A policy of centralisation

Reprinted from The Corporate Treasurer, June / July 2015CorporateTreasurer

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A policy of centralisation

A t the beginning of 2015, Hong Kong’s financial secretary John Tsang Chun-wah outlined tax reforms to attract more companies

to set up treasury centres in the city. The headline announcement was to “reduce profits tax for specified treasury activities by 50%”. On June 1, the city’s top regulatory bodies came up with a proposal to bring this goal to fruition. With a vibrant financial market, deep renminbi roots, and the rule of law, the city-state already has a lot to offer. However, it recognises that to attract companies more needs to be done to level the playing field with places like Singapore and Shanghai. The Corporate Treasurer, with Thomson Reuters, set about to learn more.

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PARTICIPANTSHoward Lee

Executive director for monetary management,

HK Monetary AuthorityTony Lam

Former Asia treasurer, ValsparFrancis Ho

Director of treasury, CLPPeter Wong

Executive board member, TMA, and director, PwC

Sanjeev ChatrathManaging director and region head, Asia

financial and risk, Thomson Reuters

MODERATORDaniel Flatt | Editor,

The Corporate Treasurer

THE CORPORATE TREASURER: How is Hong Kong planning to attract corporate treasury centres to its shores?

HOWARD LEE: Hong Kong is an international financial centre. We have a strong banking sector, and good capital markets. We are the world’s biggest offshore renminbi centre. However, in the past, we haven’t been a forefront destination for regional treasury centres. There are a few reasons for this. Firstly, there is some asymmetry in the tax treatment of interest incomes and expenses. We don’t have interest withholding tax, so we have an anti-tax avoidance regime which disallows deduction of interest expenses of corporate paid to overseas associates. This is to prevent profit shifting, but this also proves to be a deterrent for corporates to use Hong

Kong as a lending and borrowing centre. We are also aware of competition in the region for corporate treasury activities. That is why the Financial Secretary, John Tsang, announced two policy initiatives in his Budget speech in February. Firstly, to address the tax asymmetry issue, and secondly, to provide a concessionary tax rate regime for corporate treasury operations here, provided they fulfil certain criteria. So, we will provide them with a half tax rate of 8.25%, instead of the usual 16.5% for profits tax.

THE CORPORATE TREASURER: What research have you conducted to feel confident that this particular strategy – especially as tax concessions seems to be the key – is going to work?

HOWARD LEE: There are a lot of studies and surveys in the market. We worked with a consultancy firm last year and looked at the data they provided. It covered a lot of companies and the key factors they would consider in setting up a centre. We do well in some areas compared to other regional choices, [such as] Singapore and Shanghai. We don’t have FX controls, and we have free flow of capital. But we acknowledge some companies may actually be attracted by headline incentives. We know that double taxation agreements (DTAs) are clearly important. We have made a lot of headway in the past few years to improve on this. Hong Kong DTAs increased from five in 2009 to 32 up to date. And 13 more are being negotiated now,.

SANJEEV CHATRATH: I agree with Howard that tax by itself is not a strategy, but proposed tax changes address a reason that is holding corporates back from centralising more of their treasury functions in Hong Kong. Hong Kong has many things to offer as an attractive location for treasury centralisation. Being a gateway to China, Hong Kong is of strategic importance to many corporates and institutions that have substantive interests in the mainland. Hong Kong has a strong market infrastructure and operates with the rule of law. It has deep financial markets and liquidity venues for treasury centres, and a strong base of skilled talent to operate these centres effectively. All of these factors work together to attract more flows and treasury centres in Hong Kong.

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Tony Lam, ex-Valspar

THE CORPORATE TREASURER: Francis, would you agree these proposals are beneficial and attractive?

FRANCIS HO: I think when we look at the attractiveness of Hong Kong or elsewhere as a regional treasury centre, we look at a number of key parameters. Tax is important, but we also look at the infrastructure, the integrity of the speed of the information flow which is provided by companies such as Thomson Reuters. If I can look at the CLP, we are a utility company based in Hong Kong, but we have investments outside Hong Kong, in mainland China, in Taiwan, Australia, India and Southeast Asia. We always prefer to have the management of banking and treasury centralised to the extent it is appropriate. It’s about better corporate governance, and internal control and compliance. We can also come up with the right management and the team of staff to perform the group’s activities as a whole. Any initiative that delivers more infrastructure, a more favourable tax regime, or less complicated but effective policies to help corporates to further consolidate their financial treasury management, will be welcomed.

