Taiwan is an important step in IT supply chains for companies around the world, but the country’s oversaturated banking industry will continue to pose challenges. Cybil Huichen Chou reports.

Taiwan’s economy expanded by 10.5% in 2010. The economic boom, spurred by robust exports, facilitated large banks in Taiwan to score 30-40% annual growth in trade finance.

But since the start of 2011, the earthquakes in Japan and aggravating sovereign debt crises in the US and Europe have cautioned some Taiwanese traders. That said, the impact on most Taiwanese firms are containable, bankers argue.
“While the earthquake disrupted supplies of some electronic components to Taiwan, the impact is not remarkable given Taiwan can alternatively source these products from other suppliers like South Korea or find local suppliers,” says Carl Wegner, head of transaction banking at Standard Chartered. “In fact, it gave an opportunity for some smaller suppliers to expand to meet new markets.

“Although the sovereign debt crisis may caution some Taiwanese exporters relying on these markets, the consumer side of electronics businesses have been fairly steady and relatively immune from the headwinds as demands for IT products, such as iPhone or iPad contracted to Taiwan manufacturers remain robust this year,” he adds.

For several Taiwanese banks, whose largest cross-border trade portfolios come from China, a slew of recent banking industry liberalisations by the Financial Supervisory Commission (FSC), the country’s main financial regulator, offer a ray of hope to generate and boost profits. In Taiwan, interest-rate spreads for banks are among the lowest worldwide.

In 2010, Taiwan and China signed the Economic Cooperation Framework Agreement (ECFA), the landmark free trade agreement between both sides, which gave preferential treatment to Taiwanese banks, including the right to set up ranches one year after opening a representative office, whereas other foreign banks need to wait two.

In July, FSC gave the green light to 10 domestic and foreign banks to run renminbi (Rmb) business in their offshore banking units and overseas branches, with plans to extend Rmb licences to domestic branches in future.

Meanwhile, FSC announced in September to loosen existing restrictions on Taiwanese banks’ business operation in mainland China.

Under the new regulation, a Taiwanese bank and its overseas subsidiary or bank affiliates will be permitted to enter China by establishing branches, subsidiaries or make direct equity investments in mainland banks. Current Taiwanese regulations limit Taiwanese banks to using only two of the three options. In addition, banks or financial holding companies will also be allowed to invest in more than one mainland Chinese bank.

Both local and foreign banks in Taiwan hold that such deregulations are positive news as they leave banks more leeway to manoeuvre in expanding their business, achieve higher growth, diversify earnings and increase interest margins.

“We expect an increase in trade flows to be denominated in Rmb, which will provide us a better position to compete with foreign banks as all banks have to rely on Chinese lenders for settlement,”says Frank Shih, chief strategy officer at Chinatrust Commerical Bank, one of Taiwan’s largest private commercial lenders. “As a result, we can expect to build better working relationships with Chinese banks. On the basis of such relationships, we expect more cross-strait trade flows deriving from Taiwanese manufacturers or even Chinese companies, which will naturally enhance our businesses in trade finance, Rmb foreign exchange and deposit business.”

Shih goes on to explain that based on increasing deposit position and enhanced settlement/correspondent bank arrangement, his bank will be able to develop more Rmb lending, deposit and foreign exchange services to satisfy customers and expand clientele base. He also points out that Chinatrust will be able to roll out Rmb services to all countries it operates in as most of these expect to forge stronger bilateral trades with China given its expanding economy and stronger Rmb.

Large global banks, which were already given a green light to run Rmb business in Hong Kong and China, also have a clear vision of the merits of freer and more liquid markets across the strait.

“Due to the direct investment restrictions with China in the past, many investments in China were conducted through offshore companies. To support this, offshore banking units in most commercial banks would handle this business and the funds stayed onshore in Taiwan. With liberalisation of the market to Rmb settlements in the offshore units, and eventually in domestic branches in Taiwan, it will create a new currency for international trade with Taiwan as previously more trading was done in US dollar, and to a lesser extent, Japanese yen as the Taiwanese dollar is not a freely-convertible currency,” Wegner of Standard Chartered illustrates.

