Considering ways to cash in on the China boom? Are you baffled or overwhelmed? Well, you're not alone. The China market continues to pose many challenges to U.S. exporters. Government policies, such as differential tax treatment, subsidies, price controls, and disparate technical regulations and product standards, often favor domestic producers. In addition to creating barriers to entry, such policies erode profits for U.S. exporters. Moreover, as a result of stringent currency controls, it is not uncommon for U.S. exporters to experience delays of several months for payment of goods shipped. This situation is further complicated by a cultural divide, which can make it difficult to understand what is really happening, as well as the slow adoption in China of online cross-border trade management platforms, which can facilitate supply chain communications and provide timely updates on trade activity.

Payment delays can be a reflection of the current regulatory environment in China. The Chinese government, under the auspices of the State Administration for Foreign Exchange (SAFE), carefully monitors and controls the flow of funds in and out of China. SAFE's policies have created enormous cash deposits that can be further deployed to drive economic growth in China, but make it difficult to move funds offshore. With rare exception, for every remittance, there must be a corresponding import transaction that is documented by Customs. No import payments can be wired without government documentation confirming that the goods have arrived and cleared Customs. Government-issued IC cards (similar to Smart cards) must be used by the banks to verify the status of goods per Customs' records. If there are delays or inconsistencies in Customs' record keeping, the banks are prohibited by SAFE from making payment. U.S. exporters are consequently subject to payment delays.

Making the system work for you

The value of traditional trade instruments, namely the centuries-old letter of credit and documentary collections, extends beyond risk mitigation in this scenario. Although their use incurs fees, which are often borne by the exporter, these instruments help ensure timely payment as well as assurance of payment. In effect, they provide a means to legally circumvent SAFE's requirements, since both Chinese and foreign banks operating in China will not require Custom's clearance documentation in order to make payment. This can mean lowering a payment cycle of 1-2 months on an open account sale to a matter of days.

Selling on partial pre-payment terms-be advised

U.S. exporters seeking pre-payment, either to mitigate risk or to obtain capital to produce goods, should examine whether their payment policies factor in Chinese regulations to their advantage. Ideally, these regulations should be factored into their contract negotiations from the outset.

The Chinese government stipulates that U.S. exporters arrange to have a standby letter of credit issued for the amount of the pre-payment. This measure is another tool used by SAFE to prevent the illegal transfer of funds offshore. In some instances, this requirement can be waived if the amount of the pre-payment meets a certain percentage and dollar value of the total transaction. Generally, the rule of thumb is that no standby letter of credit is required if the down payment is less than 20 percent of the total purchase price and less than $200,000.

If the requirement cannot be waived, the exporter should consider whether he could shoulder the potential liability. There will be a drain on working capital since the exporter's line of credit will be used to secure the standby letter of credit and fees will be assessed by the issuing bank. Should the buyer decide to cancel the purchase after prepayment is made, the standby letter of credit is issued, and production has commenced, the exporter may face a significant loss. The buyer can draw on the standby letter of credit to recover the pre-payment while the seller is saddled with half-finished goods and no payment.

Expediting payments under open account

Open account, which now accounts for more than 80 percent of global trade, is especially appealing for U.S. companies that export to subsidiaries in China. Still, the higher risk of selling into China, even to a subsidiary or a known and trusted buyer, justifies the use of direct collections. Rather than send the export documents to the subsidiary in China and contend with the vagaries of SAFE, it is usually much more expedient to send the documents through a bank via direct collections, which can reduce days sales outstanding by several weeks. Exporters can also take advantage of the online trade platforms offered by their global trade banks to automate and streamline the processing of their documentary collections.

Looking ahead

China's regulatory environment is changing. In July, the peg to the dollar was scrapped, allowing the yuan to trade more freely, albeit within a range defined by the Chinese central bank. This change has, in turn, necessitated other reforms such as the trading of yuan currency forwards and swaps in the onshore interbank market and the participation of non-financial companies with annual import-export business in excess of $2 billion in the spot currency trading market.

It is important to note, however, that foreign exchange reforms are separate from SAFE currency controls, which are not likely to change in the foreseeable future. U.S. exporters are well advised to factor in these constraints when deciding the terms on which to sell to China. The regulatory environment can have a dramatic effect on your success when cashing in on the China boom.