ACT 2014 - Managing excess liqudiity in China

Surplus Liquidity Management in China
Tony Lam, Asia Treasurer
March 2014

Agenda
Part Topic
1 About Valspar Group and China
2 Surplus Liquidity Repatriation Channels
(Traditional vs New Options )
3 Investment Options in China
4 Lessons Learned

VALSPAR Group
 Established in 1806, headquartered in Minneapolis, USA
 Fifth largest Paints and Coatings Company in the World
 Over US$ 4 billion Turnover in 2013
 9,500 employees in over 25 countries

China Treasury Reform Roadmap
 Fully centralized Treasury Centre in Shunde.
 Cash management (pooling, investing excess cash,
fund transfer to ensure sufficient cash for payment ,
forecasting ).
 Full range of treasury support to China entities such
as daily payments, trade finance (Bank Acceptance
draft , LC, DA, bank guarantee etc…), custom duty ,
FX etc.
 Regional support to other Asia countries (Singapore,
Malaysia, Indonesia, Thailand, Vietnam, etc.)
Tianjin
Shunde
Shanghai
Dongguan
Hong Kong
Centralized
Treasury
Operation
Business case SSC /
Bank bidding SSC project
Site / BU finance
Mid 2012 to date
Set up shared services /
Upgrade Cash pool / H2H
2011/2012
Valspar in China
1996 - 2010 2010/2011
2008
First China
Cash pool
 Totally 6 manufacture plants. Located in
Shanghai, Dongguan, Tianjin and Shunde.
 Regionally headquartered in Shanghai.
Treasury Operation

Surplus Liquidity
Repatriation Channels
(Traditional vs New Options )

Roadmap of China open-up in
Cross-border Liquidity Solutions
More flexible alternatives are now available
Before July 13
July13
onwards
Feb14
onwards
Limited ways for cash repatriation
Global liquidity solutions on pilot base
Cross border RMB Cash pool
Cross border RMB Pay & Collect on behalf
Expansion of RMB Cross-border Usage in SHFTA, PBOC SH Yin Zong Bu Fa [2014] 22, 20 Feb 2014
Cross border FX Cash pool / Cross border FX Pay & Collect on behalf (Open-up)
Implementation Rules of Foreign Exchange Administration Supporting China (Shanghai) Free Trade Zone
SAFE SH Hui Fa [2014] 26 , 28 Feb 2014
PBOC opinion on
providing financial
support for the
development of the
China (Shanghai) Free
Trade Zone (SHFTA) , 2
Dec. 13

Surplus liquidity onshore
More flexible alternatives are now available
Pledge
RMB Standby Letter
of Credit
Onshore deposit Offshore loan
Dividend payment /
Royalty / Service fee
Credit
Facility
Payment from China to offshore entitles
Cross border loan/
Cross-border cash
pooling
Offshore Loan on
pledged local
deposits
(内保外贷)
2
3
(1) Dividend / Royalty/ service fee payments are subject to withholding tax, the rate for which varies from country to country.
Once paid, cannot flow Back .
(2) Offshore Financial Guarantee is subject to limited resources of China banks’ foreign debt quota.
(3) Interest charged on cross-border loan/physical pooling balance on arm’s length base and subject to China income tax
1
Onshore liquidity
Intra-Group Loan
Proceeds received offshore
Participation in global
liquidity structure
Increasingfrequency
Bank XYZ -
Onshore
branch
Bank XYZ -
Offshore
branch
2 way sweeping
Onshore Offshore

Cross-Border Cash Pooling Via Shanghai Free Trade Zone
Sub
1 **
SFTZ leading
company’s RMB
special account
(Daily Zero balanced)
RMB Cash Pool
Leading entity **
Master Account
of Domestic
RMB Cash Pool
SFTZ Lead Entity
Sub
2 **
Sub
3 **
China
Singapore
HK
USA
Global Notional Pooling
Etc…
Subject to :
Total Available foreign debt quota =
Foreign debt quota – “registered” mid/long term Foreign borrowing –
“unpaid short term foreign borrowing
IFMA – International Foreign Currency Master Account
DFMA – Domestic Foreign Currency Master Account
** Entities can be inside or outside SHFTZ
RMB
FCY
RMB
FCY IFMADomestic
Particpiant ** -
FCY Account 1
SFTZ Lead Entity
DFMA
Domestic
Particpiant **
FCY Account 2
Pay Receipt
on behalf/
Netting

