The treasury departments of many multinational companies have been on an evolutionary journey in recent years, but the next step could be the biggest yet: going truly global by making the leap to an international treasury center (ITC).
Whether on a regional or global basis, ITCs are being used to efficiently centralize and standardize many treasury functions — including liquidity and risk management, intercompany and external funding and investments — and housing them together within a tax-efficient legal entity.
The streamlining alone of these functions can save significant time and money, but an ITC is capable of much more than that as the visibility and access to liquidity it provides can reduce the impact of increasingly unpredictable turns of the global economy.
Financial market volatility, the complexity of financial instruments, far-reaching accounting and regulatory changes, the euro crisis, emerging market growth — these and other dynamic forces can pose sudden and urgent challenges to a company’s earnings, market share, cost of capital and shareholder value. A properly designed, located and operationalized ITC can help supply the stability and flexibility needed to meet these challenges.
The transparency and coordination that an ITC brings to the typical multinational’s sprawling network of operating units and subsidiaries can even fuel new possibilities for growth, by making financing, risk management and support functions more closely available to where they are most needed.
As attractive as the potential benefits from shifting to an international treasury center are, a company first needs to determine that it is ready for an ITC and to understand the key steps in the transformation.
The Current State of Affairs
As companies expanded internationally over the years, many of the processes for managing treasury operations arose independently to meet the needs of each new situation, market or country. For a time, these processes worked well in serving those needs. But in many cases, they operated separately from the needs of the rest of the company. Nor did they benefit from the efficiencies that come from scale or from possible offsetting intercompany positions.
As international markets matured and the parent company’s operations spread and became more complicated, this patchwork quilt of treasury functions and processes has become ever more cumbersome to operate. The monitoring and processing of the resulting myriad of transactions — and the need to manage currency risk and cash flows — suffers not only from a lack of economies of scale but also from potential duplication and inconsistency.
What’s more, subsidiaries with excess cash in one market often invest in their own country location while sister subs that are in need of cash in other markets may have to borrow externally. Similarly, subsidiaries that are short a particular currency do not benefit from subs that are long in that very same currency. In addition, information needed to support management decision-making may not always be accessible, delaying reactions to market shifts and possible liquidity shortages.
The disparate nature of many of these current processes can thus act as a barrier to transparency, become a drag on operating performance and hamper the pace of growth.
At some point, multinationals have to adopt a model that reflects the reality of operating in a truly interconnected global environment and accept the fact that they can no longer function as a loose federation of international entities. Accordingly, many multinational corporations could benefit from the ITC’s approach of standardizing, centralizing and automating processes from both a treasury and a tax perspective.
Depending on how a company is structured and where it operates, one or more regional treasury centers might be the best solution for now. For increasing numbers of multinationals, though, a move to a single global center can make the most sense.
An Abundance of Benefits
The benefits achieved by a well-designed global center can span the full range of treasury activities. (See Sample Structure for a Treasury Center)
For openers, financial managers will gain increased visibility and access to cash across the organization, thanks to the use of pooling, standardized cash management techniques and the application of robust treasury technologies to consolidate cash management, investment and liquidity operations.
The impact of currency exposures on corporate earnings and cash flows can be minimized once the company’s exposure points are centralized. Local currency billing, assignment of risk — back-to-back, in-house foreign exchange (FX) contracts — and reinvoicing can help on that front.
Due to the concentration of information and data in the ITC, FX and cash flow forecasting capabilities will become sharper, minimizing the FX impact at the local country level and helping to improve cash usage and better anticipate future needs.
In serving as the intermediary between intercompany trades across the organization, a global center can capture the exposure by denominating the transactions in the buyer’s and the seller’s currency. Additional benefits can be gained by centralizing all intercompany loan activities in the ITC, concentrating both the funding and currency risk of these loans.
Support for the development of new business can also be enhanced, in part through the addition of treasury advisory assistance in the ITC that is closer and more operationally focused on the needs of the businesses in their particular areas.
