We continue our popular series of interviews with senior figures in the world of treasury and finance, this month talking to Neil Cotter, Group Treasurer, Logica plc.

How do you manage your cash?

I see three elements to cash management.

Firstly all permanent large cash balances should be deposited with central treasury – after all that is where the investment skill base resides. It is my job to make sure the businesses realise that the centre is the “bank of first resort” to them rather than their local bank. It is critical that we act as a professional banking service to our businesses to minimise local concerns over access to cash. The end result is that we can maximise investment returns whilst minimising counterparty risk.

The second element is that the day-to-day balances – the working capital balances – operate via a cash pool in each country. We try to have a single bank, wherever possible, to run a particular country’s cash pooling operation.

The third element is to have an overlay banking structure. The overlay bank is there to extract surplus balances from the country cash pools on a day-to-day basis and bring it back to the UK effectively maximising the centralising of the cash on a daily basis.

I think these are the three elements which are standard for most treasuries, but we need to keep things in perspective since the first element is by far the most important.

How did you go about setting up the cash management structure? Do you have local treasurers?

We have treasury professionals in Ireland and the Far East – elsewhere the job is performed by the general finance function. I have to promote the concept that cash flow and working capital should be managed locally, but that cash management is the prerogative of the central treasury function. It is a matter of repeating this message again and again and being clear that it is the best way forward.

We haven’t actually implemented the overlay bank yet – that will happen quite shortly as we have been going through a selection process over the last few months. But it all takes time, with all the bank accounts and processes that need to be set up.

What do you do with your cash surpluses?

Apart from a couple of minor periods after paying cash for acquisitions, Logica has been net cash positive for the last five years or so. In particular, we have had a lot of surplus cash recently. Our rights issue in October 2000 raised £460m of cash, mainly to pay for an acquisition, which completed in July this year. Being used to having £40m or £50m cash and then suddenly having £500m cash was a major issue.

With a rights issue, almost all the cash comes in over one or two days. We had to distribute that cash rapidly – to maximise returns and manage counterparty risk. Logica is very conservative on counterparty risk with strict limits. We never put more than £50m with one entity and that’s only when it has a AA+ rating or better. If it’s between AA- and AA+ then the limit is £25m. If it’s below AA- we don’t invest.

I put over 80% of that money into CP or CDs to enhance the return and this achieved a 10 or 15 basis point enhancement relative to bank deposits. I also managed to find a bank that, for some reason, offered base plus five basis points on a 7 day notice bank account – which was good because one week LIBOR has averaged about 10 basis points below base for some time. We are ruthlessly opportunistic within our counterparty risk framework.

What CP market did you go for?

We invested in sterling denominated Euro CP because we benchmark our returns against sterling (since the cash was transient) and other currency denominated CP didn’t generate a higher return than sterling CP on an afterswap basis. I also managed to find banks that would act as custodian on the paper, so I didn’t need to open a Euroclear or Cedel account. This was helpful as the long cash position was only for 6 months or so.

How do you raise funds to finance your continuing expansion?

Logica adopts a very conservative approach to debt and, as I have said, has been net cash for several years, apart from some short periods. Generally speaking those short periods have been due to timing differences between when we can access equity markets and paying for acquisitions. There are no short or long-term borrowings although we do have a £150m bank facility that remains undrawn at the moment. This facility is primarily to fund minor acquisitions and to help bridge the gap between raising equity and paying for acquisitions so markets can be tapped optimally.

The rights issue in October 2000 was a deep discounted rights issue (DDR). A typical rights issue used to be at a 10% to 15% discount to the share price. The company would pay underwriters to buy the shares if the share price dropped below the discounted price – effectively a very expensive put option on the company’s own shares. Since the stock market has recently exhibited high volatility, underwriting fees on rights issues with a 15% discount would be heavy. We therefore agreed to do a rights issue at a 50% discount to the prevailing share price. This meant that instead of paying something like a 2% underwriting fee, we only paid ½ % underwriting fee – a saving of £7m. The only problem with a rights issue is that you have to produce a detailed document which is time consuming compared with a non pre-emptive equity placement. It is interesting to note that DDRs have rapidly become the market norm for raising significant equity.

How do you arrange project finance?

Part of Logica’s growth stems from Design, Build, Finance, Operate (DBFO) projects. For example, we have a contract with OFSTED, which involves developing software and infrastructure, and then running it, primarily so their staff can work from home.

Customers often want us to pay for all the development costs and then they wish to pay us over the life of the project in the form of an operating license. This gives us significant negative cash flow on those projects in the early years. The problem with these contracts is that the stock market sees the negative cash flow and it gets concerned – businesses are at the end of the day measured on cash flow. In effect, Logica is acting as a bank to the customer – that is, financing the customer’s capital expenditure. In this case (OFSTED) it is a very good quality customer – the government with its AAA rating – so there are no credit concerns but we still have the cashflow issue.

But Logica is not a bank and we have no aspiration to be one! These projects need to be structured so that we can show the stock market that, although we have got working capital building up on these projects, there really is no financial counterparty risk on Logica – we will still be paid (other than us not performing on the contract which is an inbuilt risk of Logica). Our solution is to enter into contracts with banks where we sell the future receivables under these projects to the bank. They provide cash up front and, in return, they obtain a stream of payments direct from the customer. It is like factoring except that the debt hasn’t happened yet – although we have incurred the expense. The bank does not have recourse to Logica in respect of customer credit default. We have effectively ring fenced the debt and the working capital, which, under accounting standard FRS5, are shown together on the balance sheet. We like this structure because it clearly shows working capital post non-recourse financing – a much truer measure of Logica’s working capital management. This also means that we can avoid complex project finance structures as well – it keeps it simple and cheap. At the end of June, the OFSTED project was the first to be drawn. But if we are going to do a significant amount of DBFO work, this will be our preferred route to mitigate counterparty risk on the commercial side of the business.

