Regulation & Standards

One for all?

Published: Mar 2015

If basic processes of payments and collections are centralised, the cost of those processes decreases; it is a simple economy of scale. But do payments on behalf of (POBO) and collections on behalf of (COBO) deliver more than just cost benefit – and are there any drawbacks of note? Treasury Today goes ‘back to basics’ with these vital functions.

Bunch of colourful pencils under a magnifying glass

When the quantity of goods produced rises, the fixed costs per unit will fall; this is the basic theory of economies of scale. It can apply to the manufacture of parts in an automotive factory equally as well as it can apply to certain basic processes executed by a corporate shared service centre: do more of it in one place and it will cost you less.

When it comes to the core – but vital – payments and collections functions, the last five years or so have seen the rise of ‘on behalf of’ (OBO) processing. As regional and even global treasury or shared service centres have gained in popularity, so payments on behalf of (POBO) and collections on behalf of (COBO) have risen up the ‘to do’ list of many a multinational corporate looking for cost and process efficiencies across multiple entities and where multiple currencies have necessitated the use of many different banks and bank accounts. The elimination of redundant processes and the sharing of facilities is often seen as a sensible move.

A POBO/COBO operation is essentially a single point of payment or collection, each set up as a separate entity, administered from a commercially convenient location for the benefit of other entities within a group of companies. It allows corporates to consolidate bank accounts and transactions across the enterprise by using a standard payments process and streamlined bank account structure. Instead of each entity owning and operating its own external bank accounts (and maybe participating in a pooling structure) there is a single legal entity that sits at the heart of the company, supported by an in-house bank (IHB), that manages collections and all payments on behalf of participating entities.

With the centralisation of treasury gaining ground since the onset of the 2008 crisis, models of cash management that offer visibility and control over company cash have become much favoured. Anecdotal evidence suggests that corporates in the ME have been using POBO-type structures since the early 1990s and it is understood that almost all large, multidivisional conglomerates in the region today use a POBO model.

In Europe, it was regulatory change that finally threw open the doors of opportunity around Accounts Payable (AP) with SEPA. A significant benefit derived from the roll-out of the Eurozone payments mechanism is the reduction of banking costs. In creating a standardised payments environment large corporate groups have been able to rationalise their multiple bank accounts and payments formats potentially down to just one for the entire zone. Increased automation of payments processes has become a very real prospect under SEPA too, especially with the homogenisation of electronic direct debits and credit transfers facilitated by the across-the-board adoption of ISO 20022/XML payments standards.

In Asia Pacific too there is movement in the direction of POBO/COBO with Deutsche Bank, for example, launching its comprehensive ‘Payments and Collections On Behalf Of’ programme for regional clients in 2013 (see its ‘Corporate User Guide – POBO/COBO’ for a detailed look at the topic).

Progression

The expansion of payments and collections management processes into POBO/COBO by treasuries tends to follow a common path. Collections and payments commonly start with local execution by subsidiaries. From here, regional centres of liquidity may evolve to include shared service centres (SSCs) for basic functions that reach across an enterprise. An in-house banking structure may extend the centralisation programme, replacing most or all external bank accounts for subsidiaries with one in-house operation.

With the centralisation of treasury gaining ground since the onset of the 2008 crisis, models of cash management that offer visibility and control over company cash have become much favoured.

With the technical and operational structure of an IHB in place the next logical move is to establish a regional payment factory. With a change in the internal bank account structure, a POBO/COBO operation may be deployed to pay/collect using a single bank account per currency or country for all participating group entities.

Whilst there is a common path, there is no one route. Each transformation programme should be planned on its own merits, constraints and objectives.

Basic requirements and set-up

Before embarking on a COBO/POBO project a number of elements must (or in some cases should) be in place to ensure the best outcome. Deutsche Bank recommends the following: central treasury and all entities to be included must be on the same IT systems, including accounting and ERP.

Whilst it is ideal to have central treasury and all participating entities on the same IT systems, it is often not achievable or practical. What is more important is to ensure that all the centralised payments and reconciliations processes are standardised and controlled by one process owner.

Provider agreements must be in place between payments and collections factories and the participating entities. An SSC, IHB or payment factory setup will usually see to it that these are met.

