Afp Guide To Mobilizing Global Cash - Part 2
AFP GUIDE TO
Mobilizing Global Cash
Global Liquidity Guide Series
Welcome to AFP"s Liquidity Management Guide to
Mobilizing Global Cash.
In today"s volatile and dynamic market environment, global treasury
operations are consistently being challenged with optimizing liquidity.
Prudent departments have instituted fundamental cash visibility and
forecasting structures to assist in addressing these challenges. For leading,
multinational treasuries, deploying optimized cash mobilization structures
through notional or physical cash pools proves to be the key to unlock
liquidity and mitigate risk.
With new risk areas continuing to surface across the enterprise, treasurers
must carefully monitor and mitigate the risk landmines of today"s financial
environment. When mobilizing cash, danger areas such as liquidity risk,
credit risk, country risk, continent risk, currency risk, counterparty risk, tax
risk and operational and compliance risk can rear their ugly heads. Without
transparency and visibility into those cash structures you can leave yourself
exposed to these numerous risks.
Optimized cash pools and structures allow treasurers the transparency into
cash movements, positions and currencies thus providing visibility into your
risk positions and allowing you properly to assess your risk tolerance.
This guide provides key insights into common treasury objectives on
mobilizing global cash and the factors that are leading so many organizations
to examine how they optimize cash and manage risks, and the transformational
changes they need to undertake. This guide also outlines structural diagrams,
tax rules, banking considerations, risk awareness and other proven techniques
around the "how-to" of sweeping and notional pooling.
There is no perfect structure. Each organization has unique elements that
require mixtures of models and shifting of structures over time. The benefits
are well worth the effort. Organizations that mobilize and optimize global
cash benefit from:
"" reduced borrowing costs;
"" maximized opportunity for investment;
"" reduced transaction and administration costs;
"" improved control of group cash;
"" optimized foreign exchange hedging and risk management; and
"" a better understanding of the opportunities for the strategic deployment of
cash via, for example, acquisitions, stock buyback, business reinvestment
and business divestiture.
Banks and technology partners serve as strong allies in your analysis and
deployment. Lean on them for insight and assistance "" the upside is tremendous.
Introduction
Treasury practitioners are under tremendous pressure
to manage cash efficiently, while at the same time
minimizing any risk to their organization. For those
in international businesses, the challenges involved in
managing cash are multiplied by the complex nature
of international regulation, and varying local banking
practices around the world.
The core challenge for all treasury practitioners is to
ensure visibility of their group"s positions globally.
Having clear knowledge of each operating entity"s
cash position can help to ensure it is funded as
economically as possible, and that any surplus cash is
invested safely. Additionally, complete and accurate
visibility into cash positions also helps the group
treasury to identify how the group is exposed to risk,
and to develop strategies to manage those exposures.
For an organization which has few transactions
outside its home market, it is possible to manage
all payments and collections without opening bank
accounts in other countries. In such a case the cost of
operating and managing bank accounts abroad may
not be justified, even though managing cross-border
payments can be expensive and time-consuming.
However, once an organization has an appreciable
number of cross-border transactions, or has a physical
presence in different markets, it becomes more
cost"'effective to open bank accounts outside the
home market to manage these transactions. Where
such bank accounts are opened by the local operating
entity, the organization"s central treasury may find it
difficult to obtain accurate, timely information on
cash balances and foreign exchange positions in each
foreign location.
The greater the number of a group"s bank accounts,
and the number of currencies in which they are
denominated, the harder it is for the group treasury
to keep track of the balances on those accounts.
Mobilizing cash on a global basis via the use of
notional and physical cash pools can help the group
treasury operate more efficiently. These structures
allow balances on the various bank accounts to be
aggregated, typically by currency, so that the group
can more easily identify those accounts with cash
surpluses, and those which require funding. Where
cash is pooled on a cross-border basis, intercompany
transactions are part of the structure, allowing entities
with a cash requirement to be funded automatically.
At the same time, such structures help the group
treasury to understand its foreign exchange positions
and to ensure that they are hedged appropriately.
This paper looks at the reasons for mobilizing global
cash, identifies the main techniques used to do
so, and outlines the main barriers to using these
techniques. The paper then provides a guide to the
key stages in developing an appropriate global cash
management structure for meeting an organization"s
objectives. It concludes with an appendix outlining
the availability of physical and notional pooling in
key markets around the world.
Why Mobilize Global Cash?
Any organization with operations outside its home
market will need to decide how to manage those
operations. In the past, there was little choice,
especially with respect to cash management. Today,
however, changes in banking practice, improvements
in communications and the effect of steady regulatory
change mean that organizations now have many
different options when making that decision. At
the same time, treasury practitioners are under
greater pressure than ever to reduce operating costs,
while simultaneously taking steps to manage risk as
effectively as possible.
