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In a Bind

Spoke to Rebecca Brace from Financial I magazine about growing companies focus on the emerging markets. Published on Financial I Magazine on Q3 2011 issue.

Growing companies are increasingly looking at emerging markets, but there are some pitfalls. Some are falling victim to 'trapped cash', and with each country devising its own set of rules for foreign exchange, it is essential to read the small print, warns Rebecca Brace.

Low interest rates and economic growth in the Western world are prompting companies to  look  at the growth  opportunities  offered by emerging markets. "It's a huge trend," remarks Juan Pablo Cuevas, managing director, Latin America corporate GTS sales executive, Bank of America Merrill Lynch.

"In Latin America, since the cri- sis, Brazil, Peru, Columbia and Chile have been booming. While we're not seeing double digit GDP growth, they are growing at 6%, to 8%,." However, the emerging markets' growth story does come with a tale of caution for companies. While they  may  be drawn in by the fact that countries in Latin America, Asia and Africa typi­cally boast high  levels  of growth, they also tend to be highly regulated and companies moving into these countries for the first time could encounter a range of obstacles - not least when it comes to cash management.

Many of them have restrictive for­eign exchange controls and tax laws, often designed to prevent a sudden exodus of foreign currency from the country. For  corporate  treasurers, this can cause a major headache in the form of "trapped  cash",  which is cash that a company owns in a particular country but cannot easily move out of there.

In such countries, often  the  only way that funds can be repatriated  is in the form of dividends. However, this has its limitations, as the trea­surer of a technology company operating in Asia ex plains: "This is a time-consuming process:  you  need to wait until the end of the year, complete the accounts, get them audited, pay any  taxes  which  are due (and get a certificate  confirm­ing this), pay any withholding taxes due on the dividends, and then finally complete the remittance. In the best of cases, you can get cash accumulating for a period of up to 18 or 19 months."

For  treasurers  aiming to build global or at least regional liquidity management structures and look­ing for a worldwide view  of  their cash position, this is less than ideal. However,  the  extent  to  which  this is a problem for individual com­panies depends on the  nature  of the business and the countries in which it operates. "There are  a  lot of myths about liquidity trapped in the largest countries," says Cuevas. "It's certainly complicated in Venezuela, where large companies are growing 30'% but they have dif­ficulty moving their liquidity out. But in the rest of  the  countries in Latin America, treasurers have learnt that it's a  matter  of under­standing local practices and rules. For example, in Brazil, you can move liquidity out and have access to the FX markets - it's just a mat­ter of presenting to the  central banks what you're going to do."

Problems and solutions

For information provider Wolters Kluwer, trapped cash in Asia and Latin America only represents 0.5%, of the company's total revenues and therefore  the  impact  is  less than for some other companies. Nevertheless, the trapped cash question does present certain diffi­culties. Wolters Kluwer operates in markets such as China, India and Latin America, each of which presents different problems. "China has regulatory and compliance procedures which you need to fol­low if you want to bring in money - getting money  out  of the country is far more difficult," comments George Dessing, vice president, corporate treasurer. "In South Africa there are some currency exchange regulatory constraints. In Latin America it's more general regula­ tory and compliance constraints." Despite these obstacles, Dessing is undaunted by the difficulties pre­sented by trapped cash. "I would actually say that trapped cash is a result of doing business globally. It does prevent us from having our liquidity as efficient as  we  would like, hut overall it's pretty minimal."

Dessing outlines four key steps that are important when manag­ing trapped cash: "First of all we educate ourselves: we try to learn from other companies by  using our network, particularly via the Dutch Association of Corporate Treasurers, which has more than 400 members. Secondly, we communicate with people on the ground. Thirdly, we have a dis­ciplined process; with tailored funding amounts we try to ensure liquidity for those countries. And finally, we stay tuned - so we try to monitor those amounts in a certain processed way."

Where liquidity management struc­tures are concerned, often notional pooling can help where physical pooling cannot. "In emerging mar­kets, there are  often  restrictions  on the physical flow of cash  where foreign currency is involved," says Adnan Ghani, head of global trade finance at RBS. "Rather than the physical movement of cash to a centralised operating account, com­panies can do notional pooling - in other words, the bank notionally calculates the benefit of those bal­ances and gives the benefit to the company at its head office account."

Other companies are looking beyond the more traditional solu­tions. White goods manufacturer Indesit, headquartered in Italy, has operations in a number of emerging markets, including China, Ukraine, Russia, Poland, Hungary and Argentina. The diverse nature of these countries has led to the com­pany taking an innovative approach to the trapped cash problem in the form of a  hybrid cash  pool.  Unlike a notional pool, the  hybrid  pool does involve physical cash flows: each entity holds an account in Amsterdam and transfers funds to that account. Unlike a typical physi­cal cash pool, however, there is no co-mingling of funds and the bank offsets credit and  debit balances  on a notional basis, thereby avoiding inter-company loans, which several countries prohibit.

While the hybrid pool is not a panacea - funds from Ukraine and China cannot be  included  due  to regulatory restrictions in those mar­kets, for example - the  solution does cover more countries  than other solutions would have  done and has resolved the trapped cash question in countries  like  Russia and Argentina, while enabling the company's external financing needs to be reduced. "There is no single solution that works across all of the countries we operate in, but this solution works beautifully in sev­eral difficult countries," comments Mustafa Kilic, regional treasury and group insurance manager, Indesit.

Even when cash is not trapped in emerging markets to start with, it is important to ensure that it does not become trapped. International children's charity Plan International raies funds in 20 countries, including the UK, Germany, Canada, USA and Japan and spends them on develop­ment work in countries across Asia, Africa and the Americas. Budgets and expenditures are monitored closely in order to ensure that cash does not become trapped in  those  develop­ing markets. "We could have  issues of repatriation if our expenditure changed or was lowered from  bud­get during the course of the year, so we negate this  potential  problem by delivering funds to  those  market on an as-needed basis," explains Annemarie Moore, group treasurer. "Therefore if we did need to repatri­ate cash, it would not he very much."

Sudden change

Even for companies that have found solutions for their trapped cash i sues, it  i important to continue to monitor the regulatory climate in emerging market. In some countries the rules can change with little warning - as in Argentina, where the refusal to process certain imports at customs is currently mak­ing it virtually impossible for compa­nies such as Indesit to  import  goods or indeed to  continue  production there. "Although we've found a solu­tion to the trapped cash problem, for the past few months the government has not allowed companies to import raw materials or finished goods," says Kilic. "It's making  conditions for importers impossible - including some local producers. At this stage, we can't see how we're going to get around this situation." Despite this, Kilic remains philosophical. "Every day another surprise comes up - while this can be difficult for treasurers to deal with, when  you are working in emerging market you are used to these kinds of barriers. //

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