Treasury Today Country Profiles in association with Citi

Cash management tools compared – Part two

Mix of paint brushes on top of pallette

Last week we analysed a number of the cash management tools available to corporates. This week we look at another suite of tools and our treasury expert David Blair, Managing Director at Acarate outlines how these can be used to meet different cash management objectives.

Leveraging a payments factory

Payments factories evolved from a desire to reduce the costs and operational risks of leaving each subsidiary to manage their own payments. Payments factories are typically run by treasury or shared services and handle financial and commercial payments.

With many different kinds of corporates having varying requirements, payments factories can be grouped into three different types:

  • Payment processing: subsidiaries upload payments to the payments factory for execution in some agreed format, often from the subsidiaries’ own accounts (which precludes lowest cost routing.) A variant of this is that subsidiaries upload the payment files from their ERPs to the payments factory.

  • Invoice processing: subsidiaries upload invoices to be paid to the payments factory, which in turn executes the payments and delivers remittance advices to the beneficiaries.

  • Integrated payments factory: the payments factory downloads invoices due to be paid from the subsidiaries’ accounts payables systems, then executes the payments and delivers remittance advices to the beneficiaries. This is often combined with POBO to achieve lowest cost routing, and with payment aggregation to achieve lower payment volumes.

The main benefits of payments factories include:

  • Centralisation to achieve consistent and better control over payments and also scale economies in terms of employee time and bank fees.

  • Aggregation to reduce the total number of payments made (and thus the bank fees).

  • Lowest cost routing to reduce the bank fees on payment execution.

According to Blair, “Payments factories continue to evolve. Adding intercompany current accounts essentially turns a payments factory into an IHB.”

Other payment control methods

An interesting alternative to simple payments factory functionality is to use multi-bank e-banking as a single bank communication channel for all subsidiaries, says Blair. “This only gets you the first of payment factories’ benefit – centralised control – but it can do so with minimal disruption. Take, for example, a group which for commercial or cultural reasons wants each subsidiary to be independent, with their own accounts and banks and so forth. The CFO/treasurer will want consistent control over and security for payments, and also visibility of bank balances. The solution is to use a multi-bank portal to access all banks, which means no change to bank relationships, subsidiary processes and authorities, and so on, because the multi-bank portal gives each subsidiary access to view its bank accounts and instruct payments, just like proprietary bank e-banking. The difference is that everyone is using the same portal which is approved for IT and process security, and treasury is able to have cash visibility over all accounts and visibility over payment processes.”

Such multi-bank portals are available from SWIFT, Fides, TIS, and other vendors. “Most global cash management banks offer similar functionality, but that might cause bank relationship issues if the other banks are unhappy with losing direct connections with their clients,” he adds.

Many of these tools are used by nettings centres, payment factories, and IHBs as a means of bank connectivity.

In-house banks (IHB)

As mentioned, an IHB essentially adds intercompany current accounts to integrated payment factory functionality, typically using OBO as far as possible. (Disambiguation: IHB sometimes refers to treasury centre functionality. This is logical in so far as treasury centres typically do intercompany FX, loans and deposits with their subsidiaries, replacing external banks for those requirements. In this article, we use the term IHB as defined above.)

IHBs are typically highly integrated with ERPs, providing straight-through processing and automated booking and reconciliation with accounts receivable (AR), accounts payable (AP), and the general ledger (GL). The external bank account is replaced with the intercompany current account, which is multi-currency so that it also reflects balance sheet FX exposures. As Blair explains, flows typically work like this:

  • Third-party payments are downloaded from AP and executed OBO with a debit to the intercompany current account; the IHB aggregates and where possible nets flows to minimise banking transactions, then uses lowest cost routing to minimise fees; AP ledger is updated to reflect paid status.

  • Third-party receipts (collections) are received to an IHB bank account using virtual account technology to aid analysis with a credit to the intercompany current account; receipts are auto reconciled to AR ledger.

  • Intercompany receipts and payments are credited and debited directly to the intercompany current account, taking them out of the banking system altogether

  • FX and other financial transactions are 100% internal and settled against the intercompany current account – subsidiaries cannot do external bank deals because they have no bank account.

“Depending on the subsidiary’s working capital situation, its intercompany current account will show a credit or a debit balance. Steps to adjust this balance such as dividend payments and equity injections are also booked to the intercompany current account,” notes Blair.

“So funding is automatic. Further, any FX exposures will normally be handled by integration with the ERP, typically extending through AP and AR for the near term to purchase orders (POs) and contracts for the medium term, and reconciling these with business planning data for the longer term. All hedges are of course internal, and will be settled against the intercompany current account.”

