HOW U.S. COMPANIES ARE USING CHINESE CURRENCY TO GAIN A COMPETITIVE ADVANTAGE
For years, international transactions were denominated in U.S. dollars, and in deals between U.S. importers and Chinese exporters, it was the Chinese exporter who carried all the foreign-exchange risk. Even as the euro and the Chinese currency supplanted the dollar as the currency of choice among global traders, U.S. importers of Chinese products relied on the dollar. Chinese companies watched as the declining dollar squeezed their margins.
The crisis for Chinese manufacturers reached its nadir in the wake of 2008’s financial meltdown. The dollar collapsed worldwide. Suddenly in a position of authority, Chinese exporters revolted, demanding exotic forms of security against foreign-exchange volatility.
“It was getting painful for Chinese suppliers to manage the risk,” says Douglas Reichman, VP of corporate foreign exchange at California Bank & Trust. “Chinese companies came to U.S. importers and said, ‘We need to dramatically increase your price or you need to find a way to manage that risk on your end.’”
U.S. forex advisors have spent most of the intervening time dealing with U.S. importers who face increasing pricing pressure from their Chinese suppliers. The result: most have found ways to settle in the Chinese currency.
Since then, the consensus around settlement in the Chinese currency has grown as rapidly as China’s economy. Whatever you call it—renminbi, RMB, yuan, CNY, CNH—the Chinese currency is on the rise as a preferred means of settlement for global trade.
Reichman recalls the case of one client, a U.S. household products company that began life as an importer of lighting fixtures from China. The importer saw the chance to sell its products in a new market: China. And he had an ambitious plan to make himself more competitive in the China market by settling transactions in the RMB.
“They’ve benefited substantially as that currency has appreciated,” says Reichman. “As restrictions have become looser, we’ve been able to go back and do some of the things they were thinking of years ago. They were kind of ahead of their time.”
That willingness to take on the risks associated with U.S.-China currency fluctuation can give U.S. companies an edge in the China market.
“There’s a cost to the one who doesn’t want to take the risk” associated with exchange-rate fluctuation, says Christopher Lewis, executive VP and head of global trade and receivables finance for HSBC Bank in North America. As Chinese companies shed that risk and U.S. exporters to China pick it up, U.S. exporters can “charge more or be charged less because of that. So the U.S. exporter says, ‘I’ll go and I’ll hedge it myself. In the meantime you need to give me a break on the invoice.’”
Accommodating the Chinese buyer or seller by dealing in the RMB also provides another competitive advantage: an incentive for the Chinese party to do more business with you. Lewis believes that this secondary advantage “is equally important in many respects” because “it helps to build relations with the buyer/supplier in China. If you, as a U.S. company, are exhibiting greater flexibility in your approach to international business by agreeing to be invoiced in a currency other than your own, or invoicing in that currency other than your own, you’re showing flexibility. You’re showing that you’re happy to play on the world stage. And that means that you probably will have the opportunity to reach out to more buyers and suppliers in China.”
“There are a lot of companies showing interest in settling in RMB,” Lewis says. Reichman agrees. “We are seeing an increased demand for transactions denominated in the local [Chinese] currency.”
Just a few years ago, the only method for settling in RMB was a Non-Deliverable Forward, or NDF. “Our customers were looking for a way to hedge the foreign exchange exposure to their U.S. dollar payment, because the amount they would ultimately pay on the due date was affected by the market rate in China,” Reichman explains. The NDF served as an insurance policy, locking in the purchasing power of the U.S. dollar in a transaction involving another currency by a specific date. Since 2008, the fixing rate has generally been stronger; in that case, the NDF policy covers the difference.
The NDF was a good first solution for Reichman’s client. But a better option soon emerged.
The next step for Reichman’s household products client was to register as a Mainland Designated Enterprise (MDE). That requires establishing a physical presence in China, but it allows U.S. companies to handle the RMB and take advantage of the appreciation rate.
You don’t have to open a satellite office in China and register as an MDE. Another way to lock in an exchange rate involves the use of the newly available Outright Forward Contract. Unlike the NDF, an Outright Forward allows your company to sell receivables in RMB at a fixed exchange rate for a certain period.
Some large U.S. companies have issued “dim sum” bonds to better serve their Chinese customers and suppliers. These are bonds denominated in RMB and issued in Hong Kong. Such instruments appeal to foreign investors who are restricted from investing in domestic Chinese debt. The bond takes its name from the Chinese dish made popular in Hong Kong—a little like calling U.S. instruments hamburger bonds, perhaps.
Dim sum bonds give you the benefits of trading in RMB without actually handling the currency; that, technically, falls to the bondholder. Construction equipment manufacturer Caterpillar raised Chinese capital via dim sum bonds, and then on-shored the funds to mainland China to support its customer base there.
Like other global traders, Caterpillar uses that strategy in markets beyond China. “We use this approach globally, funding in local currencies around the world where possible, in support of customers in those regions,” says Caterpillar Financial spokesperson Jim Dugan.
Dealing in the RMB gives U.S. companies a lot of leverage “by increased trade and a lower cost of doing business,” says HSBC’s Lewis. “If you look at the trade flows to grow between the U.S. and China alone, over time it will be pretty significant. You’re looking at about 9.6 percent as a compound annual growth rate between now and 2020. So there are a lot of reasons why American companies should be interested in this sort of thing.”
Conducting transactions in RMB can be beneficial for virtually any type of business. “I’ve seen it in just about every type of product you can imagine,” says Lewis. “Commodities, construction equipment, apparel, food. It’s just another currency. It could apply to anybody doing any sort of trade with China, primarily. You could even have two countries outside of China dealing in the RMB, but you don’t see that as often yet as you do with trade between China and another country.”
“You can see the RMB is taking hold,” says Lewis. “One of these days, and probably in the not-too-distant future, it will be the RMB that will overtake the euro as the second favored trading currency.”
Settling In Asia