The starting point of a POBO operation will usually be a payments factory (the latter typically using a common IT platform to consolidate SSC processes) which manages a centralised standard payments process for participant entities. With the technical infrastructure and processes in place, a single legal entity will be established to pay the third-party debt obligations of another legal entity in the group. The process requires the exchange of external bank accounts owned by the group entities for IHB accounts (owned by the payment factory) per country and/or currency.

COBO has a similar structure, requiring entities to substitute external accounts for IHB accounts. In this set-up, a central collections factory initiates a claim on behalf of a group entity for payment from a third party. The third party will make the payment into the relevant central account for the currency/country. This account may also be a source account for the group’s sweeping/pooling structure. Reconciliation of paid invoices and ultimate fund ownership will be managed and assigned within the internal accounting process (hence the need to have IT alignment).

Technology supports the entire OBO concept. Having a centralised treasury and an IHB in place facilitates consideration of POBO or COBO implementation simply because the technical infrastructure will already be in place, underpinned by a single instance of an ERP. One of the major set-up issues for COBO is the fact that the majority of receivables data is held locally; where the single bank account is used for collections, if reconciliation is managed locally, determination of which payments belong to which entity will be difficult.

One of the main considerations for COBO then is reconciliation of paid invoices. Improving STP rates for cash application relies heavily on the payer attaching all the required invoice data (often they do not). The centralisation of this process and the receipt of paid invoices into a single COBO bank account will enable more effective control and improvement on the quality of information received and the effectiveness of the matching process. This is often supported by optical character recognition (OCR), learning matching algorithms and dedicated workflow. Not least of the issues here is that slow reconciliation can tie up client credit lines and restrict sales. Bank-provided tools such as electronic virtual accounts (in which every client has its own unique identifier number attached to the single main corporate account, the identifier keeping all transactions with this number virtually separated from all others) can provide much-needed assistance: Bank of America Merrill Lynch, Citi and Deutsche Bank, for example, all offer variations on this theme.

Plus points

By its very nature, a COBO/POBO structure will reduce complexity in terms of managing points of contact with group entities, simplifying banking relationships and infrastructure maintenance.

Replacing multiple external bank accounts with a single internal account (per currency/country) equates to potential cost savings on bank fees, especially around account maintenance, transaction fees and foreign exchange (the latter simply by reducing the number of required transactions). This can be driven by control of process execution as much as scale. Other business drivers to evaluate would include the rationalisation of pooling structures and potential for increasing net interest enhancement.

The convenience of POBO/COBO typically also means lower running costs in terms of personnel and overheads. Savings will be made by consolidating local IT systems and software licensing into a single platform. IT and process consolidation should also lead to standardisation of these elements. Focusing banking and IT elements on fewer providers could positively change the dynamic of the relationship with the chosen third parties; an increase in wallet share for those providers could increase buyer-power.

With the technical and operational structure of an IHB in place the next logical move is to establish a regional payment factory. With a change in the internal bank account structure, a POBO/COBO operation may be deployed to pay/collect using a single bank account per currency or country for all participating group entities.

Because incoming and outgoing company cash can to a large degree be centralised, POBO/COBO will also typically be expected to deliver improvements in visibility of that cash, in turn affording distinct advantages around areas such as working capital management, forecasting and risk management. In the case of COBO, payments from third parties may be expedited with more efficiency and collections may be reconciled sooner.

An efficient POBO/COBO operation should enable local operations to focus more on adding value rather than tackling time-consuming core functions. Although set-up costs are inevitable and are likely to be significant (these are discussed in the costs section), the ongoing costs of processing payments and collections through a single entity should reduce, simply based on economies of scale.

Who needs to know?

From the outset, tax, legal and compliance teams must be consulted; the initial investigation/proof of concept will certainly call upon their expertise and knowledge to reveal any potential pitfalls. Obviously the individual group entities will need to be brought into the discussion not least because some local entities may resist the move to COBO, particularly sales offices which may resent losing control over receivables activity and the direct relationship with (and knowledge of) their own clients. Indeed, local entity clients must also be informed of a move to an OBO model. Client conversations might, for example, throw up concerns and issues around the adjustment of direct debit mandates and any stipulations in trade contracts or local legal matters that may hinder or even prohibit movement from local to central payments and collections.

