REGULATIONS
Bringing It Home: International Cash Management, a Banking Perspective
November 28, 2005
AFP Staff Writers

From the Nov/Dec issue of AFP Exchange magazine.

As multinational companies centralize treasury processes, they're running up against a few challenges.  Three banks with global presence discuss the techniques their corporate customers use to manage their liquidity.

Andrew Yeates, Senior Vice President, Head of Corporate Sales-Global Payments and Cash Management, HSBC

Structures:

There are a multitude of banking structures used by corporate entities outside of the United States, the most popular revolving around centralization and liquidity management. One is the "bank overlay" structure, which is based upon a two-tier banking structure that encompasses the selection of a key local in-country banking partner for a corporation's day-to-day domestic cash management requirements and the selection of a pan-regional, or global, banking partner to act as a centralized overlay account provider.

The "bank overlay" structure allows a corporate to select a best-in-class provider for local services, which doesn't disrupt historical in-country bank relationships. The overlay bank account component of this structure encompasses opening a separate account with the overlay bank for each country the corporate conducts business in, or possibly for each legal entity. These overlay accounts facilitate the movement of cash from multiple local levels to a single centralized hub at a financial center. The overall cash position for an entire region is now centralized on a daily basis into a suite of accounts managed through one central bank relationship. This creates greater visibility and access to cash, as well as an effective means of managing the positive and negative cash flow positions of multiple in-country entities.

Other popular banking structures take on many different forms and levels of magnitude:

• Shared Service Center / Payment Factories - Account structures associated with shared service centers or payment factories are becoming more common across the globe. These banking structures allow a corporation to create a "center of excellence" as it relates to centralized accounts payable and accounts receivable processing. Common A/P and A/R systems managed within a shared service center can interface directly with strategic banking partners to facilitate a high degree of automation and straight through processing (STP).
• In-House Bank - In the case of a corporate establishing an in-house bank, it is common for each of the operating entities to maintain an account in its name, which is owned by the legal entity that supports the in-house bank. In-house banks make managing such items as inter-company loan positions, third party payment obligations and foreign exchange exposure much easier.
• Multilateral Netting - A multilateral netting bank structure is designed to help a corporation efficiently manage F/X exposure related to inter-company foreign currency invoices, and in some cases third-party foreign currency invoices. Rather than a one-off settlement of invoice-by-invoice, a netting bank structure settles all invoices once per month, or more frequently if preferred, and are netted off of each other. This netting process creates an end result where each participant in the netting process is either a net payer or net receiver of funds. Thus, multiple one-off invoice-by-invoice payments are now reduced to a single payment, per participant, per month.
• Centralized Bank Reporting Structure - Allows a corporation to efficiently manage and centralize the multiple bank reporting streams that constitute their regional or global operational footprint. One key bank in the region (i.e., the overlay bank), or the globe, is selected to be the centralized recipient off all bank data-most commonly via SWIFT MT 940 messages. The selected bank will then consolidate all 940 messages into a single data file that can readily be uploaded to a corporation's ERP system for management reporting.
• Continuous Link Settlement Structure (CLS) - Originally designed for the financial institution marketplace, a CLS-based banking structure for corporate entities is becoming a more recognized tool, providing for a reduction in foreign exchange settlement risk. It further provides back office automation improvements and better control of the settlement process that directly effects a corporation's overall operating efficiency.

Techniques:

Of the many techniques HSBC's customers use to manage their cash overseas, one of the most common is the cross-border ZBA-or the physical movement of funds from one location to another, a common practice within the "overlay banking" structure. Although an efficient means of liquidity management, the method may not meet regulatory hurdles in certain regions-most notably throughout Asia where it is prohibited to physically concentrate funds offshore in places like China, Korea and Taiwan.

As many U.S.-based companies with overseas business still maintain USD receivables and payables, the ability to concentrate the USD back into the U.S. is an effective liquidity management tool. Cut-off times in the U.S. are more favorable for payment initiation, and the investment alternatives for excess cash positions in the U.S. are generally more robust than offshore alternatives. Further, banking partners such as HSBC can offer an automated means of concentrating USD from across the globe, making it easy to centralize all dollar positions into a central account(s) on U.S. soil.

Challenges:

Each of the topics noted above provide for different level of challenges for our customers as they manage their growing global businesses. The ever-changing regulatory environment creates the challenge of best determining how to operate most effectively across the globe. As the world's local bank, HSBC's level of local market knowledge and intelligence is of great benefit to our clients facing such issues and allows us to provide solutions that take into account each market's regulatory environment.

