Cash & Liquidity Management

More to come from netting and pooling

Published: Mar 2024

Despite neither being a new concept, there is significant untapped potential for cash pooling and intercompany netting implementation among corporate treasurers.

Person putting coins in a piggy bank

Intercompany netting has been described as a relatively underappreciated treasury solution, particularly by international corporates who do a lot of business between linked entities in different locations.

Corporates that already have an in-house bank in place are fully aware of the possibility of using a netting process settled in the intercompany account and/or in a bank account, suggests Eric Aillet, Product Manager Enterprise Solutions at Finastra.

“Typically, those corporates that have not implemented cash pooling are less aware of the potential of an in-house bank because there has not been a history of structuring payment flows in this way within the group, or they are less sensitive to needing to centralise cash,” he says.

Erik Smolders, a Deloitte Risk & Financial Advisory Managing Director in Treasury Management refers to significant interest in netting from smaller global companies, but acknowledges that the tools are not always in place to allow them to fully benefit from netting for a variety of reasons – including competing priorities and costs.

“The most successful netting implementations occur at organisations where the treasury and accounting teams are fully aligned on the benefits,” he says.

Awareness is not a challenge, but rather internal buy-in from other finance teams – including tax – to commit to implementing a global netting structure. That is the view of Bob Stark, Head of Market Strategy at Kyriba, who cautions that netting programmes are not simple to construct as they require a dedicated effort, often originating from the CFO.

According to Justin Callaghan, CEO of FTI Treasury the financial benefits are generally well understood but often not well quantified at the business evaluation stage of implementing a netting process. Whilst these financial benefits are often the catalyst for introducing intercompany netting, the additional softer and knock on benefits are often only really understood after implementation.

These include the impact of balance sheet deflation by removing intercompany balances, systematic reduction of FX noise caused by these balances, the ability to settle third-party FX payments, and the dovetailing of the netting process with an internal FX hedging strategy.

“Besides the obvious benefits of saving on currency spreads, the main benefit that implementing an internal FX netting process brings is the structure and regiment imposed by such a process,” he explains. “In a centralised ERP environment an automated process can be implemented. In a more decentralised environment the requirement to hedge exposures internally within agreed parameters and timelines can provide a focus for subsidiaries that may otherwise be less concerned with FX exposures.”

Enterprise cloud communications company Bandwidth has derived numerous benefits from netting of FX and intercompany transactions, explains Treasurer, Scott Taylor.

“We have a large number of cross-border, cross-currency transactions and prior to netting we were settling these bilaterally,” he says. “The first step in that process was similar to piecing together a puzzle where we would determine which subsidiaries had enough cash to settle their open payables balances. Then once subsidiary ‘A’ paid subsidiary ‘B’, we could proceed to ‘B’ paying ‘C’ and so forth.”

This turned into three phases of settlements as the treasury team would enter the trades in its bank’s FX portal and wait for settlement before moving on to the next group of transactions. Once all of that was finalised, the team made manual journal entries to record all the settlements.

Netting these transactions has reduced the processing time from weeks to days, reduced the notional amount of cross-currency trades by 90% and eliminated hundreds of manual journal entries, while the speed of settlement limits Bandwidth’s exposure to FX volatility.

“The integration process was extremely easy,” says Taylor. “Implementation only took a few weeks and most of the work was formatting the input file so that we could get the information back in a way that could be easily uploaded to our ERP system. We were able to get the process up and running with very little IT systems support.”

Andy Schmidt, Vice-President & Global Industry Lead for Banking at CGI refers to two primary cost benefits from netting foreign currency exposure – lower transaction costs, and lower foreign exchange costs. “The transaction cost benefit will be easy to calculate because these transactions typically have a fixed fee, while the foreign exchange cost will vary depending on the currency pairs involved,” he says.

Some corporates may not be fully aware of the potential benefits of intercompany netting, while others may face challenges in implementing it effectively due to internal complexities or limitations, suggests Jim Kessler, Vice President Global Treasury Solutions at Corpay.

“These challenges can include organisational silos, disparate systems and processes across subsidiaries, legal and tax complexities, and resistance to change from stakeholders accustomed to traditional payment practices,” he continues.

Daniel Cugni, Manager Director GTreasury Netting observes that corporates without a cash flow hedging programme often don’t have any visibility on intercompany flows.

“Intercompany payments are prepared by the accounts payable department and included (and hidden) in third-party payment runs,” he explains. “Foreign currency payments are often settled from the main EUR or USD bank account with a very high spread. Intercompany reconciliation is done by accounting, and they don’t always talk to their treasury colleagues.”