THE CORPORATE TREASURER: Tony, you have worked for a large US

multinational as a treasurer. How would they view these proposals?

TONY LAM: I agree with Francis. I think we welcome the tax incentives, but honestly, from the multinational perspective, it’s not the primary factor. I think for Hong Kong it’s a good step to launch the tax incentive to ensure it is in line with Singapore. But I think Hong Kong can do more, because I cannot imagine a major business setting up a regional treasury centre here if its major business centre or trading company is elsewhere, say, China. For example, in Singapore, not only do they have the tax incentive for the regional treasury centre, they also have tax incentives for regional headquarters. This is something that the government should look into. Singapore also has a tax incentive to promote themselves as the hub for the trading of commodities, where the tax can be as low as 10% if companies satisfy the requirement.

THE CORPORATE TREASURER: How do you respond to these comments, Howard?

HOWARD LEE: I think for the concessionary tax rate, this is like icing on the cake, so to speak, because as you know, Hong Kong doesn’t usually practice tax incentives schemes like some other places do. So this is more of a facilitation to ensure that a multinational corporate can operate its treasury centre here on a regional basis on a concessionary rate scheme, rather than to give a particular industry, a particular sector, preferential treatment. I agree, however, that one or two measures are not going to be enough and we will continue to strengthen different aspects of our financial platform. We have also stepped up our engagement with corporate treasurers and have met with over 50 companies in the past year.

THE CORPORATE TREASURER: Ultimately, the decision to locate a treasury centre will boil down to where the business is, no?

SANJEEV CHATRATH: Companies are rethinking how deep they should go into a market and how they leverage new technology to enhance their consumer’s experience while improving their own operating margins. There is a rise of new firms or disruptors that are challenging

traditional business models and changing treasury flows. It is important to remember that treasury management by itself is not the goal of the firm. Treasury is there to serve a purpose for the broader institution. And, in my experience, the most progressive treasuries are ones that appreciate what business strategy is, and, in support of that strategy, they provide an environment that is robust, risk prudent and enables the business to head where it aspires to get to, as opposed to tying its growth ambitions to the treasury and financial infrastructure of the past.

HOWARD LEE: So many more multinational companies, with increased business presence in Asia and rising revenues here, are having to deal with not just renminbi, but also other currencies in this part of the world, when in the past it was just the US dollar. So now they probably need to rethink their treasury strategies to accommodate these changes. This presents a different opportunity for financial centres in the region. Another trend is that many mainland companies have a really strong desire to internationalise. Given the size of the mainland, many companies are of global scale in terms of their operations, assets or revenues. But compared to many Western companies, they are still lagging behind in terms of internationalisation. These companies also need to set up new treasury operations as they go out of the mainland. I think we are entering at the right time.

FRANCIS HO: That’s a valid point. When China companies come out, they will need to apply good treasury strategies in terms of managing fund flows, FX risk, and also to look into global debt markets to source optimal funding. That is one of the reasons why in the past five to eight years or so, China-based companies have featured so much in the international debt markets via Hong Kong. They come to raise funds, not only in US dollars but also sterling and euro recently, where they have investments in those regions. That’s the changing landscape that would further strengthen Hong Kong as a treasury centre.

THE CORPORATE TREASURER: Tony, do you agree Chinese companies think along those lines?

TONY LAM: I think finance executives

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Howard Lee, Hong Kong Monetary Authority

Francis Ho, CLP

in China understand the Chinese system, but they don’t know so well the Western models, which are very different. That’s why I think Hong Kong has the advantage. We have a talent pool. When they are talking about China, they don’t have the talent pool; they don’t know how to notionally pool internationally, for example… That is why big Chinese companies establish their financial centres in Hong Kong; they have an incentive to raise capital there, whereas Western multinationals don’t use Hong Kong so much, preferring to opt for New York or London. That’s the difference.