Also, in this time of Sarbanes-Oxley concerns, the accurate and timely flow of information from multiple banking partners is important. Centralized reporting via a unique global bank platform has moved from a "nice to have" to a "must have" item for treasurers. HSBC's ability to collect reporting streams from multiple regional banks (via SWIFT 940 messages) and deliver a consolidated data stream via a central Web-based gateway is essential to our client's centralized reporting priorities. 

Daniel Rosenstein, Head of U.S. Corporate Sales, Global Transaction Banking- Cash Management, Deutsche Bank

Structures:

U.S.s multinational companies are moving at a much faster pace toward increased centralization and standardization of global treasury processes.  The following market dynamics are cited by about 70% of our clients as driving this trend:

• Increased regulatory scrutiny requires financial transparency and better control over global cash flows. 
• Budget constraints demand companies to seek end-to-end automation and better utilization of resources. 
• The continuing need to trim costs forces companies to seek lower banking fees by consolidating banks globally and driving higher volumes through them.

Some tried-and-true practices, as well as some newer ones, are helping companies build globally centralized structures and standardized processes.  These include shared service centers, treasury centers, payment factories, payment agents, etc.  Our customers want a single bank to be their window to the world.  They are asking us for a combination of overlay structures and local banking capabilities, supported by expertise within each country.  Their unique requirements demand flexibility in terms of technology as well as service structure.  This means banks must offer technology to help companies send and receive information via mainframes, treasury workstations and bank Internet systems, including direct interfaces to certain systems.  When clients say, "We have no IT resources, please accept our current format," banks need to accommodate such requests. 

Similarly, clients require U.S. customer service staff to be the parent company's portal into their global cash flows, while also providing service staff locally within each country to support their subsidiaries' specific needs and languages. It is imperative that banks respond to their customers' demands by offering centralized global as well as local customer service.

For example, we have recently worked with a number of U.S. companies that have looked into "payment agent" models. In such a structure, a single legal entity is elected as a payment agent on behalf of other entities and thereafter is responsible for maintaining a single local currency account per country, which is used to manage the transaction processing on behalf of multiple legal entities.

Techniques:

Our customers are increasingly relying upon us for tools to automate their global processes.  Many are utilizing the formerly European practice of creating in-house banks, which control global cash pools and netting centers. 

Customers are taking better control of their global USD positions, centralizing them in the U.S. via USD global cash concentration.  This practice provides corporate treasurers with the flexibility and the automation to consolidate their global USD positions held outside of the U.S. into New York City, reducing external dependencies on costly credit lines and maximizing the value of surplus balances.  Balances are automatically concentrated on a same-day basis across regions, thus allowing for tighter control over the cash forecasting process.  Conversely, USD global cash concentration offers the capability to recall funds from New York to overseas locations to cover deficit balances. 

Our clients have shown tremendous interest in this sort of structure, spurred initially by the American Job Creation Act of 2004 as it allows for a one-time repatriation of USD with more favorable tax rates under certain conditions.  Our customers tell us that they need to control cash better and manage working capital more closely.  These requirements will keep the trend going.

A pooling service, whether physical via a ZBA structure or notional, is ideal for driving the proper behavior among many subsidiaries that are not managing their cash flows tightly.  An in-house bank sets advantageous rates for cash-rich businesses, while setting punitive rates to those that are cash poor.

Overwhelmingly, corporations continue to look to physical pooling (cash concentration) to consolidate their cash balances through ZBA structures as the preferred method of managing cash overseas. This consolidation can take place on a domestic, regional or even global basis now with tools and technologies that can automate both transaction flows and any associated inter-company administration. However, we are seeing a lot more interest in notional pooling structures within the U.S.
Clients use a netting center to control and manage global inter-company and preferred vendor payment flows, while reducing costs associated with foreign exchange, transactions fees and cash flow reporting. 

To improve their working capital, customers need to automate elements of their cash flow forecasting and improve how they reconcile global collections of receivables.  On the accounts payable side, there is increased need to automate the ability to finance the customers' vendors or through greater transparency, take advantage of global vendor discounts.  The smarter global banks are offering some type of "integrated working capital structure" that helps companies achieve these goals in an automated fashion, globally. 

