ERM’s UK based holding company was formed in March 2001 following a leveraged buy-out (LBO) of 32 independent consulting businesses, which had previously been operating independently but under the ERM name. The company was supported in the LBO by venture capitalists, 3i. Carol Power joined ERM in December 2000 in the new role of Group Treasurer.

Why was treasury introduced to ERM?

Initially, we needed a treasury function to manage the significant amount of bank debt raised at the LBO. We raised facilities of $148m during the deal and needed to service the debt with cash flows from a large number of companies. This meant we had to focus on working capital management, cash management and cash flow forecasting. Although, in treasury terms, these are all basic functions, they are very important for a leveraged business such as ours. As the debt structure was new to the business, the companies needed to be aware of the importance of cash generation so there was a need for someone both to drive these processes through and to educate the companies on cash generation.

Treasury is based in the UK alongside the Group’s finance team. It is a very small function and consists of a treasury assistant and myself. My treasury assistant helps with some of the analysis and all of the record keeping.

When you were appointed, what was the first thing that you did?

Apart from having to produce a post-LBO Treasury Action Plan on my third day, and spending most of the first four months working on the LBO, day and, often, night, the first thing we did was to establish a process for cash forecasting. As debt is the main risk we have to manage, we had to be comfortable that we could forecast cash to meet the debt and interest payments. We initially required companies to send us a rolling six-month forecast each month but we soon realised that accuracy deteriorated rapidly after month two so we revised the process. Currently, companies are required to send us a two-month forecast twice a month. We intend to increase the forecast period to three months soon, once we have worked on accuracy levels with the companies.

How difficult was it to implement?

It was reasonably difficult to implement, but not because the companies did not have the desire to provide the information. In some cases, the companies did not have the necessary systems, as they had not focussed on cash flow forecasting in the past. In addition, Treasury was competing with all the other new initiatives being rolled out by other areas in the group. It is now easier to get information from the companies as they become more sophisticated and as they understand why it is important. In addition, the formation of a global finance structure has helped educate and train the operating companies on the importance and mechanics of cash flow management and forecasting.

You started with cash flow forecasting cycle. What did you do then?

We wanted the companies to focus on sending cash to Treasury as well as generating it, as the debt and interest obligations are with the ultimate Parent company. Therefore we devised and implemented a new concept, which we call our remittance scheme.

This is a notional scheme where each company has a target, calculated as a percentage of their year-to-date profits at the testing date – the companies have to send cash into Treasury to meet those targets. At the end of each month, remittances are tested against targets. Remittance balances earn or incur notional interest which we call ‘bonus interest’. If the companies meet their target, then they earn very good rates of bonus interest. If they do not, then they will be penalised heavily as they lose any bonus interest earned that month and incur a penalty on the target shortfall. At the moment, companies earn 3M-LIBOR plus 4% on credit balances, pay 3MLIBOR plus 10% (soon to be plus 20%) on debit balances and, in addition, are penalised between 16% and 20% on any shortfall against target.

The interest and penalties are built up as a shadow interest charge, which is then notionally applied to their profits. These profits, whether inflated or deflated, are used to calculate the bonus pool allocation for the company. In this way, we make a direct connection between cash generation and remittance. Also, because there is a direct link between the remittance and each company’s bonus pool, we hope we have created a scheme to encourage good working capital management by creating an incentive for companies to generate and then remit cash to treasury and a disincentive for them having to borrow from Treasury. With few exceptions, previously agreed with me, companies are not permitted to borrow or lend locally. At the end of each financial year, all remittance balances in credit are returned to zero whilst those in debit are carried forward.

We have found that this scheme has worked extremely well. In the first six months following the LBO, we needed an additional level of comfort to ensure we could upstream cash to meet our debt and interest obligations. We knew there was cash in the group, but as the companies had not previously sent cash to Treasury, we did not know how easy it would be to encourage them to do so, hence the concept of bonus interest. As a result of the remittance scheme, we know that we can meet our requirements well in advance because the companies have already sent it to the US holding company or directly to Treasury.

Initially, there was a view that the scheme was draconian because the target and penalties are high. We argued that the target, in a consulting business, was, in fact, very low. We feel that companies should not have much tied up in working capital and that they should be able to turn almost all their profits into cash within their invoicing terms.

There is also a real administrative and legal side to the remittance cycle. In order for it to work, we needed to set up a set of inter-company loans. There is an educational aspect here too, as we have to investigate and explain the consequent legal and tax issues to the companies. It would be pointless implementing an internal scheme like this and then find that it falls foul of an external regulator or tax authority.

Were there problems implementing this in the different regions?

In these types of schemes, it is always the smallest regions that cause the biggest problems from the tax and legal point of view.

Most of our cash is generated in the US and those companies have performed particularly well in the scheme. All companies in the US have loans with our US holding company. The US holding company is connected by an inter-company loan to the holding company in the UK.