As advantageous as all of these benefits sound, many of them spring from a very down-to-earth approach: by coordinating all treasury activities, and capitalizing on the resulting synergies, savings will accrue, risks will be reduced and new opportunities will become accessible.
From its central vantage point, an ITC can address cash liquidity issues arising from new regulatory requirements in far-flung country locations. It can also take into account currency issues surrounding both gains and losses and mobilize cash by issuing intercompany loans. In addition, it can generate supplemental fee income from activities performed on behalf of subsidiaries, such as risk assumption and funding.
Add to all that its ability to take advantage of “tax friendly” locations and the value of the ITC becomes even greater.
That said, a thorough feasibility study is needed to determine the degree to which a company could benefit from having a treasury center and the level of resources and commitment needed to move it forward. Tax and treasury planning is required to design the right type of center. And decisions have to be made about location, management, operationalization, external banking connectivity, technology and staffing, among other areas.
Taking the First Steps
A major consideration in moving forward is determining the center’s breadth of functionality. An ITC can be narrowly defined or encompass the full range of treasury activities. For example, it can function as an in-house bank, a shared-services center, a payment factory or a place to concentrate cash or manage FX risk.
Or it can serve as an omnibus center for all of those activities. As noted earlier, it can even provide advisory support for new business development through adroit and timely financing and local country regulatory input.
To get started, a company needs to form an accurate picture of the current state of its treasury activities as well as its current and future business and financial needs. It can then decide on the right mix of functions to house in the center and pick the best place to locate the center for tax purposes.
To determine the existing state of play, senior members of the treasury, tax, finance and business sectors of the company need to be debriefed. The goal is to understand the strategic and operational aspects of important treasury processes, including controls, structures, roles, resources, technology, data and reporting requirements.
Part of the analysis is to determine which functions are now handled by the headquarters, regions and/or countries. A second part is to review the existing jurisdiction, organization, legal structure and ownership of these functions from a treasury, tax and regulatory perspective.
A dozen or more structural and operational areas are typically part of this review. Of course, an assessment of the overall organization and design of the existing treasury department is key, including roles, responsibilities and mandates. So, too, is a picture of treasury’s existing and planned technology, encompassing external vendors, enterprise resource planning (ERP) modules, spreadsheets and other available technology tools.
The full scope of cash and liquidity management, cash flow forecasting and financial risk management (currency, interest rates and commodities) also needs to be explored and analyzed.
A rationalization of the company’s bank relationships and accounts will be necessary to drive maximum efficiency from the process. This exercise entails a complete snapshot of all domestic and international entity structures, bank relationships and accounts, by country, as well as all services currently used, including those provided by non-bank financial services companies and the associated fees.
Once properly rationalized and centralized, global banking relationships will become more efficient, resulting in reduced fees and better service support. There can also be potential tax benefits, including the efficient access to excess cash and, for U.S.-based multinationals, reduced foreign withholding and income tax without an increase (and possibly even a reduction) in U.S. income tax.
Finally, a picture must emerge of existing governance and controls, covering such areas as treasury policies and procedures, management reporting and performance metrics.
A thorough review on all of these fronts will reveal how the various functional areas (including treasury, tax, accounting and planning) interact and communicate with the business units.
The review will also show what services the functional areas require from treasury and the value they place on those services. These insights will form the foundation for identifying and evaluating potential improvements to existing functions and the addition of new ones.
A Complete Menu to Choose From
The menu of activities that can be built into a treasury center is rich with choice. The activities are all within reach for two main reasons. One is the availability of new treasury technology that can be designed or customized to meet the specific needs of each company. The other is the development of third-party financial services in such areas as pooling, netting and funding.