Challenges:

Depending upon a company's specific circumstances and locations, the complexity and lack of harmonization among global tax and regulatory rules makes total centralization very difficult.  In countries where participation in a centralized global model is not feasible, customers are setting up regional structures with as much standardization with the other regions as possible. 

Challenges to harmonization are most pronounced in Asia, where there are many cultures, traditions, regulations, clearing systems and taxation rules, which are unique to each country and limited by few existing intra-regional treaties. Two of the countries attracting attention are China and India, which are evolving in their regulatory infrastructures and their openness to foreign investment. While the rules and regulations appear to be straight-forward, they may be open to interpretation based upon individual circumstance. Customers need to ask their bank to be both a savvy local and international consultant.  Banks need to spend time with corporations to understand their specific difficulties and provide technologically-driven solutions and outsourcing capabilities. 

Deutsche Bank has brought efficiencies and economies of scale to our own back office successfully via our shared services center in India.  This experience has given us a powerful wherewithal to share best practices with our clients. 

For example, a transportation-related company was able to meet the following objectives with our close cooperation and guidance:

• Improve service levels to industry partners in settling payments and receivables
• Grow aggressively
• Reduce cost of settlement services
• Create a lean organization structure
• Execute a benchmark comprehensive outsourcing solution, including the settlement process, billing, collections, reconciliation, payments, logistics management, as well as ticket stock storage and management, and delivery to Agents
• Deutsche Bank has a dedicated infrastructure and re-sourcing process to run this turnkey solution

The best way for a corporation to address global complexity is to find a bank with international and local expertise, a global view strategically, products which operate in a consistent fashion worldwide and a customer service infrastructure that can provide a global interface for the parent company in the U.S., as well as a local presence to provide support to the subsidiaries.

Michael Fossaceca, Large Corporate Sales Executive, Treasury Services, JPMorgan Chase

Structures:

Local banking structures predominate for operating cash flows (collections and disbursements) to provide access to local clearing systems.  These accounts may be held with a local bank or the local branch of a global bank.  Either way, they generally are linked or integrated with a global or regional overlay banking structure that provides a corporation-wide liquidity and working capital funding mechanism and transparency of cash flows.  The exact implementation will depend a great deal on company specific variables, such as the legal entity structure (holdco with many subs vs. monoline businesses) and degree of regulatory oversight of the industry (health care and pharmaceutical vs. general diversified).  Both impact treasury.  For example, netting and inter-company loan structures are required for holdco environments, especially when regulated industries are involved.  The amount of local regulatory oversight on legal entity types and ownership structures, as required by local law, must be taken into consideration.

Techniques:

Cash management techniques overseas are highly dependent on currency.  When "common" currencies are involved, various techniques are used to concentrate cash in those currencies.  For example, notional pooling is commonly used to manage cash overseas especially for Euros.  Cross-border ZBAs are employed when functional currencies are used in multiple countries, and generally just USD and Euro.  U.S.-based concentration is still the most common method for concentrating USD across the U.S. and NAFTA, including cross-border USD in Mexico and Canada; however, it is possible that wide-scale adoption of distributed capture will make the traditional concentration via ACH obsolete. 

Where multiple local currencies are being managed, these generally are confined to in-country solutions, and sometimes, cross-currency pooling techniques.  Netting, once the most common method for dealing with cross-border intra-group trade payables, is still readily used for arms-length requirements from a legal standpoint.
Increasingly, in-house bank structures are replacing netting as the optimum model for managing liquidity, cross-border third-party payables, as well as intra-group payables. Taken together, this combination is often referred to as a global payment factory.

Challenges:

The largest challenges clients face with managing cash overseas are systems and information flow, specifically around the variety and complexity of clearing systems.  Global banks now make it possible to connect to local country clearing systems in a seamless way by offering local payments functionality and costs comparable with the U.S. ACH systems.  However, issues still occur with regard to the handling of information, rejects, and returns.  Information flows are particularly difficult with the low-value clearing and check clearing systems, but are getting better with high-value clearing. For example, real time nostro will help on the bank side (cable and wireless service with realtime, nostro reporting via Swift Net).  Taxes rarely prevent corporations from creating a solution, but they can narrow the choices.

Also, both in-country and U.S. regulations can seriously affect the way solutions are made workable, especially in Asia and Latin America.  FX risk continues to be a challenge, as the challenges now swing toward Asian currencies and Eastern European countries.

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