PETER WONG: The CTC policy adds an important dimension to the development of Hong Kong’s role as an international financial centre. The intensity of the volatility in the market has not actually subsided after the global financial crisis. Market uncertainty and expected volatility have actually increased. Look at the Swiss franc, the uncertainty of renminbi and also the asymmetrical movement of interest rates between the US, Japan and Europe. This treasury risk aspect is very important.

With a strong corporate treasury sector, we have a pool of players located here that are able to transfer the risk and liquidity efficiently between the corporates and the banks to avoid gridlocks and risk concentration in the financial system… Successful CTCs can run their operating cash balance with minimum liquidity buffers and use their core and strategic cash holdings to improve banks’ net stable funding ratio and liquidity coverage ratio.

THE CORPORATE TREASURER: Is there a race against time here? When the renminbi fully internationalises, surely places like Shanghai become even more attractive as financial hubs?

HOWARD LEE: China itself is a huge market, and Shanghai would be a very strong financial centre for the domestic market, and to a certain extent, cross-border. But if you are talking about requiring an international cash pool facility, I think it makes a lot of sense for the international pool to be in Hong Kong and a domestic pool in Shanghai with a linkage between the two, for

example. I think this makes sense to many companies.

THE CORPORATE TREASURER: You mentioned rule of law and corporate governance, Francis. Does this offer Hong Kong an advantage too?

HOWARD LEE: I think Hong Kong’s legal system and infrastructure works well because it is easy to understand. And you can have access to a lot of products and services, with very reasonable cost. In Hong Kong, whoever you approach, whichever organisation you access, will generally give you very efficient product and services, whether it’s on an institutional or a retail level. I think that China and other countries, are catching up fast, but I believe Hong Kong still offers very competitive advantages. People in Hong Kong are very committed, effective, and they have a high level of integrity.

SANJEEV CHATRATH: Typically, treasury centres centralise a range of financial flows and activities. Because they are centralising a lot of the operations from the markets to the centre, it’s important to have close oversight on those activities that are happening in the markets. Hence, access to timely and accurate information is absolutely key to any efficient treasury centre. This includes internal data as well as access to external market news and events. Many treasury centres are leveraging technology to have dashboard visibility to their underlying financial flows, performance benchmarking, and their risks to market events or counterparties. They are also looking for

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Peter Wong PwC

open and trusted platform, where they can have access to multiple providers as opposed to propriety one-to-one solutions.

THE CORPORATE TREASURER: By virtue of competition?

SANJEEV CHATRATH: Yes, That enables you to run your treasury centre more efficiently. Lastly, the pace of regulatory reforms has been enormous in the past few years. Treasury centres have to anticipate the impact of those changes to their counterparties. These regulations are extending beyond national borders and financial institutions into corporates. That’s where prudent governance and risk management plays a role – executing to international accounting standards, managing financial crime and reputation risk, improving processes for know your customer and know your suppliers. Given Hong Kong’s infrastructure and regulatory standards, it is well positioned.

THE CORPORATE TREASURER: On the theme of governance, the HKMA has proposed how it will allow companies to take advantage of the perks. Please outline your thinking.

HOWARD LEE: We do have a particular qualifying set of activities to be eligible

for the concessionary tax rate. The current thinking is that the qualifying corporate treasury centre would need to be a special purpose vehicle (SPV), conducting corporate treasury activities. We have to define what these corporate treasury activities are, and they need to be all-encompassing. Any corporate treasury centre would do cash and liquidity management, hedging, financing – and all these would be counted as qualifying corporate treasury services or transactions of the corporate treasury centres for enjoying the half-rate concession. There will also be safe harbour rules allowing the qualifying corporate treasury centres to conduct certain non-qualifying activities.

FRANCIS HO: I understand the SPV concept comes from the thinking that no one should shift non-CTC income into the half rate concession with a single entity with this kind of tax reduction scheme. Speaking to some corporates, including

CLP, there are a few issues here that they would like to clarify. When we look into the corporate world, there is a good percentage of companies that set up the corporate treasury management centres, including a regional treasury centre, in the form of a division under a business group instead of a SPV. But before jumping to conclusions, I think corporates should keep an open mind as to whether they can leverage on the tax incentive to come up with the right structural change; and if they encounter impediments they cannot mitigate, they should voice their concerns in the consultation process.