“With the permission to run Rmb businesses in our offshore banking units and eventually in Taiwanese branches, we can extend Rmb-denominated credits directly to both Taiwanese and Chinese firms for trade and investment transactions, enhancing liquidity while also averting foreign exchange risks and reducing hedging costs as there is a natural hedge for those that need Rmb for the other side of their business,” he adds.

“In addition, the lure of the appreciation of the Chinese currency and higher returns for deposits gives more incentive to leverage the new trading currency. Rmb deposits in China could be used as collateral for Rmb-denominated letters of credit (LCs) that now can be negotiated in Taiwan.”

Challenges in China

While business prospects appear rosy in China, Taiwanese lenders, far smaller in scale compared with their Chinese state-run counterparts, acknowledge that several challenges lie ahead when competing in China.

Shih of Chinatrust cites a few examples. The Chinese banking regulator currently mandates a 75% loan-to-deposit ratio requirement, which may seem like a double-edged sword for some banks, as it is now very expensive to attract deposits in China, and without deposits, banks cannot extend loans. Meanwhile, Taiwanese banks may find it challenging to decipher complex regulations in China, compete with local Chinese lenders given their smaller scale, while also lacking sufficient local knowledge to identify a sustainable niche, thanks to their relatively short history of operating in China. All the issues, nevertheless, can be overcome in time, Shih stresses.

The closer partnership between Taiwan and China in banking has also manifested itself in the offer of the first syndicated loan co-arranged by banks from both jurisdictions. In September, state-run Taiwan Cooperative Bank and Bank of China signed a US$30mn syndicated loan project for Jiangsu Aide Solar Energy Technology.

For Taiwanese lenders keen to tap the lucrative syndicated market with their Chinese counterparts, the legal and commercial discrepancies between both sides need to be ironed out, lawyers say.

“For one thing, there is not much convergence between both sides in terms of commercial laws,” says William Bryson, the partner who heads the Greater China banking and finance practice of law firm Jones Day. “Also, Taiwanese lenders determine the loan rates by referring to Libor plus a mark-up, while Chinese lenders refer to the rate set by People’s Bank of China plus a mark-up within a range. Both sides may need to divide the loan project into tranches to comply with terms and conditions stipulated in respective jurisdiction.”

Bankers in Taiwan have a consensus that funding has become more expensive in 2011, although local and foreign banks feel the pinch to a different degree.

“We are seeing US dollar liquidity being strained and thus driving up funding costs for US dollar loans due to the sovereign debt crisis in the US and Europe,” Standard Chartered’s Wegner says. “Despite this, international banks in Taiwan can still replenish their capital through injections from home countries or international branches and therefore are less stretched than their Taiwanese counterparts.”

TAIFX, the interbank US dollar loan rates in Taiwan, surged to 2.05% in October for three-month loans, nearly 165 basis points higher than Libor, meaning US dollar loans extended by Taiwanese banks are more expensive than those by their foreign counterparts in Taiwan.

Despite the higher funding costs, Taiwanese lenders have seen a large influx of demands by Taiwanese firms operating in China for interbank loans, US dollar syndicated loans and trade credit facilities through their offshore banking unitswhich have largely boosted the balance sheets of Taiwan banks.

Alternative methods

With decades of experience in international trade, Taiwanese firms are well versed in various trade settlement solutions. In particular, its factoring market became the world’s largest in 2006, then second largest in 2007.

“In Taiwan, high factoring transaction volumes are mainly driven from sectors like textile, garment and hi-tech industries, such as TFT-LCD, IC, computers and electronic components. It is common to use open account as the payment instrument among these industries. Thus, factoring is a suitable solution for them to fulfil the needs for buyers’ credit coverage and financing,” Shih articulates.