In terms of numbers, Stark reckons that reducing the number of FX hedges needed to hedge intercompany exposures can lead to a reduction of up to 75% in trades and related costs – which for a multilateral netting programme could easily equate to a seven figure saving annually for larger treasury teams.

There are other advantages that are less visible, but also contribute to reducing the overall hedging cost. Having a single entity that is allowed to hedge on financial markets improves control, ensuring that all legal entities within the group are following the same hedging policy. Concentrating the bank relationship with a more restricted number of counterparties – and setting up forecasting processes to better predict future exposures – also helps ensure compliance with financial regulations and standards such as IFRS 9.

In addition, netting foreign currency exposures can help protect businesses from ‘trading against themselves’ by reducing trade volumes and managing staff costs, bank fees, hedging errors, and even the counterparty risk inherent to foreign exchange trading.

“However, it is important to remember that while the netting of corporate exposures prior to hedging those exposures can yield substantial advantages, any cost savings opportunities from netting should be evaluated on an after-tax basis as there could be tax or statutory reasons that would make this type of netting unattractive or impossible for some organisations,” says Smolders.

The answer to the question of whether physical or notional pooling is the best option for the business depends on the liquidity structure of the business and local regulations. For example, some governments believe that notional pooling is co-mingling of funds from different entities.

“The physical pooling structure is a straightforward one and the concentration and management of cash centrally provides a feeling of control and security,” says Callaghan. “The downside is that you then need to manage all of the resulting intercompany loans.”

Notional pooling can allow for easily managed structures with no intercompany loan management required. However, it can also lead to over-inflated balance sheets, potential issues with net debt covenants, and credit issues with banks.

Banks are obviously keen to improve corporate access to services that can improve business performance by increasing the efficiency of internal liquidity management and the cash conversion cycle – services that include cash pooling programmes.

One of the most interesting aspects of demand for cash pooling is the extent to which it has been affected by higher interest rates. “CFOs recognise the opportunity cost of trapped cash and welcome programmes that increase cash utilisation while minimising the percentage of cash allocated for working capital,” says Stark. “Cash forecasting has also increased in importance to help finance teams be more confident in investing cash for longer, within cash pools or externally.”

There is no doubt that that there has been a much keener focus at board level on cash levels and visibility driven by both increased governance requirements and the higher cost of capital. Those organisations that have good liquidity structures can maximise yield on available cash and have also focused on finessing these structures by adding structures like multi-currency notional pools and intra bank sweeps, suggests Callaghan.

“Organisations which were a little bit behind the curve in terms of efficient pooling structures have had to react quickly to the increasing rate environment to ensure adequate control over non-earning cash assets that could achieve a good yield elsewhere,” he adds.

Concentrating cash within an organisation provides similar benefits to netting foreign currency exposures. This becomes increasingly important in a higher interest rate environment, not only because of the savings inherent when balances in opposite directions are netted or when aggregation gives better conditions, but also for the improved monitoring and control it offers. “Large, listed corporates are used to working with a high degree of centralisation so for them the demand for cash pooling services is not interest rate sensitive,” explains Aillet. “However, for medium sized corporates this is an area where demand has likely increased.”

Cugni reckons demand for cash pooling has increased as decentralised companies started to realise that some of their subsidiaries were borrowing funds at a very high cost, while others had excess cash poorly invested. “Many companies have taken this opportunity to improve their liquidity structures and have started to centralise their treasury activities with physical or notional cash pooling by region and currency,” he says.

Higher interest rates have clearly highlighted the opportunity cost of inefficient bank account and liquidity structures. In a near zero-rate environment it is difficult for many treasury organisations to make a business case for implementing a cash pooling structure due to the lack of monetary benefit.

“But there are benefits of cash pooling that exist whether interest rate levels are at zero, 5% or any other level,” suggests Smolders. “These include access to liquidity, global visibility of cash, and the possibility to provide intercompany liquidity using notional pooling without currency risk. For this reason, many treasurers have maintained and in some cases expanded their cash pools even when the interest benefit of cash pooling has not necessarily been present.”

Corporates are keenly aware of the impact that using pricier working capital lines of credit can have on their margins and net income and have been asking their banks for more efficient ways to manage liquidity and forecast cash flow according to Schmidt.

“Better liquidity management and cash flow forecasting services provides corporate banks with an opportunity to create stickier relationships and gain greater insights into their corporate clients’ cash management needs while also creating additional recurring revenue streams,” he concludes. “This type of partnership gives treasurers more time to focus on bigger issues, making these types of services well worth the additional investment.”

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