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International Treasurer

China: Foreign
Currency Controls
What efforts to retain
foreign currency
mean for countrylevel treasury.

The Corporate Treasurer's Guide to Global Financial Management


September 5, 1994

page 7

In-house banks

Country bri efing

China: Foreign
Currency Controls
Part I: With the Chinese government eager to
prevent an outflow of foreign exchange, MNCs
have to work harder and smarter.
"If you understand the basic underlyin g philosophy that the Chinese authorities are adopting," says an MNC Asian regional treasurer,
" you can get around m a ny problems in
China ." The current philosophy concerns foreign exchange: How to keep as much of it in
China as possible without discouraging beneficial foreign investment.
To keep tabs on foreign exchange and control speculation on renminbi , Chinese authorities are discouraging foreign investors from
transacting in the local currency. Instead, they
require foreign MNCs to maintain a loc a l
account in non-RMB currency, which is debited or credited for local transactions. Beijing is
also requirin g investors to maintain specific
foreign currency reserves, which reduce working capital and increase funding requirements.
Reserve requirements are set on a case-bycase basis, largely in accordance with the perceived need/benefit of the investment project
in question. This is where understanding " the
philosophy" comes into play: it opens the
door for negotiation .
Treasurers backing beneficial projects (e.g.,
infrastructure) should press for lower reserve
allotments. All treasurers should seek flexibility in managing the reserves . Securing permission for the use of holding companies to transfer surplus/ deficit reserve positions between
subsidiaries/ JVs or to m a ke us e of intraChinese invoicing are two options.
In effect, FX reserve requirements are forced
loans to the Chinese government, helping its
own reserves while propping the RMB . Part II ,
appearing in the next issue, will look at some
techniques being used to manage China' s regulations, improve local treasury management,
and reduce country risk .

Tate & Lyle's


Finance PLC

Tate & Lyle's


Finance PLC

The heart of a "service-driven" profit


center.

By Joseph Neu

page2

The UK sugar and sweetener MNC uses a classic in-house bank structure as the nexus for all
its funding activities. It is run as a "service-driven" profit center.

Tate & Lyl e's group treasury function is divided into two parts: corporate finance and an
in-house bank. The in-house bank is a separate legal entity, Tate & Lyle International
Finance PLC, and serves as the center for all
group funding activities. It is used to achieve
eco nomies of scale with funding, repatriate
funds and manage debt tax-efficiently, and
deliver " free, " quality financial services to
group operating companies worldwide.

In-house banking operations


Tate & Lyl e's in-house bank provides aJJ the
services that might be expected of a small
bank, including taking in deposits, on-lending
group funds (cash recycling) , and foreign
exchange services. The operating companies
that use the in-house bank have full control
over the tenor of deposits and borrowings
(overnight out to five years), the amount, and
the currency. This leaves the in-house bank to
manage a significant portion of the group's
interest rate and foreign exchange exposure.
Borrowing and lending rates are set by the
in-house bank accord ing to benchmark market rates. For example, most money market
operations with subsidiaries use LIBOR screen
rates as a reference, adding 40 bp on one side
and deducting 12 .5 bp on the other. The 52 .5
bp margin is what the in-house bank uses to
help cover its yield curve risk. Call money on
deposit receives a fixed rate 1-2% under the
base rate of the currency .
The in-house bank currently uses a reference rate of 30 bp over LIBOR, for its own
continued on page 2

No Tax-Free
German Income
A German tax act
closes loopholes for
"dividend stripping."
page 3

The Currency
to Hedge
Functional currency
implications for US
hedge accounting.
pageS

A Country-level
Decision Matrix
How to avoid
unplanned investments in emerging
market economies.
page 6

Embedded Options
with Refinancings
Why a reader should
look at swaps and
swaptions.
page 8

Tate & Lyle


continued from page 7

medium-term borrowing, which for


most of Tate & Lyle 's subsidiaries
beats their local cost of funds.