Traditional channels to repatriate surplus liquidity
Channels Pros Cons
Dividend
 Permanent repatriation of funds
of large sum at once
 Once a year (maybe twice)
 Withholding tax (10% or 5% for tax
treaty location)
 Audited financial report is required
Royalty
 Permanent repatriation of funds
with standard tax treatment (Vs
service fee)
 Simplified document requirement
after Sep13
 Withholding tax (10% or 5% for tax
treaty location)+ 6% business tax
Service fee
 More flexible payment timing
 Simplified process after Sep13 (<
USD 50,000)
 Ongoing
 CIT 25% on deemed profit 20-30% of
charging entity (effective tax rate
around 5% - 7.5%)
 Needs to negotiate with Tax Bureau
on a case by case basis
 Cannot do a lump sum transaction

Flexible Cross border liquidity solutions ….
Channels Pros Cons
Offshore loan on
local pledged
deposits
(内保外贷)
 Cash able to remain in China
 Net gain on investing holding cash at higher
onshore rate & borrowing at lower (CNH/FCY)
offshore rate
 To be renewed annual
 Complex tax consideration if the borrower is US parent
 Increase external loan balance of whole group
In RMB - No limitation for foreign debt quota of bank
 Offshore CNH lending rate higher than FCY loan.
 Limited use of RMB overseas (offshore notional pooling
may help)
In FCY - Lower FCY offshore borrowing rate than CNH
 Need negotiate with banks for banks’ foreign debt quota
being limited resources
Cross-border
loan to offshore
affiliates
 Only bank approval required, easy & quick
 Flexible – allow auto sweeping & multiple draw-down
(up to the initial RMB loan amount)
 Opportunity cost : loss of higher RMB onshore return
 Limited to onshore groups with overall net positive profit
& operation cash inflow
In RMB – Higher quota limit than FCY loan, No regulatory
filing required (FCY cross border loan required)
 Limited use of RMB overseas (overcome by offshore
notional pooling)
In FCY - Funding can come from external borrowing
(mainly used by local-capital entities without oversea bank
relationship).
 Lower quota limit than cross border RMB loans
2-way cross-
border Physical
Cash pooling
via SHFTZ
 Most flexible liquidity solution for global companies
 Draw cheaper oversea funding to meet China needs
(inside & outside SHFTZ)
 Limited to onshore groups with overall net positive profit
& operation cash inflow
 More time & effort to work with bank on initial control
cap limit setup for fund inflow to China
In RMB – Higher quota limit than FCY cash pool
 Limited use of RMB overseas (overcome by offshore
notional pooling)
In FCY – more common than CNH for use overseas
 “Available Foreign debt quota” on inflow funding for
usage outside SHFTZ & lower quota for outflow to
oversea
 Need register foreign debit with SAFE for each
oversea fund inflow to SHFTZ