One wrinkle with IHBs is that the balances are all intercompany, therefore interest will be subject to withholding tax and thin capitalisation regulations. Zero interest will attract attention from a transfer pricing and BEPS (Base Erosion and Profit Sharing) perspective. Adding notional pooling to IHB arrangements can help – the downside is additional complexity.

Many corporates have an IHB fully implemented in tens of countries, meaning that their subsidiaries have no bank accounts at all.

Comparison

With clarity about the various tools, we can now compare them with typical cash management objectives.

From a balances and flows perspective: ZBA and notional pooling address balances, netting and payments factory address flows, and IHB addresses both balances and flows.

We can also look at these tools from the perspective of the benefits they bring as set out above. In terms of balance management: notional pooling keeps bank balances in an efficient way, ZBA sweeps bank balances to zero, so you end up with intercompany balances like IHB, but you still have all the cost and hassle and risk of bank accounts, and IHB gets rid of bank accounts altogether, so you have balance efficiency (no subsidiary bank balances) which is very efficient (subject to the fiscal issues discussed above).

In terms of flow management: netting in its basic form brings efficiency and control to intercompany settlement but does not change third-party flow processing. A payments factory extends the process efficiencies and control improvements and cost reductions to third-party settlement; OBO adds further efficiency. A multi-bank portal does not intrinsically change the flows themselves but brings enhanced visibility and control to flow management, and the opportunity to better negotiate fees, and an IHB done properly with full OBO and lowest cost routing reduces banking flows to the minimum and concentrates flows to maximise scale economies and control processes.

Corporates operate in diverse markets and geographies with different cultural and structural constraints. The objective here is not so much to pick a winner, but rather to clarify the alternatives.

Restrictions

“Everything described above works for a multitude of corporates over a wide range of geographies. Some, especially developing, countries have regulations that restrict treasurers’ freedom to operate efficient cash management,” says Blair. These tools can be adapted to comply with most regulations when the benefits are analysed in a granular way. In particular it is critical to remember that, while the external cost savings are very important, the biggest benefits come from process efficiency and improved control.

So here, Blair provides some pointers on how to adapt to common restrictions.

  • Can’t net? Then aggregate – often called gross in/gross out. Netting typically reduces hundreds of in and out flows to one net flow per month. Aggregation gets them down to two flows per month (one inflow and one outflow), which will provide 99% of the cost savings and 100% of the process and control benefits.

  • Can’t do OBO? Then replace the intercompany current accounts with subsidiary bank accounts. Of course, it is preferable to have no bank accounts at all, but, by opening subsidiary accounts and letting treasury operate them, you can operate processes and control that look like, and are as efficient as IHB, albeit with additional bank fees.

  • Intercompany loans not allowed? Use bank loans managed by treasury instead. Again, the objective is to get the process and control efficiencies, even if you have to accept paying bank spreads. At least treasury can minimise the damage, and local staff don’t have to waste time managing banks.

  • Documentation required for cross-border payments? Arrange with your bank to accept electronic instructions from treasury pending local staff providing supporting documents. Yes it will go wrong occasionally, but the rest of the time you will benefit from the process and control efficiencies and eliminate float and unattractive FX spreads.

The point is that these tools can be broken down into their constituent parts so that treasurers can determine how to maximise the benefits while complying with regulations.

Reader Comments 

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  1. Well thought out article - a couple of extra twists could be the following I) Even if the local subsidiaries still have to maintain their own bank accounts, the multi-bank portal could be replaced by the same single bank in each jurisdiction ; allowing the treasurer to run an RFP process, leveaging the total transactional volumes process around the group to drive a much lower pricing tariff, along with robust SLA’s and accountability that comes with having a single provider. ii) Having central Treasury visibility of receipts and payments not only offers payment efficiencies, but in multi currency situations it can be used to gain better visibility by currency of flows - therefore potential matching of FX surplus in one entity with a shortage (in the same currency) elsewhere. The group can then run internal currency trades to minimise the exposed currency positions that need to be traded externally. Even better is in the IC netting situation, where potentially the entity (e.g. IHB) running the netting will first of all have netted across each currency, leaving single individual currency positions (long or short) to be hedged. Of course company FX accounting policy would need to be matched to this activity. Overall this article is a great insight how really switched on corporates could have great end to end cash management and ancillary solutions.
    Colinho63's Gravatar

    Colinho63 2015-10-08 12:10:17