The movement of financial management from one country to another brings with it a number of potential legal and taxation issues which must first be investigated for each proposed entity; not all may be permitted to join whilst others may be required to meet certain conditions before acceptance (or it may prove too difficult to warrant inclusion).

It will be necessary to establish whether the entities proposed for participation are, by local law, even permitted to take part in a COBO structure – what central bank approval and reporting requirements may arise as a result of participation where they are allowed, and if there are any restrictions on types of payments made by the centre.

Undertaking a significant change to one of the most fundamental aspects of a business’ operating model will almost certainly come with a price tag.

Where client data is shared across borders, provision for data protection will need to be investigated in every jurisdiction. Other regulatory issues may arise, not least the possible requirement for a banking licence; although in most European countries this is not necessary, in the Americas it may well be a requirement (for example, Argentina and Brazil require a licence and in Canada one is required for a central collections operation).

At an individual local entity level, where other bank accounts are retained, treasury will need to establish if the OBO structure infringes any individual banking covenants that may exist for those relationships (such as the removal of all or most funds to a central location).

Tax considerations

Taxation is never far from view. Conversion to an OBO model using an IHB effectively creates an inter-company position which requires the preparation of a combined or consolidated financial statement for tax and reporting purposes.

Corporates must investigate whether withholding tax and thin capitalisation rules are applicable for a proposed OBO operation. Issues around transfer-pricing, Controlled Foreign Companies legislation (designed to stop companies from reducing tax in one jurisdiction by diverting profits to tax shelters and ‘preferential’ regimes), VAT and stamp duty may also impact the feasibility of an operation or the entities it covers.

Whereas the underlying bank account for POBO is normally viewed as an ordinary operating account, a COBO account is in most jurisdictions considered to be a trust account for tax purposes. Where these are established, their operation, documentation and reporting must be considered in the light of local tax law. Such accounts may have some downstream impact on existing liquidity and credit matters; the corporate’s cash management banks should be consulted to see what, if anything, this means.

There may be detrimental tax treatments of inter-company lending applied to OBO structures – all Asian and American markets require a close look at this, and around half of all European jurisdictions require detailed review in this respect too.

Cost of change

Undertaking a significant change to one of the most fundamental aspects of a business’ operating model will almost certainly come with a price tag. Prior to implementation it will be necessary to undertake feasibility studies around tax, legal, regulatory and market matters (including banking, vendor, customer and supplier relationships) for the proposed location of the POBO/COBO site and how these elements may impact each entity targeted to join the structure. These elements require continual reassessment due to their constantly evolving nature – the level of understanding needed represents a significant outlay.

Perhaps the main cost for corporates seeking the advantages of OBO, as recognised by Deutsche Bank’s white paper, will be technological: implementing and managing IT interfaces, workflows, system configurations, internal and external reporting and reconciliation processes.

In terms of business case, direct costs can be heavily influenced by the cost of IT implementation and integration but other costs, both direct and indirect, should not be underestimated. These can include considerations of the impact on people, organisational structure and the cost of running the programme.

Careful consideration should be given to the implementation approach to control cost and manage implementation risk. All centralised operations will be judged by their ability to execute flawlessly – there is normally no ‘honeymoon’ period in an ‘on behalf of’ model.

Is migration an option?

The decision by a large corporate to migrate to an OBO operation is far from obvious. The set-up process requires considerable effort, not least with the legal, tax and regulatory investigations that must take place in advance of that decision and thereafter to keep pace of any developments – for each and every country involved. The need to develop and maintain the IT infrastructure, enabling continued connectivity between the relevant entities and the IHB/OBO facility, is essential. Process automation (including reconciliation) requires standardisation as far as possible if bottlenecks are to be avoided and any resistance by local teams to let go of their client relationships must be tackled sensitively.

However, once in place, an OBO structure can deliver a number of benefits for corporates including bank account consolidation, lower account, transaction and FX fees, re-focus by local entities on value-added work, lower longer-term IT costs and, perhaps the leading driver, improved visibility over working capital. Economies of scale can, and indeed do work – but not before a lot of hard graft has been put in to prepare the ground.

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