Branch Info

Regulatory Compliance in Cross-border Renminbi Trade

January 26, 2017
Regulation of cross-border renminbi transactions aims to achieve a combination of low key but pragmatic guidance for the market while maintaining a healthy respect for compliance requirements. This differs from foreign exchange management in several important areas from the regulatory process to the regulatory framework and the methods of enforcement. With the continuous improvement of the regulatory system, greater demand is being placed on banks for ensuring regulatory compliance in cross-border renminbi trade.
Using the renminbi simplifies transactions. Management of cross-border business in the national currency has largely relied on market-based principles. The aim has been to encourage market players to use the nation's own currency in cross-border transactions. In order to do so we have reduced the reliance on prior approvals for transactions in favor of post-transaction supervision combined with what is called "negative list" management (which permits a wider range of activities) and more information sharing among regulatory bodies.
Regulatory procedures for domestic currency business also differ from those governing foreign currency in terms of business registration and classification as well as bank account management, the requirement for the use of foreign exchange accounts for foreign invested companies, the management of early-stage investment expenses of foreign-invested companies and non-resident account management. Using renminbi in transactions has its advantages regardless of whether the funds are moved under the current account or the capital account.
In merchandise and services trade as well as foreign direct investment, overseas (outbound) direct investment, trade financing and other areas, the use of cross-border renminbi settlements is not subject to any access restrictions. There also are no requirements for prior registration and approval, and there are no restrictions on transaction volume. Banks and enterprises can carry out cross-border renminbi business based entirely on business needs.
As far as supervision and management are concerned, there are policy differences between the management of cross-border capital flows in foreign currency and domestic currency. Cross-border renminbi policy falls under the direct management of the People's Bank of China's Monetary Policy Second Department, which is responsible for focusing on promoting the internationalization of the renminbi and carrying out inspections to ensure compliance with the central bank's requirements. The State Administration of Foreign Exchange is responsible for managing foreign currency business to promote a balanced payment position. In accordance with the Regulations of the People's Republic of China on Foreign Exchange Regulations, it investigates violations of foreign exchange rules and has the authority to impose severe penalties.
Case analysis
As China's economy grows and the renminbi gains ever wider acceptance as an international currency, there is a growing business for payments in domestic currency related to foreign trade and investment. The expanded role for the renminbi has emerged in tandem with the creation of onshore and offshore markets. In addition to interest rate differences in the domestic and offshore markets, there are differing exchange rates for the renminbi as well. On the offshore renminbi market, the exchange rate is more volatile, and mainland banks and their HongKong branches have devised a series of arbitrage products to take advantage of the market divergence.
At the same time there are numerous instances of policy arbitraging. When there is insufficient access to short-term foreign currency credits, market participants could use a number of sophisticated tools to circumvent the problem. They can make use of advice of letters of credit and converting renminbi into foreign currency or renminbi usance letters of credit plus the issuance of back-to-back letters of credit in a currency different than the master letter of credit. Interest rate arbitrage, export refinancing and import refinancing, cross-border discounting, and overseas loans with a domestic guarantee -- all offer opportunities for.
Such arbitrage affects cross-border capital flows and can run counter to the objectives of macro-prudential policies of regulators. This has created concerns from the departments of cross-border renminbi management. There are more cases to illustrate the point.
Scenario 1:
A Chinese company registered two affiliated companies in Hong Kong as upstream and downstream entities. Between February and September of 2016, the company bought a bill of lading from an overseas company by paying a fee of 1% of the total stated value.It then fabricated a contract and invoice according to the contents of  the bill of lading, and carried out an offshore “sale” under terms of “payment on receipt of goods.” The company received renminbi as payment from its downstream company, and later paid the upstream company in US dollars after purchasing foreign exchange.
This was considered to be a “domestic purchase of foreign exchange with overseas foreign exchange settlement,” taking advantage of the price differentials. The company benefited from higher interest rate by placing the US dollars in an offshore fixed deposit and it recorded gains from the appreciation of the dollar against the renminbi. The company in question madean illegal profit of more than two million yuan using this method.
