Approaches to Funding Subsidiaries
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This call came out of a series of discussions with treasurers: we spend a lot of time worrying about intercompany loans, external funding locally, etc. But a lot of these issues arise as a result of a series of key decisions, which are strategic and often historical: how do we structure our subsidiaries?
This is a complex decision. A non-exhaustive list of considerations includes:
- Company policy: the more equity in a foreign entity, the bigger the perceived risk
- Flexibility: loans can be quickly repatriated (at least, in theory): equity cannot
- Duration and refinancing risk
- Involvement of the in-house bank
- Exchange controls
- The need for internal loan agreements
- Tax. This is very complex, and can become circular:
- Local thin capitalisation and equity requirements
- Arm’s length pricing for intercompany loans – the end of LIBOR complicates this
- Profitability of the local business
- Charging for credit risk – this is circular, as we control the credit quality
- Country risk
- Implicit guarantees
- Business performance issues: equity does not result in a charge in the local books. This can disguise the true cost of funding working capital or capital expenditure
- Difference between local accounting rules and those of the parent
- Workload: the analysis is usually manual, which can be a problem if there are many subsidiaries
Most of these topics came up in the call. As always, there are a variety of approaches, with no one right (or wrong!) answer. But some shifts seem to be under way:
- People seem to be considering equity more than in the past
- Transfer pricing is becoming more of an issue, so Tax is having a bigger say
- Specific problem with negative interest rates, especially for the euro
- In-house banks initially just provided short term funding. Some are moving to do all funding
Bottom line: it can be worth taking some time to stand back to look at the overall structure, and ask “What would I do if I started from a clean piece of paper?” We never start from a clean piece of paper, but it is good to have a view of what the preferred structure would be, and work towards it.
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