FCY cross border
pooling via SHFTZ
FCY cross border loan
RMB Cross border
pooling via SHFTZ
RMB cross border loan
Approval
process
Filing with SAFE(SH)
**(If no objection from SAFE
within 20 days, then start…..)
SAFE approval
(SHFTZ – filing with SAFE)
Bank approval Bank approval
Lender
Eligibility
MNC with entity at FTZ
No breach in last 3 yrs
Grade A enterprises
No special requirement
MNC with entity at FTZ
(Unofficially - Capital fully
injected + financial
requirements same to RMB
cross border loan)
No official requirements.
Local PBOC interpretation -
Positive profit;
Positive net assets;
Positive cash inflow (Ex
financing)
in last preceding year.
Participants Related company
Oversea Parent Co /
subsidiaries
Related companies Related companies
Lending
Limit
50% of equity (Net
assets) of all
participants
Lower of 30% equity & Share
of undistributed profits +
dividend payable (SHFTZ
Lender - 50% of equity)
No formal quota
(PBOC SH interpretation:
consolidated income from
operation & investment)
No formal quota (norm is
Net equity subject to city-
specific guideline)
Lending
Tenor
Flexible 2 years (renewable) Flexible
No official limit – matching
the loan purpose
Lending
fund source
No formal restriction Borrowing or self funding
Self generated operating
fund ; Not from bank loans
Self fund from Cash pool
members (or one entity)
Borrowing
limit &
tenor
Available foreign debt quota
=All participants‘ foreign debt
quota – (registered) mid/ long
term foreign borrowing –
(unpaid) ST foreign
borrowing ; Tenor : flexible
Foreign debt quota
Tenor : can be > or < 1 yr
No official quota ; bank’s
Interpretation : meet real
business needs , cap limit
at consolidated expenses
Tenor : flexible
• Foreign debt quota
• SHFTZ borrower - can
select Paid-in capital x
adjustment factor (now 100%)
but tenor need be > 1 yr &
use of fund limited within
SHFTZ for operation or
oversea project )
Cross border liquidity solutions - lesser restriction / Openness

Changing China Regulatory environment
 Different approach in New rules of SHFTZ
 SAFE (FCY)- Clear quota limit, although relaxed, still strong control, close monitoring
 PBOC (RMB) – No official quota & flexibility, Encourage cross border RMB
 Trend on the role of regulators & banks -
 More rely on banks’ “Know your client”, “Know your business”, “Due diligence”
 Regulators : Pre-Transaction approval control => Post-transactional monitoring
 Flexibility on Cross border RMB loan /cash pooling –
 Invisible rule behind
 Enterprise can get different answers on quota limit etc… for :
 Different interpretation of PBOC at city level
 Different understanding of banks on training / oral guidance from PBOC
 Different Risk aptitude of banks
 Regulator may step in if any abuse (Principle is to serve real economy)
 Implications & future developments :
 Principle-oriented guidance will likely evolve into a “norm” of more clear cap limit
 Still flexible to over cap limit if any justifications (Enterprises to prove it), as more
practical and executable to the banks & clearer to enterprises
 Large MNC banks of closer relationship with regulator may have advantages, before
new rules become mature
 Setup entity in SHFTZ now or wait…. Rules on Cross-border cash pool still new / May
have more FTZ coming…

Cross Border RMB Loan
 A ready-to-use tool to share surplus liquidity in China
 Fast implementation time : 2-3 months
 Post pilot stage - Quick approval by banks
 Many live cases since July 2013
 Allow multiple drawdowns and repayments
 A breakthrough of open-up reform
 Enterprises with profit and positive cash inflow generated from operations &
investing activities is free to share liquidity with offshore
 Allow sharing of onshore liquidity to a very deep extent
 Bank assessment bases on audited report of preceding year
 Unofficial quota limit of Net equity
 Illustration…...
 Cross-border loan Vs dividend
 Re-think rationale for annual dividend …
 Can improve annual bottom-line to foreign MNC
 Illustration…...
 Impact to MNC banks’ deposit
 Faster & more cash repatriation of MNC client

Illustration I : Depth of liquidity sharing with offshore
 Interestingly, in certain scenarios, there is chance to reduce cash balance to a
level less than capital.
 For profitable entities, may be used for faster capital funding withdrawal upon
exit from China market, instead of idle capital funding sitting in China during
long liquidation process.

Illustration II : Cross Border RMB Loan VS Dividend
 For those corporations holding long-term strategy & interest in China market, may
consider cross border RMB loan to share surplus liquidity / cash generated from
China business in replacement of annual dividend. Can benefit with a net tax
saving. For example :
 Annual Dividend US$ 50 million
 Dividend Withholding Tax = US$2.5 million (5% preferential tax treaty rate)
 Tax on Interest income of cross border RMB loan
= US$50 million x 3.4% Int’** x ( 5% business tax + 25% EIT)
= US$50 million x 1% approx.
= US$0.5 million
** assume use oversea CNH loan rate as transfer price
 Entrustment loan bank commission = 50 million x 0.1% = US$0.05 million
(PS: Trend of bank commission is once off, lower or even free. Talk to more banks ! )
 Net saving at bottom line / ST cash outflow for tax = US$ 1.95 million
 Re-think : If cash can really be moved freely & easily cross-border at arm’s length
interest now, re-consider rationale to pay out dividend payout annually.
 Other considerations : eg. Uncertainty in China policy in tax, banking &
monetary policy ; sovereign risk ; chance to exit China market etc…