“There are no specific Taiwanese companies or industries who are the main users of forfaiting services. However, the main source of LCs is conducted with forfaiting which are issued by Chinese and European banks. One of its most important functions for traders is to mitigate country risk,” he adds.

Shih explains his bank’s forfaiting volume reached US$1.1bn in the first nine months of the year, including secondary forfaiting (trading of the paper) hitting US$966mn, driven by China’s monetary tightening policies that prompted Chinese banks to re-sell the trade assets to other banks to lower their funding costs and improve US dollar liquidity.

Meanwhile, Taiwan has migrated from using LCs to settle 85% of trade transactions with the remainder being settled through open account 20 years ago, to the present day where the mix has flipped to 15% of trade managed by LCs, according to Wegner.

“While LCs are still used in traditional sectors, open account is dominant among Taiwan’s IT firms, given they are typically large-scale with heavy capitalisation and infrastructure spending and thus have a better access to credits without requiring funding through LCs, while their buyers don’t want to pay through LCs given the rapid speed of movement of payments and goods in the IT industry,” Wegner adds.

“Open account is popular in Taiwan for various reasons. The operation cost is low as fees for issuance, acceptance and negotiations can be slashed. Documents can be sent to counterparties directly to save processing time. Meanwhile, they can help transfer buyer’s non-payment risk or credit risk by a factoring agreement or standby LC,” Shih says.

A natural home for supply chain finance

Other trade products, such as supply chain finance, prevail in the country, particularly among Taiwan’s IT industry. Bankers argue that when structuring such transactions, the ability to address pertinent issues of the complex IT industry along a long supply chain is key.

“The nature of IT industries with rapid turnovers where new products might become obsolete only within months means high demands for short-term loans are expected to be delivered in days or even real-time. Contrary to some traditional industries that cater to seasonal demands, IT industries churn out products all year round with different brands being launched in different seasons,” explains Wegner at Standard Chartered.

“Meanwhile, there are some Taiwanese IT companies which produce certain products under their own brand names, while at the same time being the original equipment manufacturers for other brands.

“Given these factors, it is pivotal to understand the eco-system of the industry, identify positions that clients fit in while recognising their collaborators and competitors when structuring supply chain finance transactions.” he stresses.

Within the next decade, Taiwan expects to transform the economy and industrial structure by focusing on six new industries, including green technology and biotech. The government also designated industries associated with intelligent technologies, including cloud computing, electric cars and green building as key development areas.

By developing the cloud computing industry in Taiwan, the government aims at boosting the gross margin rate of the domestic personal computer industry to double digits from current single digits, while also tapping the US$10bn global cloud computing market by helping other countries set up cloud computing centres.

Economic transformation is pivotal for Taiwan as profit margins for Taiwan’s high-tech industry have continued to erode over the years as competition increases, prices slide and wages in its manufacturing base, China, go up.

Following ECFA, Taiwan has also expedited its efforts on FTA, including signing an investment pact with Japan, and is in the midst of negotiations with Singapore. It also hopes to kick-start FTA negotiations with the EU, India and some Southeast Asian nations, with a 10-year goal of joining the Trans-Pacific Partnership agreement, an Asia Pacific regional trade agreement being negotiated between the US and eight other partners from across the Pacific.

Forging FTAs with key trading partners is pressing for Taiwan as it has been entirely excluded from regional integration initiatives over the past few years thanks to its diplomatic isolation status. China aside, Taiwan so far has signed FTAs with only four Central American countries, with which trade accounts for a mere 0.2% of Taiwan’s global trade.

In the near term, several Taiwanese industries will be affected by the FTAs South Korea signed with the EU and US, given the similar industrial structure both Taiwan and South Korea share. According to the ministry of economic affairs in Taiwan, around 1,121 of its export items to the US, including textiles, garments, machinery and plastics, are valued at US$3.37bn, and roughly 1,500 export items to the EU, involving transport and metals estimated at US$11.6bn will be affected by these two FTAs. GTR