When the Russia/Ukraine conflict unfolded in February 2022, it suddenly became obvious to businesses around the world what it means when geopolitical risks materialise. With the backdrop of sanctions, capital controls and warfare, supply chains of commodities such as wheat or gas were disrupted, and companies were forced to close or reallocate production facilities. More recently, Russia has also blocked many Western companies which continued to operate in Russia after the war broke out from accessing billions of dollars of profit.¹

While the war in Eastern Europe continues, this is not the only geopolitical conflict that the politicians and business leaders face. Over the last couple of months, bipolar trade tensions between China and the US have intensified – nurturing the concern of a decoupling of the world's largest economies, which would further hamper international supply chains and economic growth.²

In early August 2023, US President Joe Biden signed an executive order aimed at restricting US investments into Chinese semiconductors, quantum computing and artificial intelligence (AI) companies over national security concerns.³ The restrictions are expected to come into force next year. Last year, the US had already implemented new export controls cutting China off from certain semiconductor chips made anywhere in the world with US tools.⁴

On the back of these decisions, Deutsche Bank Research has recently identified ten technology areas at risk of decoupling: advanced semiconductors, AI, quantum computing, deep sea cables, space, 5G infrastructure, biotech, electric vehicles, clean energy technology, and advanced robotics.⁵

Given these developments, what are the key risks that treasurers of multinational corporates (MNCs) should consider? How do the tensions between China and the US affect business operations of European companies in Asian countries such as Vietnam, Malaysia, or Indonesia? And what can corporate treasurers do to mitigate the financial risks that stem from geopolitical tensions and economic slowdown? This article provides some insights.

In the past few decades, Western companies have invested significantly into China due to low production costs and the size of the domestic market. In face of geopolitical tensions, however, some companies have now started to diversify their production bases beyond China in order to protect their supply chain – this strategy is commonly known as China+1.

Furthermore, it is evident that geopolitical tensions between China and the US are already impacting investment decisions of MNCs. According to a report published by the American Chamber of Commerce, 17% of the surveyed companies reported that China was their number one investment destination globally, down from 27% in 2021 – with 70% blaming the uncertainty about US-China tensions for this development.⁶

Yet, MNCs still want to keep their existing supply chains in China, with 37% of those surveyed producing or sourcing goods and services in China for the Chinese market. For another 23% their Chinese operations are part of their global supply chains.⁷

“Treasurers play a crucial role in strengthening the resilience of multinational corporations in the prevailing environment of geopolitical uncertainty”
Konrad Haunit, Head of MNC Coverage Asia-Pacific, Deutsche Bank

This observation is shared by Konrad Haunit, Head of MNC Coverage Asia-Pacific, Deutsche Bank: “Despite the lower-than-expected GDP growth, US-China tensions, and the underperforming property sector, China remains a critical growth market for multinational corporations globally. Outside of China, investment plans often target the ASEAN region, in particular Malaysia and Vietnam”.

Corporates seek to strengthen their supply chains through increased diversification while simultaneously achieving proximity to key markets. “For many of our corporate clients, making supply chain more robust includes reducing dependencies on individual countries, for example China,” observes Haunit.

In doing so, their attention often shifts to the ASEAN countries, which appeal with relatively lower wages, fast-growing markets, and proximity to industrial clients.⁸ Danish toy giant LEGO Group for example broke ground in November 2022 on its €1bn factory in Vietnam to “expand its supply chain network to support long-term growth and locate production facilities close to its major markets”.⁹

Another example is the automotive sector in Thailand, which has a strong infrastructure of automotive suppliers across various levels of the value chain which in turn attracts more players in this industry to produce in Thailand. “The new investments in the region have the potential to over time significantly alter international supply chains,” says Haunit.

Overall, the EU’s overseas direct investments (ODI) to ASEAN has increased by about 20% from 2021 to 2022 according to an estimate from Deutsche Bank Research (see Figure 1). Yet, the report also states that “US and Japan are further along the supply chain diversification process than Europe, which appears to be keeping a more balanced approach to where to invest”.

Figure 1: FDI recorded by ASEAN countries from Europe

Source: Deutsche Bank Research Report Supply-chain diversification: Europe's investment patterns in Asia published on 6 June 2023

“A key focus area for corporate treasurers, and CFOs alike, is the structure, fungibility and resilience of the cross-border funding strategy of subsidiaries and the efficient deployment of liquidity involving capital-controlled markets,” Haunit continues. “Treasurers play a crucial role in strengthening the resilience of multinational corporations in the prevailing environment of geopolitical uncertainty.”