The spread between the reference rate


and the rate at which money is on-lent
to group operating companies is a
benefit of centralized funding and not
considered to be a contribution of the
in-house bank.
Increm ental profits, or the direct
contribution of the in-house bank are
co nsidered to be the gain (or loss)
generated by its market view. In other
words, if an operating company wishes to borrow money for 6 months, the
bank may borrow money for a 1
month term and roll over the debt. It
also might use a future or FRA to
hedge. The gain or loss on this strategy is the direct contribution of the inhouse bank. Spreads from the banking
operations are factored out of the inhouse bank's performance evaluation.
The same method applies to foreign
exc hange services. Each operating
company must identify its FX exposure
(w ith treasury consultation) and is
obliged to cover it back into its local
currency of account (most with the inhouse bank). They get a screen rate,
eve n for small-size transactions, and
the in-house bank aggregates its exposures and lays them off in the market
or takes on additional exposure in line
with its market view.
Local managers are measured on
their financial decisions (after interest
but before tax) regardless of the subsequent actions taken by the in-house
bank. The in-house bank in turn is
measured on how well it improves on
these decisions. Decentralized decision-making fits the philosophy of the
Tate & Lyle group.

Corporate financing
In addition to its role in money-market
and FX operations, the in-house bank
also serves as the " he art" of lon ge r
term corporate financings. If the Tate
& Lyle group wishes to borrow money
for a major capital spending project,
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acquisition, or dividend payout it will


use Tate & Lyl e International Finance
to access the mark et (with a parent
guarantee). That mon ey will then be
lent on to Tate & Lyle PLC (the parent)
or one of the other holdin g
companies- e.g ., Tate & Lyle, Inc.
The in-house bank serves as the
nexus even when borrowing must be
done through a local entity. For example , when tappi ng the US private
placement market, Tate & Lyl e, Inc.
tapped the market and on-lent the
funds to the in-house bank. It in turn
on-lent them to the appropriate nonUS subsidiary.
The rate at which this money is onlent from Tate & Lyle Intern at ional
Finance to UK holdin g companies is
not the corresponding market rate, but
a composite rate. Th e composite rate
is a weighted ave rage of the one-,
three-, five-, and seven-year rates. The
composite rate is set once a year, and
incremental borrowings, or excess
funds, in between us e the LIBOR
benchmarks until the reset date at
which time th ese amounts are rolled
in . Except ions are made for ce rtain
specific capital projects.
This composite rate serves as treasury's benchmark as well. Treasury's
performance is measured on its ability
to beat this resetting index. Reset
annually, the benchmark encourages
a degree of flexibility as to how treasury hedges its exposure, and gives it
an immediate sense of performance
on the in -hou se bank's swap portfolio
in particular. For whatever term the
funds are need ed, the in-house bank's
goa l is to borrow them more cheaply
than the rate of the benchmark index.
Given the size of these transactions,
gains and losses against the composite
benchmark are record ed in a separate
account, somewhat analogous to a
bank's treasury book.

Tax at the center


Tax proves an important reason why
funds are funnelled through the inhouse bank- Group Treasurer David
Creed is also directo r of the group's

tax function . For one, in most jurisdictions, withholding tax rates for interest
payments are better than those for dividends .
More importantly perhaps is the fact
that the in-house bank is considered a
financial trader and taxed as such.
Ta xat ion of financial instruments
(while getting better) is complicated,
uncertain, and somewhat archaic for
UK corporates. Banks however enjoy
a more advantageous and straight forward regime.

A relatively small number of corporates, Tate & Lyle among them, have
made the case to the UK revenue
authority that their treasury operations should be recognized as a financial trader and taxed like a bank dealing at arm's-length.
This trader status is particularly important for a company that wishes to use
swaps and other financial instruments
to manage its debt portfolio .
For example, if the company were to
borrow fixed-rate money from a
Eurobond issue and swap it into floating rate debt as it did last Spring, both
the swap and the bond would be held
by the in-hou se bank. If treasury determin es that it is now more advantageous to have fixed-rate debt before
the bond expires it can terminate the
existing swap rather than changing the
terms of the underlying bonds .
By holding them in one place it can
record the profit or loss on the swap
with greater ease and with more tax
confidence than if the swap were held
off-shore.
In-house banks also help solve a
second UK tax problem: that of unrelieved advanced corporation tax (ACT)
credits. Companies in the UK often
face this problem when the profits
needed to cover their dividend payments come from overseas revenues.
The ACT credit problem arises from
the method used to withhold tax on
dividends and prevent double taxation. When a company declares a dividend in the UK it has to pay 20% of
that amount to the UK Revenue, disIn tern atio nal Treasurer/ September 5, 1994

Professional Guidance: Tax Planning


continued from page 2

tributing the remainder to shareho ld ers.


