Home » Business » Biz Commentary
Globalized yuan deals gain currency
By Nathan Chow |
July 15, 2013, Monday
|
Print Edition
Print Edition
LAST Wednesday, the People's Bank of China announced a series of measures aimed at simplifying cross-border transactions of the Chinese yuan. We highlight the following measures and the respective implications to the market.
Based on the basis of "know your customer," "know your business," and "due diligence," banks in the mainland now can process yuan cross-border trade settlement for their corporate clients before verifying the documentary proof of underlying trade transactions.
Overall, the improved streamlined process will increase the efficiency in handling yuan-denominated trades. This should, in turn, increase the adoption of the yuan for trade transactions globally.
To simplify the procedure for corporate use in yuan, the central bank also approved a new scheme in March to make it easier for a European Fortune 500 company with substantial sales in China to manage its yuan holdings.
Before the new model was introduced, the company had to process multiple cross-border yuan payments separately for regulatory oversight, resulting in transaction costs and a lack of central monitoring. Some domestic banks were also frustrated that settling trade separately had been both time-consuming and labor intensive.
To address the above concerns, a new scheme - gross-in/gross-out arrangement - was introduced. The company can consolidate all incoming yuan transactions made in different time periods into a single transaction; as well as all outgoing yuan payments into another. This centralized approach to cash management significantly reduces the exchange rate exposure and optimizes liquidity management for the company. It also sets a precedent for other foreign corporates to adopt the yuan in international trade.
There is some worry that the authority's efforts to promote the international use of the yuan is dependent on the appreciation expectations for the currency.
We do not share this view. For corporations trading with China, the use of the yuan can lower their foreign-exchange costs and risks. They can also enjoy the price discounts offered by some Chinese companies. That explains why currency appreciation or depreciation might be less relevant from a supply chain perspective. Cost advantage is the main driver that fuels the growth.
Secondly, non-financial companies can now use the yuan fund held within their organizations in China to extend loans to their overseas affiliates.
With a more balanced yuan inflow and outflow via the trade channel, there was a need to develop other avenues to replenish the offshore yuan liquidity pool. Currently, 10 out of the 40 specific items under capital account transactions in China are classified by the International Monetary Fund as tightly restricted. The items that are still strictly controlled are related to cross-border transactions in capital market and financial instruments.
Asset transaction
Hence, the next stage of liberalizing the capital account is to allow overseas and Chinese entities to engage in cross-border asset transactions. The latest initiative allows onshore non-financial companies to better utilize excess yuan liquidity to fund related offshore business, which is consistent with the "Going Out" strategy promoted by the central government. The new rule also encourages overseas M&A activity, especially to promote yuan outward direct investment, which has lagged behind its inward counterpart.
Finally, for non-financial companies that plan to issue yuan-denominated bonds in the offshore market, they now can set up a special deposit account at a domestic bank to keep the remitted proceeds raised via the bond issuance.
No significant rise
The latest arrangement complements the existing regulatory framework governing offshore yuan bond issuance by Chinese corporates. Nevertheless, the latest policy change would not induce a significant increase in Chinese corporate bond issuance in the near term. Specifically, no changes have been made regarding the remittance process and usage of proceeds.
According to the current rules, proceeds need to be deployed mainly in fixed asset investments, and must comply with the macro-control policies, industrial policies, foreign capital utilization, and foreign investment policies.
Of equal importance, offshore funding costs have become comparable to those of onshore. Since June, the weakening yuan rise expectation amid moderating mainland economic activities has already pushed offshore bond yield sharply higher. Also, the recent liquidity squeeze onshore will possibly generate more interest among mainland companies for borrowing from Hong Kong banks.
Overall, the latest policy changes highlight Beijing's determination to allow the yuan to play a role commensurate with China's economic power. But the regulator is also wary of potentially destabilizing capital flows.
According to the new rules, the amount of the cross-border yuan loan repayments cannot exceed the original principal plus the interest and related taxes and fees. The cash raised through offshore bond sales must be used for the purpose described in the prospectus.
Based on the basis of "know your customer," "know your business," and "due diligence," banks in the mainland now can process yuan cross-border trade settlement for their corporate clients before verifying the documentary proof of underlying trade transactions.
Overall, the improved streamlined process will increase the efficiency in handling yuan-denominated trades. This should, in turn, increase the adoption of the yuan for trade transactions globally.
To simplify the procedure for corporate use in yuan, the central bank also approved a new scheme in March to make it easier for a European Fortune 500 company with substantial sales in China to manage its yuan holdings.
Before the new model was introduced, the company had to process multiple cross-border yuan payments separately for regulatory oversight, resulting in transaction costs and a lack of central monitoring. Some domestic banks were also frustrated that settling trade separately had been both time-consuming and labor intensive.
To address the above concerns, a new scheme - gross-in/gross-out arrangement - was introduced. The company can consolidate all incoming yuan transactions made in different time periods into a single transaction; as well as all outgoing yuan payments into another. This centralized approach to cash management significantly reduces the exchange rate exposure and optimizes liquidity management for the company. It also sets a precedent for other foreign corporates to adopt the yuan in international trade.
There is some worry that the authority's efforts to promote the international use of the yuan is dependent on the appreciation expectations for the currency.
We do not share this view. For corporations trading with China, the use of the yuan can lower their foreign-exchange costs and risks. They can also enjoy the price discounts offered by some Chinese companies. That explains why currency appreciation or depreciation might be less relevant from a supply chain perspective. Cost advantage is the main driver that fuels the growth.
Secondly, non-financial companies can now use the yuan fund held within their organizations in China to extend loans to their overseas affiliates.
With a more balanced yuan inflow and outflow via the trade channel, there was a need to develop other avenues to replenish the offshore yuan liquidity pool. Currently, 10 out of the 40 specific items under capital account transactions in China are classified by the International Monetary Fund as tightly restricted. The items that are still strictly controlled are related to cross-border transactions in capital market and financial instruments.
Asset transaction
Hence, the next stage of liberalizing the capital account is to allow overseas and Chinese entities to engage in cross-border asset transactions. The latest initiative allows onshore non-financial companies to better utilize excess yuan liquidity to fund related offshore business, which is consistent with the "Going Out" strategy promoted by the central government. The new rule also encourages overseas M&A activity, especially to promote yuan outward direct investment, which has lagged behind its inward counterpart.
Finally, for non-financial companies that plan to issue yuan-denominated bonds in the offshore market, they now can set up a special deposit account at a domestic bank to keep the remitted proceeds raised via the bond issuance.
No significant rise
The latest arrangement complements the existing regulatory framework governing offshore yuan bond issuance by Chinese corporates. Nevertheless, the latest policy change would not induce a significant increase in Chinese corporate bond issuance in the near term. Specifically, no changes have been made regarding the remittance process and usage of proceeds.
According to the current rules, proceeds need to be deployed mainly in fixed asset investments, and must comply with the macro-control policies, industrial policies, foreign capital utilization, and foreign investment policies.
Of equal importance, offshore funding costs have become comparable to those of onshore. Since June, the weakening yuan rise expectation amid moderating mainland economic activities has already pushed offshore bond yield sharply higher. Also, the recent liquidity squeeze onshore will possibly generate more interest among mainland companies for borrowing from Hong Kong banks.
Overall, the latest policy changes highlight Beijing's determination to allow the yuan to play a role commensurate with China's economic power. But the regulator is also wary of potentially destabilizing capital flows.
According to the new rules, the amount of the cross-border yuan loan repayments cannot exceed the original principal plus the interest and related taxes and fees. The cash raised through offshore bond sales must be used for the purpose described in the prospectus.
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