Regional Perspective - Investing Surplus Cash
YIELDLIQUIDITY
 Rating by
International credit
agents (MMF / Banks)
 Principal guaranteed
by banks
 Diversification
 Meet Business &
operation needs with
certainty
 Redemption
frequency / Length
of Notice
 Cash pool supported
by OD line
 Maximize yield on
condition of
Security & liquidity
Principle
AVAILABILITY
 Easy to subscribe
 E-platform/ paper
based
 Money Market
Collective
Investment
scheme need
subscribe via local
banks
 Referral from corporate HQ
 Local banks need establish relationship with HQ to enhance understanding
CORPORATE POLICY /
RELATIONSHIP & COMMUNICATION WITH HEADQUARTER
 Secure support of Bank Acceptance Draft facility and on-site services from local banks
LOCAL BANK RELATIONSHIP / FACILITY SUPPORT
SECURITY

Investment Options for Corporate Treasury
Instruments Tenor
Yield **
(p.a.)
Comments
Bank deposits
1 day call
Contract deposit,
7 days call
3 mth, 1 yr etc.
0.8%,
1.15%
1.35%
2.6%
3%
• Regulatory ceiling limit of deposit rates
• Bank can offer max. 10% up from ceiling rate
Wealth
Management
Products *
3-7 days, 1 mth, 3
mth, 6 mth, 1 yr
etc.
2.2% to
slightly
over 5%
• Commonly offered by Local banks
• Differentiate Principal-protected or Non-Principle-
protected low risk Products
• the later is not transparent off-balance sheet products
• Return % normally is certain at the time of subscription.
Structured
deposits *
7 days, 14 days, 3
wks, 1 mth, 2 mth,
3 mth, etc.
2.2% to
4.5%
• Offered by foreign banks and local banks
• Return subject to outcome of “event”.
• Principal and minimum return guaranteed.
Money Market
Fund MMF
Daily
(T+1 or T+2)
3.0% to
5% +
Rated by local credit rating agency only or
also by international credit rating agency.
* Only low-risk Principle-protected products are discussed here
* * Being market indicative rates obtained via 3 foreign banks and 3 local State/commercial banks only at late 2013

China Wealth Management Products (WMP)
Should differentiate WHP which are …..
 Principal guaranteed by banks :
• Subject to monitoring of bank regulations like provision charges, capital weighting etc.
• Nature similar to Principal-protected structured deposits – tie to banks’ ability of repayment
 Non-Principal guaranteed by banks or Products of trust companies sold via
banks’ retail channel :
• Off balance sheets of Banks
• A large portion of such WMP invested in interbank and monetary markets according to
Government source
• Certain WMP invest in risky non-standard debt-based instruments (NSD), utilized as
channels to escape regulatory controls upon financing projects restricted by the Government
(e.g. property development) or to medium-size enterprises which hardly to obtain loan from
banks via trust companies, finance companies etc..
• Certain WHP form part of China shadow banking system - This segment of WHP poses
major risk to banking system

Regulatory controls tightened in 2013 :
 Both the industry and China regulators realized the loopholes and
potential risk caused to the country financial system since 2012
 CBRC New Circular Yin kan fa [2013] No.8 issued at early 2013
• All new WMP need be separately accounted for with own BS, P&L, cash flow
• Banks need to make risk assessment and provision for existing issued WMP
like other balance sheets assets by end of calendar 2013
• To cap investments of WMP fund in risky “non-standard” credit assets (less
liquid and not publicly traded) at the lower of 35 % of all funds raised from
the sales of wealth-management products, or 4 % of total assets.
• To stop pooling assets and to isolate the risks of such investments from their
own operations.

