Cash Management Solutions in the China Market

Possibilities & Best Practice

Beijing - Shanghai - Guangzhou - Hong Kong- Shenyang – Chengdu - Wulumuqi

(8610) 8532-1919

(8610) 8532-1999

www.lehmanlaw.com

Contents

• The Collection Cycle - Tips and Best Practice

• The Payments Cycle - Tips and Best Practice

• Liquidity Management - Tips and Best Practice

The Collection Cycle

What Are Your Options For ETF Settlement in China?

A. PBOC China National Payments Network (CNAPS)

B. Settlement through traditional channel of local and/or foreign banks’ internal branch clearing networks

An Overview of CNAPs

The Collection Cycle

The only nationwide, independently run EFT clearing network in ChinaPoint-to-point direct transfers running on PBOC-maintained, reliable settlement system; over 20,000 direct clearing membersBased on SCB client experience, 80% of the transfers arrive within 24 hoursSame day arrival between CNAPS direct clearing memebersExtended network coverage based on all member banks’ geographic locationsOne standard remittance instruction for customer’s buyer to remit fund, ease customer sales office administrationNOTE: upgraded CNAPS to be introduced in 2003

The Collection Cycle

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PBOC CNAPS System: connectingall banks

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A - Payor account at local bank branch that is PBOC eLink member hub

B - Payor account at local bank branch that is not PBOC eLink member hub, I.e. sub-branch at remote area or small village

- Collection takes total 1.5 days up to longest 2 days

PBOC Settlement System

Member hub

Member hub(A) Same day transfer (T+0)

(B) Take 0.5 to 1 day

Member hub

0

500

1000

1500

2000

2500

3000

3500

4000

4500

Foreignbanks

PBOCbranches

ICBC ABC BOC CCB ShareholdingBanks

CityCommercial

Banks

Rural CreditUnions

Policy Banks

‘Big 4’State-owned Banks

Minsheng

SPDB

Hua Xia

CN Everbright

Fujian Industrial

SZDB

CMB

GDB

CITIC

BOCOM.1727

3503

4102

1988

3743

1446

573

1687

684

PBOC CNAPS Member Hub Statistics

Summary of Traditional Channel - Routing Through Banks’ Internal Clearing Systems

The Collection Cycle

Historically, the key reason for delays in remittance process due to need to ‘settle’ between at least 2 banks internal clearing systemsLarge local banks nationwide internal branch clearing networks effectively operate as ‘separate national clearing networks’Currently, can consult with your Banking Partner on how to leverage on the local banks’ extensive network to your advantage

Tips for Best Practice in Routing Customer Payments

– Undertake a ‘PAYER BANK ANALYSIS’ with your Bank partner– Your Bank partner will help select a the payment route that will result

in the quickest settlement time– Your Bank partner will also assist in communicating any change in

payment routing to your customer base– This systematic approach to reviewing payer behavior will ensure that

your EFT collections are routed in the most efficient manner possible

The Collection Cycle

Issues Faced in Processing Payments - In Brief

How to facilitating payments processing via electronic banking platformsFacilitate remote authorizationSecure authorization environmentCentralized payables processing3rd party bank payments initiation

Trend toward establishing ‘shared service centres’ for payments processing for multiple legal entities in China

The Payments Cycle

Tips for Best Practice in Processing Payments

Choose a Bank partner in China to provide robust e-banking platform that accommodates:

Complex authorization matrix capabilitiesRemote payment authorizationChinese language capabilitiesAutomated reconciliation with internal AP system3rd party bank payment initiation

The Payments Cycle

The Payments Cycle

1. File downloadedfrom your A/P systemand sent to the bankfor processing.

2b. Direct credit posted tobeneficiary s a/cs thru ` PBOCclearing system andremittance advicefaxed to payee.

2b. Credit notes sent to localclearing and remittanceadvice faxed to beneficiaries.