In the rest of the world, we look at each country individually. There are some countries where it would be prohibitively expensive for them to remit cash to us, unless they had large amounts in which case we may have to look at alternatives to loans. In these circumstances, we think of ways in which we can get the companies into the scheme so that they can understand the principle of it.

Do local companies in the more complex locations feel disadvantaged by the structure in comparison with those in, for example, the US where it is relatively easy to operate?

We encouraged all companies, with a few exceptions, to give up their local borrowing lines at the time of the LBO and replaced them with inter-company loans. These start-up loan balances did not count in the remittance scheme, which meant that all companies started from the same position. Now, when companies need to borrow cash they have to explain why they need it. Companies with credit balances over and above their remittance targets will be subjected to less rigorous questioning than those below their targets.

What do you do with the cash once it is remitted to you?

Typically, we stockpile cash in order to meet the debt repayments, which fall due every six months, and the interest payments. The remittance scheme does not allow operating companies to gain any benefit from holding cash, as we notionally exclude any external bank interest they may earn from their profits, so they remit it to the US holding company or the holding company in the UK. To date, we have not invested the cash in the market as we always have short-term obligations to meet. However, I have negotiated with our banks for them to pay us the market rate of interest without requiring me to move cash on a daily basis. Although we may be losing a marginal opportunity due to the difference in the overnight rates versus the one week or one month rates, we feel this is offset somewhat by the saving of internal time and resources that would be required to make investments. As most of our debt is term debt, any prepayments are not available for redrawing so debt repayments are not a day-to-day operational alternative for us.

What are risks do you have to manage?

I am now working on putting some guidance in place for companies on foreign currency risk management. We do not have a large exposure to transactional currency risk as all the US companies, responsible for over 60% of our revenues, bill in US dollars; ERM is a US dollar-denominated company. Most of the other companies either contract in their local currency, where the underlying costs are, or in US dollars. One of two of the larger companies outside the US do have transactional currency risk and I work with them on an individual basis to help them manage those risks. However, at the moment, the process for managing transactional currency risk is very informal and an FX procedure is next on my list of priorities.

We also have to manage our interest rate risk. We set up a syndicated deal as part of our LBO. As a US-denominated company with US dollar debt, we have partly benefited from the fall in US interest rates over the last two years by keeping onethird of our debt at floating rates. At the time of the LBO, we were required to hedge our interest rate risk and entered into an interest rate swap to hedge two-thirds of the risk for eighteen months from the time of the deal. I monitor the position and every two months put my recommendations to the Group FD who will either put it to the board or discuss it with the CEO. Any action we want to take would be authorised at board level beforehand.

Has your strategy changed at all as interest rates have dropped?

We were required to fix our interest rate risk as part of the LBO so we have not benefited as much as we could have done. Given the highly leveraged nature of the company, we need to take a prudent approach to interest rate risk. However, the fact that US interest rates are now at historic lows is an opportunity for us and we are looking to put more hedging in place. Our current view is that we will lock in rates for the next couple of years. Although our debt is medium term, it is likely that the Group will have a different financial structure in place before the banking facilities finally mature. In the medium to long term, we would envisage a less leveraged structure achieved, possibly, by an IPO if and when the time and conditions are right.

How did you put the syndicated loan together?

By the time I joined the Group, our venture capital partners, 3i, were on board and they, together with the management team, had been through a detailed process to select our banking partner. I joined at the documentation negotiation stage. We chose to go with HBOS because they demonstrated flexibility on the pricing and structure of the financing to best suit ERM. This was indicative of their experience in the field of leveraged buyouts. The debt was syndicated following completion of the LBO. Our syndicate consists of four banks, all UK clearers. We originally intended to go to general syndication but all four banks indicated that they were happy to hold at that level. This was good news in that it showed the banks thought ERM was a good risk to hold onto. Fortunately, one of the four banks was the clearer for the UK operating company, so they kept control of the UK cash pool that they had won via a tender process only twelve months earlier.

Having only UK banks does impose some limits in terms of the range of global services these banks can offer us. For example, we had hoped to encourage a US bank to enter the syndicate but, at the time, there was no appetite for US banks to take on debt at the pricing we had secured. Our intention would have been to use a US bank in the syndicate to assist us in implementing a US cash management system. However, we are not required to use only syndicate banks for ancillary business and we are currently investigating the benefits of a US cash management system internally and with several US banks.

We have very little ancillary business so I only really need to talk to two banks on a regular basis. From a treasury perspective, this can be quite restrictive as I feel it is necessary to keep in touch with the market from a variety of sources. On the other hand, as the department is so small, I do not have much time available to maintain a worthwhile dialogue with too many banks.

What is the next challenge?

Operationally the next challenge is to continue to establish a treasury policy and framework that will leave us well placed to meet the requirements as the company develops and grows.