Views and Recommendations….
 Government tightened control is good news to ensure healthy development of WMP
sector, stability of country banking system and avoid systematic risk
 For MNC that have to keep certain level of deposits in local banks (eg. For securing
issuance of Bank Acceptance Draft and other services) –
 Principal-guaranteed & liquid (redeemable) WMP is a choice, instead of deposits.
Both bear the same counter-party risk
 Value of local / regional treasury : Provide insight to headquarter for wiser
decision and facilitate communication between local banks and oversea HQ
 Proper risk management :
 Stick to principal-protected products
 Select products from top-tier banks that are too large to fail to China

Structured Deposit
 Nowadays, it’s a common products offered by Foreign banks and some
local commercial banks
 To some extent, being foreign banks’ version of WMP to broaden deposit
base
 Typical Terms to MNC clients :
 Principal-guaranteed
 Minimum Interest return guaranteed
 Bonus rate if the linked index or commodity price stay within a
specified range during the deposit tenor
 Linked with 1 mth USD LIBOR, 3 mth USD LIBOR etc..

Money Market Funds (MMF) in China
 First choice to corporate treasury for major benefits of MMF :
 Highly liquid (T+1 or T+2), transparent and hence ideal for cash
management
 Lower counter party risk : Invested asset units kept under
separate assets custodian, separate from fund manager &
custodian assets. Risk depends on invested instrument.
 Diversification and convenient access to a variety of low-risk
investment instruments in interbank market and financial markets
with potential higher return than normal deposits & counter-party
risks diversified.
 High quality China MMF typically invested in high concentration of low risk
& liquid Central Bank notes, Policy bank bonds, Ministry of Finance bonds,
Repo etc…

Money Market Funds (MMF) in China
 MMF with AAA rating from Fitch / CCXR Moody's AAA in China: (As at Nov 13)
• Goldman Sachs / Gao Hua Sheng Yu Money Market Collective Investment Scheme
(CIS);
• MMF with foreign capital JV -
• Deutsche Bank / Harvest Prime Liquidity Money Market Fund;
• BNP Paribas/HFT Liquid Money Market Fund;
• JP Morgan / China International Fund Management Money Market Fund (CIFM);
• HSBC / Jin Trust Money Market Fund;
• Invesco Greatwall
 MMF VS CIS in China
• Legal status: CIS is under a Security Company while MMF is under a Fund management
company.
• Subscription process: CIS needs a local bank but MMF does not. (Lower availability)
• Tax treatment of income : MMF is under new Fund Law and income is exempted from
tax . No regulation of tax covers CIS. Tax treatment not 100% certain for CIS and need to
check with local tax bureau.
• Publicity : CIS can’t promote publicly

Observations on the 2014 China market liquidity and
implications ….
 2014 year starts with very tight liquidity compared to 2013 same period
 Foreign banks – Note possible impact from cross border RMB loan
 SHLIOR O/N & 1 week dropped after the end of Chinese new year (Early Feb14 ) but
discounting rate of Bank Acceptance Draft at local banks is still at a quite high level
(most 6 – 8%), although there is also some relaxation.
 Local banks – With more regulating on shadow banking, higher demand for official
bank loans and very limit quota for private enterprises.
 China MMF performance in 2014 will likely be better than 2013 – Local banks take
time to correct the mistakes of past mismatching in financing long term project with
short term WMP and continue to make “Repo” with MMF
 Both banks and enterprises need to exercise stricter credit control

Lessons Learned…..
 For MNC , insist on benchmarking with Market upon negotiation
with relationship banks for proper products – Talk to more banks .
To some banks, cash management division may not be
keen to sell MMF as not count its performance.
 Communication with corporate HQ & get trust is crucial -
Direct communication of local banks with oversea HQ
where possible
 Guideline, Interpretation and risk appetite can vary largely
among cities SAFE/PBOC and even among banks – Talk to more
banks & try different locations
 Importance of strong integrity to Treasury Team under
China environment. Clear and transparent internal guideline on
investment.

Appendix
 Comparison of annual returns on MMF Vs deposits
 Movement of China MMF
 Key consideration for MMF selection
.

