Corporate Treasury: Approaches & Experiences with Multilateral Netting

Commentary

The relentless search for efficiency and cost reduction: this is the lot of every treasurer. One of the first, and most obvious, targets is netting – so much so, that it is often taken for granted. This call was an opportunity to check up on what our peers are doing, and the latest developments.

The most obvious – and frequent – area for netting is intercompany transactions. The benefits are clear: the elimination of spreads on FX transactions which are no longer required, the reduction of bank charges and fees, the optimisation of funding, and the imposition of enhanced discipline in settling intercompany invoices.

This basic transaction has been extended: while traditional intercompany netting is cash settled, an increasing number of peers are turning netting into an in-house bank. In this case, all intercompany transactions are booked into an account with the parent company – from the subsidiary’s point of view, this means the invoices have been settled. The in-house bank will decide when, and if, the intercompany accounts are settled. This same account can also be used for third party transactions, under POBO/ROBO arrangements, significantly reducing the number of cash transactions in the subsidiaries.

Also, many peers net transactions with their banks: instead of settling all FX transactions with each bank, some peers use regional treasury centres to settle on each other’s behalf. It is also possible, for example, if there are gains and losses on hedging transactions, to net settle with each bank, or get the banks to settle between each other on behalf of the company. This reduces the number of cash movements – and can relieve pressure on intraday limits caused by large centralised hedging programmes. One peer uses Finastra to manage this.

Similarly, while netting is usually applied primarily to intercompany transactions, the use of POBO/ROBO (Pay On Behalf Of/Receive On Behalf Of) can achieve a similar result with third party payments – again, combined with in-house banking, this becomes a powerful tool.

Of course, there are complications:

• If there is a large volume of transactions – volumes in excess of 1,000 transactions per month are viewed as low – some kind of system is usually needed. The tool most used by the peers on the call was Coprocess (now owned by GTreasury), though others used Kyriba, IT2 and Integrity as well as services provided by banks.
• One of the functions of the system is to provide an FX rate for these settlements. This is usually a two step process: a first run is done using indicative rates, so every participant knows more or less how much they will pay or receive in their own currency. The second run will then fix the rate, and the treasury team will execute the FX transactions. There is an inevitable delay in this process, which peers try to keep short, to minimise the impact of any FX rate fluctuations.
• It is important for settlement to follow quickly, to reduce the FX risk. Some peers actually lock in the rates by forwards. It is an issue if any subsidiary does not settle on time. Solutions to this problem include taking the cash directly from the subsidiary’s account, or using the in-house bank approach.
• Regulations are an issue: many countries do not allow cross border netting, and rules frequently make intercompany loans difficult and burdensome. In particular, with an in-house bank, interest should usually be paid on the outstanding balance – this can create issues where there is withholding tax, or where prior approval is required for every loan.
• In cases where netting results in cash settlements, there are some important disciplines:
  • Need to establish a netting day – usually monthly – when all transactions will be fixed and settled. This usually requires a calendar published well in advance, which avoids national holidays.
  • Need to establish clear rules on invoicing currencies, and making sure it is clear what will be settled. In most companies, it is the paying entity which declares the invoices it agrees with and will settle: disputes have to be handled in a different forum.
  • One peer had experienced issues when accruals for services received were included in the intercompany account.
  • It is not unusual to have netting by region, either for historical reasons or because of regulations.
• Some peers have entities which are primarily producers of goods and services which are marketed through other entities. This structure tends to result in a substantial difference in the cash generation and cash levels: in these cases, the intercompany netting process becomes an important cash management tool.

Bottom line: netting, in all its forms, is a key driver of efficiency for international treasury teams. In fact, a case can be made for saying it is the basis on which most in-house banks and global cash management solutions are built.

The simplest form of netting is to oblige all group companies to settle on a given day: they will make, or receive a single payment by currency, instead of making thousands of payments to multiple counterparties. There is some serious work involved in the process, and most people use a system. But the savings and efficiencies are immediate. 

The next step is to debit or credit the payments to an intercompany loan account: when, where, and how these accounts are settled then becomes a cash management decision taken by group treasury. In other words, netting is the foundation of an in-house bank, which can then be expanded to third party transactions using POBO/ROBO techniques - exchange controls and regulations permitting. 

The most useful tools are often the simplest.