Apart from supply chain diversification, geopolitical conflicts may also create several financial risk categories that treasurers need to manage (see Figure 2). “Treasurers should monitor these risks, and build a comprehensive crisis and business contingency plan,” says Melvyn Tay, Head of North Asia Cash Solution Sales at Deutsche Bank.

Figure 2: Financial risks arising due to current geopolitical tensions

Source: Deutsche Bank

“Net investment hedging allows companies to preserve foreign asset value”
Charlene Chen, Co-Head of Risk Management Solutions APAC

Let’s take the example of China to explain how net investment hedges allow companies to mitigate FX risk associated with foreign operations and reduce interest expense. In 2023, the RMB had lost 5.7% of its value against the USD (YTD end of August), with depreciation pressures set to continue.¹⁰

“Net investment hedging allows companies to preserve foreign asset value and immunise their leverage ratio for changes in FX,” explains Charlene Chen, Co-Head of Risk Management Solutions APAC at Deutsche Bank. “Therefore, hedging FX risk stemming from China could be a prudent measure on a standalone basis, and particularly when considering favourable carry.”

The interest rate in RMB is lower than in USD – and these interest rate differentials are expected to widen as the Federal Reserve is raising interest rates to fight inflation while the People’s Bank of China (PBOC) is expected to continue monetary policy easing in a bid to boost the economy.¹¹ In July 2023, the country has slipped into deflation with the national consumer price index (CPI) decreasing by 0.3 percent year-on-year.¹²

The sharp repricing in interest rate differentials between Fed and PBOC has resulted in CNH carry trading at all-time attractive levels (see Figure 3).

Figure 3: CNH carry trading

Source: Bloomberg

On the back of geopolitical risks, companies also put more emphasis on subsidiaries being financially self-reliant. Contingency planning, such as securing access to alternative sources of funding and defining an appropriate capital structure, needs to be in place to prepare for a black swan event.

For instance, escalating geopolitical tensions and regulatory restrictions may impede corporates from funding their subsidiaries in a timely manner. This is why some treasurers may look to replace cross-border intercompany loans with local bank loans instead – using structures where the multinational corporate pledges cash at headquarter which enables the bank to give a local loan to the subsidiary, Tay observes: “This structure allows companies to reduce the risk of trapped liquidity, and they may even benefit from interest differentials for certain markets”.

“Repatriation of funds through various forms have also been deployed by treasurers to mitigate the risk of trapped cash,” he continues. Yet, “this needs to be carefully managed amongst multiple priorities to avoid disruptions to daily operational requirements”.

Finally, the rise of alternate payment modes and currencies also adds complexity for treasurers. While US dollar has been dominant in its use in world trade, large emerging economies are looking for alternatives to the greenback in an attempt to become less dependent on US policy makers’ decisions. At the BRICS summit in August, Brazil's President Luiz Inacio Lula da Silva, for example proposed to create a common currency for trade and investment between BRICS countries, as a means of reducing their vulnerability to US dollar exchange rate fluctuations.¹³

Some corporates have started diversifying beyond US dollars. For instance, Chinese national oil company (CNOOC) and France's TotalEnergies have completed China's first yuan-settled liquefied natural gas (LNG) trade via the Shanghai Petroleum and Natural Gas Exchange.¹⁴

All these examples show that treasurers have various tools at hand to mitigate the potential impact of geopolitical tensions on their companies. While these risks cannot be avoided, they can be managed – if corporates have implemented a robust financial and operational set-up.

Sources

¹ See markets.businessinsider.com
² See „How the great decoupling impacts global trade“ at flow.db.com
³ See whitehouse.gov
⁴ See bis.doc.gov
⁵ For more insights see the DB Research Chartbook From Integration to Isolation? 10 Slides on the Decoupling in US-China High-Tech published in September 2023
⁶ See amcham-shanghai.org
⁷ See „Asia’s multiple economic headwinds“ at flow.db.com
⁸ See „The blossoming of ASEAN“ at flow.db.com
⁹ See lego.com
¹⁰ See Deutsche Bank Research Report from 15 August “More policy easing needed to achieve 5% growth”
¹¹ See Deutsche Bank Research Report from 15 August “More policy easing needed to achieve 5% growth”
¹² See stats.gov.cn
¹³ See reuters.com
¹⁴ See lngprime.com