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From the Market: Financial Services

From the Market: Financial Services
 
     
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In 2009, the Chinese government began permitting cross-border trade settlement in RMB, which benefitted trading companies by providing less exchange loss and more efficiency in capital utility.

The rapidly expanding RMB scheme nevertheless remains in a pilot phase and is not widely applicable. Only so-called Mainland Designated Enterprises (MDE), which have been jointly approved by the People’s Bank of China, Ministry of Finance, Ministry of Commerce, General Customs, State Administration of Taxation, the Bank Regulatory Commission and other relevant authorities can settle cross-border transactions in RMB. For a Chinese list of MDEs see the official People’s Bank of China website (www.pbc.gov.cn).

However, when discussing the RMB scheme’s implications for market entry and operating scenarios in China, a number of issues arise, some of which are detailed below.

Setting up a Wholly Foreign Owned Enterprise (WFOE) in China seems like a pretty big commitment. Establishing a Representative Office seems cheaper, and I can still access a big market thanks to the new RMB trade settlement arrangements.

The RMB settlement scheme sees regulations concerning Representative Offices and WFOEs remaining unchanged and unaffected. A Rep Office is cheap to set up and has no requirement for paid-in capital, but it is not an independent trading entity. Nowadays, the PRC government strictly scrutinises China’s Rep Office activities, especially their tax liabilities. Furthermore de-registering a Rep Office is both time consuming and expensive.

Whilst a Rep Office can serve as a presence on the ground in China for liaison, market research, promotion and coordination purposes, as a non-profit making office of a foreign firm, it may not sign contracts, keep stock, issue tax invoices or receive monies on behalf of its parent company. In effect, a Rep Office may only help co-ordinate international transactions between the UK and China, though these could now be settled in RMB subject to the status of the Chinese customer.
 
Setting up a Manufacturing WFOE is indeed a larger commitment, but it can both expand the market and decrease the selling price to the Chinese customer. That said, China’s manufacturing and labour costs have increased since the implementation of the new Employment Contract Law.

Setting up a Trading WFOE, or Foreign-Invested Commercial Enterprise (FICE) that can legally import manufactured items and then sell or distribute in China is also a larger commitment, but these offices can keep stock, reduce delivery times and lower the selling price to the Chinese customer.

For exporting luxury, branded or high value items to China, a “Rep Office + RMB trade settlement” solution may be sustainable, but cost effectiveness ultimately depends on a company’s operation model and business strategy. If a WFOE cannot help reduce costs, there may be no point in setting one up.

I already have a Rep Office in China. With the new RMB trade settlement arrangements in place, I can now do everything I need to without upgrading to a FICE.

Subject to the observations above, this may be true, but under the Chinese government’s increased scrutiny, Rep Offices are not as cost-effective and helpful as they once were, while a FICE may have advantages that will add greater value to the parent company. Also remember that the Chinese tax bureau is now focusing on Rep Office activities, so be sure to operate within the existing rules.

I have been sourcing products from a Chinese supplier for my European markets for years. Now with the new RMB trade settlement arrangements, I can also distribute the products to Chinese customers, direct from my Chinese supplier. The final customer can pay RMB into my bank account.

The new RMB trade settlement regime is not linked to existing Chinese regulations on selling products in China. A foreign company cannot buy from Chinese suppliers and sell to Chinese customers directly without its own FICE. Doing so would violate foreign exchange and customs regulations, and can be seen as an attempt to avoid Value Added Tax and Enterprise Income Tax. The new RMB settlement regime means a closer scrutiny of cash flows.

Setting up a FICE could decrease the selling price to the Chinese customer and increase gross profit margins from transactions. However, China’s gross profit margins are not what they once were, after the increasing labour costs, inflation, and the RMB’s appreciation are taken into consideration.

It may be best to tread carefully; the RMB settlement regime is still in its pilot implementation stage, and implications for firms entering and operating in China will face many uncertainties.
 

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