With expectations of a depreciating renminbi, enterprises are more likely to use the re-export trade to conduct risk free arbitrage by purchasing foreign exchange domestically with offshore settlement and fabricating an underlying transaction. This can be combined with an interest rate swap, taking advantage of interest rate differences. In such cases, the company involved does not need to hedge the foreign exchange risk. It can be considered cross-border renminbi payments and receipt without an underlying trade.
Scenario 2:
As another example but with a strengthening local currency, a company decided to make low-interest financing available to its offshore shareholders each year instead of distributing profits. Profits were retained in China, accomplishing what is called "keeping assets in domestic currency and holding debt in foreign currency." In August 2015, with the devaluation of the renminbi, market sentiment shifted from appreciation to strong expectations of depreciation.
The company then made substantial remittances of the profits that had been held onshore over the previous years under the name of the remittance of the profits. This added to capital outflow pressure, posing a significant challenge to the regulator's counter-cyclical macroeconomic controls.
The steady appreciation of the renminbi in past years had encouraged foreign-invested companies to retain or reinvest profits rather than distribute them to shareholders offshore. That created a very large but invisible external obligation. Foreign-invested companies have the right to select the timing and the currency to be used for profit remittances. As long as the documentation related to the use of the funds is provided to the bank, remittance would be permitted. But this avoids foreign exchange supervision and can have an unforeseen impact on China's foreign exchange position.
The use of speculative funds under the guise of trade poses major risks to the cross-border renminbi settlement. Some funds that are under the capital account flow through trade channels. Such forms of speculative cross-border flows of renminbi could have great impact on China’s currency market and undermine China’s monetary policies. This is harmful to the steady operation of China’s economy.
In addition, speculative cross-border renminbi inflows may pour into real estate or the securities market, leading to rapid rises in asset prices and the creation of asset bubbles. After the asset bubbles expand sufficiently, capital will flow out rapidly, causing sharp falls or even a financial crisis, damaging the real economy.
Compliance Trend
On April 25, the powerful Political Bureau of the Chinese Communist Party's Central Committee held a key meeting examining the need to safeguard national financial security.Communist Party General Secretary Xi Jinping stated that financial security was an important part of national security and a key to healthy and stable development of the economy. The party chief put forward six tasks in maintaining financial security, one of which was to strengthen financial supervision by coordinating important arms of the regulatory system.
The remarks served as a guide for China to prevent financial risks and help the financial sector serve the real economy. It signaled that financial supervision in the future would pay more attention to coordination. With financial innovation, there are many cross-sector and cross-market financial products. Regulators in the future are bound to step up coordination to enhance regulatory cohesion and deal more effectively with financial risk prevention.
The nation's 13th Five-Year Plan (2016 – 2020) also contained this theme, asserting that strengthening the financial macro-prudential management system required more coordination as well as improvement in the financial regulatory framework.
In 2016, the People's Bank of China issued its Notice on Expanding the Pilot Project for Macro-prudential Management of Cross-border Financing (PBOC, No. [2016]18) and the Notice on the Implementation of Macro-prudential Management of Cross-border Financing (PBOC, No. [2016]132). These policy initiatives realized the management of an integration of domestic and foreign currencies under the cross-border financing account, built a cross-border financing constraint mechanism based on capital or net assets regarding micro players and divided the responsibilities between the central bank and the foreign exchange bureau in a reasonable manner. These were only part of a pilot program but they constituted a regulatory breakthrough, facilitating the integration of domestic and foreign currencies for domestic players as to overseas financing.
The renminbi has become an important part of cross-border capital flows. Since the second half of 2015 the renminbi exchange rate has seen significant fluctuations and domestic financial markets have come under pressure. This is partly a result of widespread expectations that the US Federal Reserve will quicken the pace of its interest rate hikes, the domestic financial market shocks and other factors, at the same time, in the current large margin difference between the domestic and foreign exchanges, many companies exploit the differences of these policies with arbitrage activities in the purchase and settlement of foreign exchange.

This could harm the long term development of cross-border renminbi business. Under such circumstances, more attention has been paid to the prevention of shocks from cross-border capital flows. It is increasingly important to improve the framework for macro-prudential management of domestic and foreign currencies. With the ongoing improvement of the regulatory system, there would be no unclear regulatory area for the punishment of the illegal cross-border renminbi behavior, and there would be more and more stringent requirements for compliance on cross-border renminbi business.

Source: China Foreign Currency

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