions have to be locally customised while trying to maximise alignment with global standards. It could be the need to supply reams of supporting documentation for foreign exchange deals or international payments, or the inability to trade on open account. It could be the difficulty of extracting trapped cash in a tax efficient manner. The restricted markets may have such day to day operational burdens and constraints that best practice treasury becomes a secondary consideration.
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| Visibility | Forecasting | Concentration | Automation |
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In restricted markets achieving visibility and control can be challenging. For example, domestic cash pooling in India is problematic. India does not yet use SWIFT for domestic use, so the standard approach to receive an MT940 which triggers and MT101 to sweep funds from local banks is not possible. Local currency pooling is common in markets such as China, Malaysia and Thailand, although in several markets treasurers can find it hard to use MT101s for sweeping purposes. In many markets local banks are unable to provide MT942 intraday statements.
In Indonesia, notional pooling is the preferred method for cash concentration due to higher tax cost for physical pooling. In Korea, multi-bank sweeps are possible, but only for single entity and not multi-entity companies. Cross border structures involving restricted markets entail significant regulatory challenges.
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| Pooling & Mobilisation | Centralisation | Electronification | Treasury Performance Mgt |
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As the regulatory environment, clearing infrastructure and tax implications are varied by market, the integration of Asian subsidiaries into foundational treasury structures, such as netting centres, Shared Service Centres (SSCs), and in-house banks can be complex. Careful analysis of company flows, banking capabilities and the market environment is needed to create solutions that will allow high efficiency and control for a company within the given constraints.
Treasury professionals look through the frictions and barriers as they seek to implement globally consistent models. While difficulties remain in restricted markets there is a clear trend across Asia to upgrade the basic clearing and settlement infrastructure that ultimately provides the base layer of a more efficient, digital treasury.
However, not all best practices are imported. As necessity is the mother of invention, treasury solutions in Asia have evolved that are now being exported to the rest of the world. For example, so-called Payer ID solutions are more advanced in Asia than in other parts of the world. Takeup of new mechanisms like Bank Payment Obligation (BPO) is faster here than elsewhere. We also find treasurers in Asia at the forefront of currency hedging, given a unique set of restricted currency constraints.
Asia infrastructure upgrades
There is a far-reaching and systematic thrust by authorities across Asia to upgrade financial infrastructure with the underlying objective to modernise, manage risk and protect consumer interests. These developments are enablers of best practice treasury operations.
| Regulatory themes | Recent regulatory changes in Asia | Common underlying objective and intended regulatory impact |
| 1. Systemic risk reduction and control |
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| 2. Transparency and consumer protection |
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| 3. Standardisation, automation and convergence |
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Looking to the medium term we can anticipate that the base layer of financial clearing infrastructure in Asia will be modern, electronic and efficient. These trends are positive, but not a one-way street. The same regulatory impulse to protect and develop can create barriers and impediments – restrictions on outsourcing and requirements to process data onshore can prevent corporations and their banking partners from implementing regional or global solutions.
Conclusion
While the macro picture remains uncertain, the drivers of Asian growth remain in place: low cost production, increasing incomes driving consumption, huge need for investment in infrastructure and developing and deepening of financial markets. Companies therefore are “long” Asia and the region continues to be a key strategic focus for any company seeking global expansion. In this highly competitive market, treasurers must continue to distil signal from noise to raise the bar on their operations.
