Afp Guide To Strategic Global Cash Position Forecasting - Part 1
Welcome to AFPs Liquidity Management Guide to Mobilizing Global Cash.
In todays 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 todays 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:
1.reduced borrowing costs;
2.maximized opportunity for investment;
3.reduced transaction and administration costs;
4.improved control of group cash;
5.optimized foreign exchange hedging and risk management; and
6.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.
Jason Torgler, Vice President, Corporate Strategy @ Reval
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 groups positions globally. Having clear knowledge of each operating entitys 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 organizations 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 groups 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 organizations 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 groups 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:
1.improving the efficient use of cash;
2.reducing borrowing costs;
3.maximizing opportunity for investment;
4.improving control of group cash;
5.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:
1.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.
1.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.
1.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 arms-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 groups 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.
Adopting a global approach to cash mobilization can also help the group treasury implement and get group entity support for a clear policy regarding the use of local and foreign currency bank accounts. As discussed, there can be significant costs associated with identifying, managing, and controlling activity on an organizations bank accounts across the world. Central treasury may be able to restrict the ability of local group entities to open foreign currency bank accounts for particular purposes,
by: Reval
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