Money Market Funds (MMF)
0.35%
1.35%
2.30%
1.60%
2.50%
0.47%
1.46%
3.28%
2.77%
3.41%
0.48%
1.47%
3.45%
2.88%
4.17%
0.35%
1.35%
3.00%
3.48%
4.46%
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
Bank current rate Bank 7d call
deposit rate
Bank 1y rate High quality local
MMF*
Local MMF*
2010 2011 2012 2013
• Source: WIND. Bank Rate: PBoC. High quality local MMF* are money market funds rated as AAA by one or more international
ratings agencies. Local MMF* referred herein not include high quality local money market funds.
•2010-2013 data is averaged yield of relevant year.
•Yields quoted are gross and do not reflect the deduction of any fees.

Source of MMF: Wind (Chinese version of
Bloomberg for MMF)
The above figures relate to the past and past
performance should not be seen as an indication of
future performance.; Settlement : T+1 Net return
Source of BADD : www.chinacp.com.cn中国票据网
Movement of China MMF
MMF movement in
2014 likely
continue at a level
better than 2013
after CNY
0.0000
1.0000
2.0000
3.0000
4.0000
5.0000
6.0000
7.0000
8.0000
9.0000
10.0000
%
SHLIOR - O/N SHLIOR - 1W HSBC Jintrust MMF
SHLIOR dropped to a low
level after CNY
Bank Acceptance Draft
Discounting (BADD) rate
still maintained at a high
level after CNY, despite of
slightly adjusting
downwards

Key Consideration for Money Market Funds
What are the underlying assets of the fund? Which guideline does it follow?
CSRC* CCXR** (Moody JV in China) US 2a-7 *** FITCH Chinese AAA MMF****
Maximum WAM ^ 180days 120 days 60days 75days
Maximum WAL^^ None 120 days 120days 120days
Maximum Asset
Maturity 1 year for Deposits, Repo, Gov bills ;
397 days for Bonds
1 year for Deposits, Repo, Gov bills ;
397 days for Bonds
397days&45days for tier 2 securities
& no limit for government FRN
397days&36months for qualified FRNs
Minimum Credit
Rating
Minimum AAA local currency rating
(not equivalent to a global AAA
rating)
Minimum AAA local currency rating
(not equivalent to a global AAA
rating)
1st tier security
(‘F1+’/‘F1’,‘A1+’/‘A1’,P1 or
equivalent)
2nd tier security (‘F2’,‘A2’,‘P2’ or
equivalent) if security maturity
<45 days and total 2nd tier
exposure <3%. Max individual
exposure is 0.5%
A- /F2(global rating)
Maximum assets
weighting
30% for licensed custodian bank,
5% for non-custodian bank
No limit for Agency bank bonds,
repos
20% for floating rate notes
30% for licensed custodian bank,
5% for non-custodian bank
No limit for Agency bank bonds,
repos
20% for floating rate notes
No limit for government securities
100% for MOF, PBoC and Exchanges
exposure
50% of NAV for any single policy bank issuer
35% of NAV for single issue by MOF or PBoC
25% of NAV for single exchange repo
(exchange as counterparty)
15% of NAV for single issue by any policy bank
Stress test None Detailed guidance Monthly No Specific Requirement
* CSRC – The China Securities Regulatory Commission, the main securities regulator in China.
** CCXR - China Chengxin International Credit Rating Company Limited , of which 49% shares owned by Moody (CCXR website Nov 13)
*** The descriptions above for “US 2a-7” are based on the U.S. Securities and Exchange Commission’s (SEC) Investment Company Act of 1940.
**** The descriptions above for “Fitch Chinese AAA MMF” are based on information from Fitch as of April 2013
^ Weighted Average Maturity ; ^^ Weighted Average Life

Disclaimer & Contact
 The views here represent personal opinions of the speaker and does not
necessarily reflect those of Valspar. All information is for reference
purpose and please consult your banks to verify regulatory requirements
and latest market situation.
 Any comments and wish to obtain further information in this presentation
can contact via tony.lam@valspar.com
Thank You

ACT 2014 - Managing excess liqudiity in China

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