In this context, treasury practitioners are expected
to use cash as efficiently as possible within their
organizations. For organizations operating in a
number of different countries, this requirement can
be translated to mean using cash as efficiently as
possible, on a global basis.
Although global cash management is now possible,
there are still some major challenges for treasury
practitioners seeking an efficient solution. Decisions
may vary according to the underlying purpose
of the group"s cash management structure. It is
important that the treasury practitioner has a
clear understanding of the core objectives before
establishing a new global cash management structure
(or when reviewing an existing one).
Companies seek to mobilize global cash for a variety
of reasons, including:
"" improving the efficient use of cash;
"" reducing borrowing costs;
""maximizing opportunity for investment;
"" improving control of group cash;
""better foreign exchange risk.
Improve the efficient use of cash
One of the most significant potential benefits from a
global approach to the use of cash is the opportunity
to reduce the costs of processing. This can be achieved
even if the organization decides against implementing
a wider cash pooling structure.
The seemingly simple act of making and receiving
payments across an organization can be made
extremely efficient. This can be done by working to
reduce operational cost. This arises in two main forms:
""Transaction costs. There are costs associated with
any transactional activity, whether making or
receiving payments. In any organization with
operations abroad, there is necessarily a greater
volume of cross-border payments. Cross-border
payments tend to be much more expensive to make
than equivalent in-country payments, even if no
foreign exchange transaction is required. As well as
the transaction cost charged by the bank, there will
be additional costs associated with the transaction.
Cross-border payments often take much longer
to process than in-country equivalents, and this is
reflected in the different value dating rules applied
by banks in these circumstances.
For example, cross-border check payments can take
many days to clear. During this time, banks are
usually not prepared to give value, or even to allow
the funds to be used, until final settlement has been
achieved.
""Administration costs. As well as the processing
costs, there are also costs associated with the
administration of bank accounts and payments.
In a global organization, there can be significant
duplication of both personnel and technology. The
need to have appropriate segregation of duties will
have implications for staffing levels in each entity
with control of bank accounts. In addition, each
such organization will have a treasury platform
to maintain control of these bank accounts
(even though a platform may simply be a set of
spreadsheets, with all the risk factors they entail).
Adopting a global approach to the mobilization of
cash can help to reduce operational cost in a number
of ways.
""Transaction costs. Transaction costs can be reduced
by ensuring that as many payments as possible are
routed as cheaper, in-country payments. Instead of
sending a series of expensive cross-border payments,
technology allows companies to send a single
cross-border payment file to a bank in a particular
country. The file contains instructions to the
bank to make a series of less-expensive in-country
payments to recipients in that country.
""Administration costs. The twin costs of personnel
and technology can be reduced via the use of
treasury workstations and cash management
systems. These systems increasingly allow treasurers
to establish payment authorization protocols which
allow personnel in different locations to approve
payments automatically. These systems also enable
treasury departments to view many different
bank accounts in different locations on the same
platform. For a global organization, the platform
will need to be sophisticated enough to manage
cash flows and bank account positions in a number
of different countries and different currencies. The
challenge for the treasury professional is to reduce
the complexity of this task.
""Bank account management costs. In a company
with a global view of cash, one of the key objectives
is to exercise a degree of control over the opening
and maintenance of bank accounts. Once bank
accounts are open, there can be significant costs
associated with identifying every bank account held
by the group. This is a core task, if the treasury
professional is to achieve visibility of cash. In this
context, it is appropriate to review every bank
account and evaluate whether or not it should
remain open. One reason for this is that, although
approaches differ between banks, they generally levy
an annual fee for maintaining bank accounts, on
top of the transaction fees. Reducing the number
of bank accounts may also allow the company to
negotiate better transaction fee levels (as volumes
through each account may well be higher).
Even where local entities have the authority to open
and operate bank accounts, the central treasury
should try to develop a clear policy governing the
use of bank accounts (the circumstances in which
accounts can be opened, the level of authorization
required), even if, in a decentralized organization,
following that policy is not compulsory.
Reduce borrowing costs
In an ideal scenario, an organization will avoid any
situation where one group entity is borrowing from
external lenders when another group entity has
surplus cash to invest. By putting in place a cash
mobilization structure, any internally generated
surplus cash can be made available to support group
entities with funding requirements.
Although the organization will have to respect
transfer pricing rules in relevant jurisdictions, and
offer arm"s-length funding, any internal cash recycled
through the business in this way will be cheaper
than arranging external funding from banks or other
sources. This is because the internal funding will not
attract the risk premium external finance providers
would need to charge. These funding streams will be
relatively reliable (assuming accurate internal group
forecasts), as they will not be subject to covenant
restrictions and other factors which can lead to banks
withdrawing funding.