A second observation is the safe harbour. In the proposal, it offers a percentage or proportion threshold as an alterative but this relativity test may prevent companies with diversified businesses to be recognised as a qualifying CTC despite having active treasury functions . For example capital and non-capital intensive businesses can create different outcomes depending on industries or business sectors. For example, CLP is in the power industry and we are very capital intensive. So, in terms of the treasury activities, even though we have a good number of treasury activities in Hong Kong – on the balance sheet we have $10 billion of US dollar hedging alone – but compared to our balance sheet, it can be a small percentage. A trading company may have a larger percentage of treasury management activities because they are less capital intensive but they will more easily qualify as a CTC under the proposal.

HOWARD LEE: I think the points are well made and we have to strike a balance between an effective tax collection regime and a business friendly regime. So where the balance should be struck is something that needs more discussion. To touch on the timetable, we hope to release more details on the proposed legislation in the next couple of months, receive industry feedback and draft the specific legal provisions. At around the turn of the year, we wish to be in the position to present

“The CTC policy adds an important dimension to the development of Hong Kong”

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Sanjeev Chatrath, Thomson Reuters

a bill to the Legislative Council, and hopefully they will enact it before the end of the next legislative year [summer, 2016].

TONY LAM: We also need to think about the human angle to this. So, from a multinational perspective, for example, we can channel cash flow from a single entity entity to wherever from an infrastructure point of view, but the decision maker can be based anywhere they like. If Hong Kong wants to ensure the decision makers locate their key treasurers here, then they need to think about how to do it. I know that to qualify for regional treasury status in Singapore there is a requirement to have qualified staff living in Singapore. Hong Kong should consider that option.

THE CORPORATE TREASURER: Noted, but there’s only so much a government can do. At some point it is down to the corporate to decide if it is necessary.

PETER WONG: By having a treasury centre you are telling the market that you have an effective treasury management framework in place, that is delegated to professional managers to implement. You will need dedicated treasurers to get this done. You find that not all companies have a dedicated treasurer, maybe a financial controller, which is okay. But as they grow to a certain size and become more global, pressure points will come out when we face another financial disturbance.

THE CORPORATE TREASURER: But the cost of setting one up may seem like a burden to those without the experience. SANJEEV CHATRATH: In the past there was a lot of emphasis on labour and cost arbitrage when setting up centres. I draw a comparison between shared service centres and regional treasury centres, whereby in the past, containing

these services at the lowest cost price point available was important. However, companies are beginning to think of them as centres of excellence and manning them with staff who understand risk and the flows much better; they can be a lot more nimble to the requirements from a business point of view.

I have observed very substantial investments being made in treasury centres. The scope of the centres might vary depending on the institution but there are still significant financial benefits to be gained by centralising and netting transactions, or by hedging flows. Many firms have also implemented re-invoicing centres, and in-house banks to manage or augment their treasury activities. And as more institutions grow, they realise they have more prudent risk management practices when much of this is contained under a single roof, as opposed to having it geographically distributed. It is then much easier to understand what exposures they are vulnerable to and how they can manage that more effectively.

FRANCIS HO: I think that when a business grows to a certain stage, then it needs to go through the process to see if a treasury centre is relevent for the company and its ability to manage its increasing risk exposure. The other aspect to consider is the ability to handle any contingent event. For example, MNCs or companies in Hong Kong that have businesses in other cities may not have instant access details of financial information, like the debt covenants for goup companies or your gross or net FX positions. Having that data centralised and accessible in a timely way is important. If action needs to be taken, people can look at the group as a whole.

PETER WONG: Companies are struggling to get bank capacity at a time when the costs of facilities are going up. Some global banks are cutting back risk-weighted assets in a big way. If you can centralise all the facilities in a CTC like Hong Kong, you can actually distribute the capacity from there abroad; you can actually optimise your funding by giving it to those who need it. Also, by compiling those pies we can actually have better bargaining power with the banks. I think we can only see the cost of financing going up and see bank facilities curtailing. The company board needs to manage liquidity risks, and that is where centralised treasury management comes in. I encourage corporates to take advantage of this opportunity to assess the importance of a CTC to their treasury function. n

“To qualify for Singapore CTC status there is a requirement to have qualified staff living there. Hong Kong should consider that option”

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