From the June Special Report issue of Treasury & Risk magazine

Evolutions in Treasury Centralization

By Elyse Weiner, Managing Director & Global Head of Liquidity Management Services, and Michael Fossaceca, Managing Director & North America Region Head for Corporates, Citi Treasury and Trade Solutions

Structural shifts in the global economy and the growing importance of emerging markets are reshaping the business landscape. With rapidly globalizing supply chains and changing market forces, along with increasing financial regulation and choppy economic growth, Treasurers have new opportunities to partner with the business and create greater value for the firm.

Elyse Weiner, CitiIntegration of Treasury and Working Capital Management

Companies are establishing new operating models, reallocating capital investment, and shifting their global supply chains. These changes reduce costs, ensure seamless movement of goods and services around the world, and generate financially efficient trading results. In response, Treasury departments are reconsidering their organizational and operating structures in order to remain aligned with these new models, support corporate strategic objectives, and manage changing patterns in sources and uses of cash.

For many Treasury departments, one element is the establishment or extension of an In House Bank (IHB). At its core, an IHB allows a company to gain financial efficiency by centralizing intercompany activity and improving self-funding and management of group foreign exchange risks. One function of the IHB is to manage the liquidity pool for main operating currencies, taking ownership of a substantial portion of group cash and funding. As the intercompany funding intermediary, the IHB can also act as the Netting Center to rationalize intercompany settlements. At a more advanced level, an IHB can allow for centralization beyond intercompany financial flows to those that are commercial, e.g., vendor payments and customer collections “on behalf of” (OBO) group subsidiaries. OBO structures help further simplify liquidity management and centralize foreign exchange activities at the IHB level, allowing for greater uniformity in processes and improved risk management.

Companies with existing IHBs are reevaluating their effectiveness to extend approaches on a more global basis, based on changes in the corporate business, local regulation, and fiscal conditions. Those that do not are looking at the opportunity to establish these structures as a catalyst for their next level of centralization.

Re-engineering Banking Structures to Support Centralization

With the change in business flows affecting where cash is being generated and is needed, many companies have legacy banking structures that have become inefficient. This, along with regulatory changes – from easing of controls in many emerging markets to the Euro zone’s mandatory move from national payment instruments to SEPA instruments – means that companies stand to benefit by refining what they have in place today. In the case of the Euro zone, companies may no longer need to maintain legacy bank accounts in many European countries. At the same time, changing regulations in emerging markets makes it easier to re-organize both liquidity and commercial flows, making it more important to reevaluate existing bank arrangements. There are significant dividends to be gained from refining bank account structures in concert with IHB deployment to make these “fit for purpose” in streamlining the management of liquidity.Michael Fossaceca, Citi

Also, as a result of sophisticated ERP and treasury management systems, and advanced solution suites made available by leading banks, IHBs can more easily manage large volumes of intercompany loans. This has led many companies to implement hybrid structures that concentrate key currencies at the IHB using global sweeps and deploy single-entity multi-currency notional pooling to ease management of cross-currency liquidity positions. In tailoring global liquidity structures, the control advantages of centralization need to be weighed in consideration of tax, regulatory, on- and off-shore interest rate differentials, and operational effectiveness of multibank arrangements to determine how and where currency positions can be optimally managed.

Improving Commercial Practices to Mitigate Risks

As supply chains “stretch” and demand shifts to new markets, strategies to mitigate risks of supply chain disruptions and counterparty default grows more urgent. Treasury’s corporate finance perspective can help create better organizational understanding of risks embedded in commercial practices. This can become crucial in driving improvement in management of working capital funding and risk exposures.

For many companies, procurement from emerging markets-based suppliers is backed by Trade Letters of Credit (L/Cs). The impending phase-in of Basel III will raise banks’ costs of capital, in turn reflected in higher costs related to the issuance of L/Cs and loans to non-investment grade companies, often the majority of a large multinational’s supply chain counterparties. For these reasons, many corporates are reviewing their vendor portfolios with the objective of seeking longer-term stability of the supply chain, while managing nearer-term costs of procurement. Supplier financing programs offer a viable alternative, enabling vendors to gain better terms for short-term credit based on the more favorable risk of their investment grade buyer.

Expansion into new markets also creates the need for closer scrutiny of credit terms and underlying commercial counterparty quality. Where commercial counterparty risk or sovereign risk is less than desirable, treasury departments are more actively considering outright sales of accounts receivable after consideration of the financing costs vis-a-vis the underlying risk. It may be possible to bundle receivables across different risk categories to diversify the portfolio and attract investors, and use insurance-wraps to enhance credit quality if needed and feasible.

Expanding Roles to Create Value

Treasury departments are increasingly going beyond traditional core functions to take broader roles in the enterprise. As business operating models evolve, Treasurers are becoming strategic partners to the business, helping identify optimal strategies and factoring in risk considerations, all the while proactively realigning their own organizations to the needs of the business.

Global In House Banking to Streamline Liquidity

The Challenge

A Fortune 100 global technology company had complex commercial and intercompany flows, the latter often with poor coordination. Treasury had management functions spread over numerous locations, multiple cash pools, and stand-alone bank accounts with no overarching liquidity structure. The result was poor cash access and utilization, added to eroding interest margins and process inefficiencies.

From Insight to Value

Citi's Global Network for Liquidity Management

The company used Citi Treasury Diagnostics to benchmark its treasury operations current state and gain insights on opportunities for improvement. To centralize control and visibility, Citi recommended a global cash pool for G3 and other material currencies; structured in global cash aggregation with automated end-of-day ZBAs sweeps “with the sun” and “against the sun” to concentration header accounts; and, a multi-currency notional pool on top. Citi also assisted the company in defining a path towards consolidation of multiple finance companies and pool headers into a single offshore In House Bank (IHB) to centrally manage all liquidity outside the US; and, in establishing a full-service intercompany netting center within the IHB. The recommendations also included alignment of the Treasury technology topography, including re-configuration and deployment of the company’s treasury workstation to support the solution globally.

Powered by Citi’s Global Network for Liquidity Management

Global liquidity structures and IHBs are effective catalysts to reach higher degrees of optimization, with treasury and commercial flows converged and managed through more holistic strategies. Citi’s Liquidity Management Services – including Treasury Advisory, Liquidity Analytics, Cash Aggregation, and Optimization – help clients achieve global treasury best practice with solutions to support the end-to-end process from identification of opportunities to execution.

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