Even if the group as a whole is a net debtor, with
little or no surplus funds available to be recycled
through the business, it should be possible to use
a cash structure to reduce borrowing costs. This is
because borrowing requirements can be aggregated
at the group center. In most organizations, as long as
the group has a better credit rating than the group
entities, the central treasury will have access to funding
at better rates. This applies for two reasons. Firstly, the
group treasury will be able to leverage its credit rating
to obtain better financing rates from its banks than
are likely to be available to individual group entities
in their different locations. Secondly, by aggregating
the funding requirement, non-bank financing
techniques, such as a commercial paper program, may
become viable. This will have the additional benefit of
diversifying the group"s sources of funding. (However,
by centralizing funding, the group may lose access
to some of the local funding sources, which would
themselves have been a source of diversification.)
Maximize opportunity for investment
Once any available cash has been recycled within
the business, the remaining cash is available for
external investment. If a group has previously been simultaneously investing and borrowing, any
return earned on net invested funds will be higher
than before. This is because any investment returns
would have been reduced by the higher cost of the
simultaneous borrowing.
Consolidating balances (even when precautionary
balances are left in-country) may give the central
treasury team access to greater levels of funds to
invest. Having a greater pool of funds to invest may
justify the employment of a specialist investment
manager (either within the treasury team on a
full-time or part-time basis, or in an outsourced
arrangement). A larger pool of funds may give the
group access to a wider pool of potential investment
instruments, helping to diversify risk. Moreover,
when combined with an effective forecasting system
(see the previous title in this series), a central treasury
may have the opportunity to invest some of the
surplus cash for longer periods. This may offer an
enhanced return, and will reduce the operational
risk associated with the process of investment
management, although the group will have to accept
a loss of liquidity in return.
However, by creating a larger pool of funds, the group
may thereby expose itself to a greater counterparty
risk, requiring a tighter focus on investment
management. While a loss of principal when funds
are invested at a local level would have an impact on
the local entity, a loss of principal when investing at
group level would affect the group as a whole. (The
next title in this Liquidity Management Series will
look at techniques to manage this investment risk.)
Improve control of group cash
One of the core benefits of a cash mobilization
structure is that it can give group treasury a greater
visibility, and therefore control, over group cash.
By pooling cash to one or more header accounts
(either physically or notionally), the group treasury
only has to monitor those accounts, rather than the
multitude of group accounts that an organization
might hold. Even if circumstances dictate that
pooling to a single global account is neither possible,
practical, nor desirable, a central treasury can still gain
greater insight from a series of pooled accounts. The
implementation of a group structure, even if it only
ever applies at country level, will allow bank accounts
to be linked and balances consolidated between those
accounts. At the same time, any action to reduce the
number of bank accounts held by the group will also
act to improve visibility and control over group cash.
Better foreign exchange risk management
A global approach to cash mobilization also offers the
opportunity to manage foreign exchange transactions
and risk more effectively. Without a global approach,
each entity will be responsible for managing its own
foreign exchange positions. Just as a group may find it
is simultaneously borrowing and investing, it may also
find it is simultaneously long and short in the same
currencies. Implementing a global structure will allow
the group to reduce the amount of external foreign
exchange transactions in such circumstances. This
will reduce the costs associated with the transactions.
There will also be a reduction in transaction risk, as
fewer transactions are necessary.
The central treasury may also be able to identify more
natural intra-group hedge relationships as a result of
tighter control over cash, reducing the need to take
external hedge positions.
There are a number of different approaches to
managing foreign exchange risk in a global cash
mobilization structure. At one extreme, there is
the required use of an in-house bank. In such
circumstances, all participating group entities hold
bank accounts only with the in-house bank, in
their own operating currencies. The in-house bank
then manages any foreign exchange transactions
and positions on behalf of the group entities. It will
require significant investment in terms of time and
resources (notably technology) to implement such
a system. However, once established, it should aid
efficiency by avoiding the need for each participating
group entity to manage its own foreign exchange.
Other organizations require group entities to
consolidate cash in group operating currencies
(typically the USD or the EUR) on a cross-border
basis. Group entities are able to maintain their
own accounts in their own local currency. These
accounts can still be pooled on an in-country
basis to provide group treasury with visibility over
positions in those currencies.
It is also possible to implement structures to manage
any internal foreign exchange positions. For example,
the use of an intra-group netting system for any
intercompany payments can help to reduce the need
for foreign exchange transactions.
(Find the rest of Whitepaper at: http://revalnet:8080/knowledgesource/Documents/Reval_AFP_Global_Liquidity_Guide_2_Mobilizing_Global_Cash.pdf )
by: Reval
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