3. Reconciliation file sentback to your office forautomated reconciliation.

2a. Payt via 3rd party bank -instructions sent to localbank to debit local bank a/c

2b. Client a/cswith foreignbank (SCB)

Banks

Liquidity Management

Corporate Structure Issues - Use of Holding Company as Re-Invoicing Centre

China Holding Company

Subsid A Subsid B Subsid C

3rd party customers

Inter-co sales -->

3rd party sales -->

Reinvoicing Centre Cont’dHolding company as distribution agent (MOFTEC approval required, K over RMB30 mio.)Distribution subsidiary, often with sales function. Can centralize collectionsRaise cheap funding through discounting commercial draftsCan iron out cash imbalances by offering preferential terms to factories in need, but amount and tenor restrictedTax impact - VAT and income tax

Liquidity Management

Reinvoicing Center

Re-invoicing centre

Factory B

Factory C

Factory A

Customers

Term payment

SuppliersTerm payment

Commercial draft

Pref. deposit

Credit line drawdown

Discounting without recourse

Advance payment

Banks

Liquidity Management

Sweeping TechniquesIn many cases, MNC will have multiple sales branches

scattered throughout China, collecting sales proceeds locally.

This results in numerous issues, including:idle balances left in branch accounts;delayed transit of funds to HQ ‘concentration account’manual compilation of bank account reports;management time/effort managing multiple bank

accounts with different banks;inadequate ‘central’ control over branch bank accounts

Liquidity Management

Sweeping TechniquesThese issues can be addressed via establishing a sweeping

structureBrief mechanics of this structure as follows:

All branch offices open collection accounts with one foreign bank.Where branch office is located outside permitted scope of foreign bank’s

RMB business, foreign bank arranges for branch to open collection accounts with partner local bank.

A minimum branch account threshold is set by HQ (could be zero balance), and foreign bank monitors balances on pre-set basis. Where funds in branch accounts exceed minimum amount, automatically swept to the HQ concentration account.

Comprehensive reporting on collections is provided for improved management information and control.

Liquidity Management

Pooling of Funds - Bilateral Entrustment Loans

Entrustment loans effectively allow inter-company financing activities by routing the transactions through a financial institution (as ‘entrustment loan agent’).

Bilateral entrustment loans are a simple and effective tool to use when group has:

one entity with consistent levels of surplus cash, and other entity(ies) that are borrowing from banks.

one entity with stable level of bank borrowings, and other entity(ies) with consistent levels of surplus cash

‘Bilateral’ means individual entrustment loans signed between the Corporate Lender and the Corporate Borrower for each entrustment loan transaction.

Cost/Benefit of a Bilateral Entrustment Loan

CostsStamp duty - 0.015% of principle amount Business tax on interest earned by cash surplus entities - 5% Trust loan fees

BenefitsImmediate reduction in loan interest paid to banks for working capital requirementsImprovement in yield on surplus cash for lending party

Liquidity Management

Pooling of Funds - “Virtual Pooling Structure”• When to use vs. bilateral entrustment loan?

• When group has BOTH multiple cash surplus and cash deficit entities spread around the country

• Benefits groups of companies with net working capital requirements• Reduces borrowing costs at individual and overall group level• Pockets of excess cash better remunerated at individual and group

level

Liquidity Management

Virtual Pooling - Implementation

• Participating entities and bank enter into master entrustment loan agreement

• Transfer funds from cash rich to cash poor entities through a designated Pool Header

• At any one time only the exact amount required can be borrowed by the operating entities from the Pool Header

• Pool Header enjoys beneficial conditions on credit line and more flexibility to invest excess cash

• Backstop line of credit provided to pool participants to ensure liquidity available at all times

Liquidity Management

Operating a Virtual Pool

Credit line drawdown (can be made interavailable to all participating entities)

Co 1 Co 2 Co 3 Co 4 Co 5

Cash > Threshold

Cash < ThresholdCash > Threshold

Trust loan drawdown

Trust loan + interest repayment

Trust loan drawdown

Trust loan + interest repayment

Cash < Threshold

Company 6 (pool header)

Pool managerBanks

Cost/Benefit of a Virtual Pool

Costs• Stamp duty - at least 0.015% of principle amount (assuming 3

parties to the entrustment loan agreement)• Business tax on interest earned by cash surplus entities - 5% • Trust loan fees• Arrangement fees• Individual drawdowns and repayments are exempted from

stamp dutyBenefits• Reduction in loan interest paid to banks for working capital

requirements

Liquidity Management