The actual method is more comp li cated,
but stated simply, the shareholder gets a
credit for the missing 20% (if hi s tax status
allows) and the corporate having paid the
20 % tax in advance can r ecover the
amount when it pays its corporation tax. If
the corporate's UK tax bill is not sufficient
to cover the amo unt of the c red it due,
however, it cannot be used. A company
can roll the credit over into the next year,
yet if taxable income in the UK does not
in crease in subseq uent years, it accumulates substantia l ACT credits that it eventually will be required to write off unused .
As a genera l rule, therefore, UK-based
MNCs try to minimize intercompany dividend flows and opt for interest payments
instead. They a lso seek to repatriate
enough funds in the fo rm of interest
incom e (whic h is tax deductible in the
country of payment) to both cover current
d ividend payments and shelter any ACT
credits.

A costly center?
Despite the numerous advantages, running an in-house bank can be costly. Tate
& Lyle's in-house bank is staffed with 12
people. A staff separate from the group
function s is needed to provide : the proper
controls, generate arm's- length contracts
(operations), maintain counterparty relationships (banking area), record financial
transactions (accounti ng), and most importantly keep systems up-to-date (systems
support) . " We learned from experience
that you cannot rely on the head office for
centra l services," notes Mr. Creed. This
creates sign ifi cant overhead- about 1
million per year.
To help justify these costs, treasury is run
as a profit center, but service is its first or ientation. Mr. Creed ta lks about treas ury as
a " service-driven" profit center. Profits are
merely a means to measure performance
agai nst the benchmark market rates- just
as service performance is measured w ith a
questionnaire . The profit object iv e is to
cover t h e over head cost of running
treasury-so the group gets treasury service
for free and not as he says " to make as
much money as we can-"

Internationa l Treasurer/ September 5, 1994

Tate & Lyle


International Finance

Cross-border payments

The key c haracte ri stics of Tate &


Lyle's in-house bank are as follows:

No Tax-Free
German Income?

Location: City of Lo ndon


Staff: 12- 4 dealers; 2
bankers; 2 acco untants, 2 systems,
a nd 2 operations.
Overhead cost: 1 mi lli on p.a.
Performance orientation:
Service-oriented profit center.
Profits from market views to cover
overhead cost of serv ice center.
Financial performance benchmarks:
Short-term operations: 40 bp
over LIBOR (excludi ng ma rg in).
Long-term funding: Compos ite
index composed of 30% in one
year debt, 30% in three-year, a nd
20% in five- and seven-year debt
(fixed annua ll y).
Non-financial performance
benchmarks: Customer rankin g on
quality of adv ice, speed of execution, and accuracy of documentation.
Customers: 55 subsid iary
counterparties world wide, a nd a
holding company in each major
country.
Banking margin: 52.5 bpadding 40 bp a nd deducting 12.5
bp.
System: DEC workstations running Econlntel Treasury a pplication.
Capitalization: 15 mil lion

By Dr. Johannes K. Gabel


Rogers & Wells
As the German economy emerges
from recession, MNCs should note
that they may not be able to expatriate profits from their German subsidiaries as tax efficiently as before.

On September 13 , 1993 the German


Legis l ature passed the In vestme nt
Securement Act (the "Act") . A major
premise of this Act was that non-resi dent taxpayers were expatriating the
profits of their German subsidiaries
relatively free from German income
ta x. To prevent this , the Act introduced measures to close down two
major methods of perceived tax avoid ance .

Establishing thin capitalization rules


The first avenue to be closed in vo lves
"thin cap itali zat ion ." Before the Act,
MNCs could fund German subsid iaries with substantial debt and little equity. This allowed the parent to
"strip" what would be otherwise dividends through the use of intercompany loa ns. It could thereby convert taxab le, non-deductibl e dividends into
tax-free, deductible interest expense.
German tax law did not attempt to
restrict " thin capitalization" until 198 7
w hen the German Finance Ministry
sought to limit deductibility of interest
where the debt/equity ratio exceeded
10:1 . This attempt was declared ill ega l
by the German Federa l Tax Court.
Under the new l eg i sl ation, th e
court's decision has, in effect, bee n
reversed. Indeed, the Act provides for
significant limit s on subsidi a ry
debt/equity ratios:
Shareholder debt whose interest is
determined by sales or profits of a
German subsidiary is now limited to
50% of equity (0.5:1).
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