How do you manage your currency risk?

We hedge 100% on trade receivables and payables. A big risk at Logica is the contingent foreign exchange risk on projects where the UK business might bid for a contract in a foreign currency. When we bid for the contract, we don’t know whether we are going to win or lose the contract. There are instruments that allow this risk to be effectively hedged. Obviously when we win a contract we will enter into a forward contract to protect the risk. I would then guarantee that exchange rate to the project manager who then has to manage the project. I make sure that I net out to zero at the centre – and perhaps show a small profit!

We also manage the foreign exchange risk on all the debt that comes into the centre. If we need to hedge a euro exposure, it is inefficient to borrow in euros (because we are net cash remember) and to deposit in sterling because we are paying a 45 basis point borrowing margin on the euros. We do it synthetically by replicating the scenario of borrowing euros and depositing sterling by entering into an outright forward foreign exchange contract. Effectively the forward points on the contract represent the interest differential on the two currencies.

A similar technique is used to create synthetic debt in Euros and USD to hedge our overseas investments. Residual tax risks can exist on currency debt but these can be mitigated through simple FX derivatives or tax matching elections. The relevant interest rates drive which is the best the option to use.

How do you use technology within your treasury?

As treasurer of a technology firm, Logica, I feel it incumbent upon myself to utilise new technologies or at least investigate new technologies on behalf of all treasurers. I’m particularly interested in two areas which will facilitate improved straight through processing for mid-sized corporates:

Firstly, I’m looking at a product called ConCord, produced by CityNetworks. This product allows me to transact foreign exchange and money markets directly with my banks. As ConCord is a service that gives me access to the SWIFT network, this will send a SWIFT message on my behalf to match with the SWIFT message send by the bank. At the moment, corporates such as ourselves are not able to do this as they are not part of the SWIFT network. This will create a system where the treasurer can electronically match the confirmations contemporaneously with transaction execution. It interested me in particular as it deals with money markets as well as FX.

Secondly I am interested in the multibank FX portals such as FXall and Currenex. Ideally what I would like is for all my banks to quote through a single window. I don’t want individual interfaces to each bank with 8 user IDs, 8 passwords and 8 individual links from their systems into my system. It doesn’t lend itself to enabling straight through processing. What we really need is a single window into the banking market for all the financial instruments. The treasurer then has a single source of data that would be able to interact with his treasury system. I am convinced that, given time, this will be the main route for procuring over-the-counter financial instruments.

How do you approach your banking relationships?

We are very focussed on relationship banking. We give our banking business to those banks that provide us with their balance sheet albeit our bank facility is undrawn. There is a general trend for many banks to reduce their exposure to technology firms at the moment and because we are in the same sector, it will inevitably impinge on some relationships despite us being cash generative and carrying no debt!

How many banks do you have?

Ten. We operate a two-tier system. We have an inner tier of five banks with whom we do most of our business and who provide the major element of syndicated finance. With the next five in the outer tier, the relationship is weaker. This is a twoway street – because we don’t do that much business with them, they don’t provide much of their balance sheet to us.

We are looking for banks with aspirations to match the global footprint that we are developing. Our relationship banks must also have the capability to fulfil some of the requirements we need at the centre – the project finance, foreign exchange and money market activity. At the moment we are in the process of reassessing our inner tier of banks to make it fit better with Logica’s requirements – we have developed in Germany and we may well expand in the USA.

You have treasurers in Ireland and Japan – who appoints the local banks?

I specify with whom they can bank. In some corporates they want to keep treasury separate in each business stream. However, Logica is a global integrated brand so, likewise, I want to centralise treasury activity. Wherever possible, I want to internalise transactions, so that I can net them prior to execution. There are also compelling control reasons to adopt this policy irrespective of a particular corporate’s business philosophy.

It is important that the local businesses deal with the banks with whom I have a central relationships, for three reasons. If things go wrong locally, I can bring central pressure to bear to sort it out. Secondly it also enables me to exercise some control from the centre. If there are some unusual transactions locally, my relationship banker can tell me, and I can investigate. Most of the time there will be no problem – but it is an extra control or comfort factor. Thirdly the bank can advise me if there are better ways of managing the local transactions.

How do you see the banking sector developing?

I think that many banks want to make more and more money from investment banking. Instead of offering bank credit they want to help us issue bonds, for example, despite not having a requirement to do so. This can be irritating – they are all chasing the cream but unfortunately there is very little to go round. Most corporates have a limited budget for investment banking. The relationships are also changing on asset finance – banks are looking to move from unsecured credit risk to lending against assets but this actually fits in neatly with our customer requirement for us to fund them – a happy coalescence for once! All in all this seems to be where things are heading.

The problem for corporates is that it will become harder to access unsecured syndicated loan financing. Corporates will have to be flexible and be prepared to tap into other investor bases such as bond issues and private placements, even if they have to be pay up heavily for the diversification. There is, however, an element of wait and see about this. We have to recognise that the dynamics of what the banks are looking for can change rapidly. Corporates have to be more flexible in the way they approach their relationship banks and recognise that the “fair weather” bank is back with a vengeance.