To give an idea of the variety of treasury functions that can be built into this structure, the following represents a brief summary of activities most commonly found in ITCs:
•Cash Pooling with Physical or Notional Structures. Cash can be concentrated or pooled in either a notional or physical pooling structure to better manage a company’s global liquidity. The centralization of cash makes more money available to the company while simplifying bank account structures and reducing overall transaction costs. The two types of pooling differ in a number of ways:
• A physical pooling structure involves the actual cross-border movement of funds, generally through single currency pools. The pool participant transfers funds (recorded as an intercompany loan) to the pool concentration account, which then sends the funds outside the country to a central account, usually in the name of the ITC.• A notional pooling structure does not involve the physical movement of funds. Instead, the pool will reflect the consolidated cash position (held by a bank) for all participants, who either deposit funds into the pool or withdraw from the pool, generally in their own currency.
Notional structures can consist of a single currency pool or a multi-currency pool, with a “member” accessing these funds from a tax-advantaged location.
As noted, by consolidating data, the centralization of funds can provide more visibility into cash flows and potentially improve cash-flow forecasting.
•Intercompany Funding. A treasury center can be used as a central point for intercompany lending by serving as the party to all loans. Loans would be made in the currency of the borrowing entity to concentrate liquidity and currency risk in the center and to provide more efficiency to the lending process. The center could also be the entity that accesses external capital markets, if necessary, to make additional liquidity available for redistribution through the internal system in a tax-efficient manner.
•Intercompany Trade, Netting and Settlement. Multilateral netting is a technique used to manage intercompany payment processes and, to some extent, nonfunctional third-party payments.
A typical netting system facilitates pre-approved payments and collections between netting participants (i.e., company subsidiaries) and offsets them against each other. The result is that each participant would pay or receive a single cash flow in its own functional currency to settle the net amount of all payables and receivables included in a particular payment cycle.
The technique is typically used by multinational corporations that have settlements in multiple currencies, with numerous subsidiaries, in many countries.
The objective of a netting system is to reduce the overall volume of FX trades and thereby cut settlement costs. The netting process can be run internally by the company or outsourced to a third party — usually a bank.
•FX Risk Management, Centralization and Reinvoicing. In this context, the ITC serves as the internal counterparty to all FX derivative transactions with each entity. This centralization of currency risk allows for the netting of all gross internal currency exposures prior to executing external hedge transactions, which occurs at the ITC level. The result: decreased FX transaction costs (rates and spreads) due to fewer, but larger, external currency transactions.
The centralization of information provides more visibility to currency exposures. This concentration of exposure can be accomplished through the establishment of a reinvoicing center or, if a less cumbersome solution is needed, through back-to-back FX contracts between company subsidiaries, the ITC and external banks.
•Bank Relationship Management and Account Administration. In centralizing this function, a standardized workflow is introduced for opening, closing and modifying bank accounts with relationship banks, resulting in a single repository for account-related information along with bank fee information. For most companies, centralizing this effort can result in reduced banking fees and other costs.
•Treasury Technology. Technology is a major enabler of efficiency gains, process improvement, scalability and governance associated with treasury processes within the ITC. The implementation of a global treasury system can streamline and automate numerous centralized processes.
The reduction in manual efforts frees up a company’s treasury team from tactical, repetitive tasks to spend more time on strategic, value-adding activities and business-level support.
Making It Real
To get from the drawing board into the field, the build-out of a treasury center requires detailed planning and execution to implement all of the functions chosen from the menu.
That effort involves standardizing, centralizing and improving processes and rationalizing bank relationships. But managers handling the shift also need to develop a proactive governance structure, select and install a robust treasury technology and determine the most suitable approach to manage and centralize currency risk.
In addition, they have to decide whether in-house market-facing advisory support will be offered to the business units, set the level of reporting required to properly monitor all operations and handle a host of other detailed design elements. The company must also build a workable and efficient operating model to execute and drive all of these functions.
Managers involved in the implementation aren’t done yet. There is also the very important matter of selecting a tax-favorable location that best meets the center’s needs once all of the functional areas have been defined. (See Finding a Home for the International Treasury Center.)
And there are a couple of practical issues to consider. For one thing, it is not clear how the Dodd-Frank Act, the far-reaching banking law adopted in the United States in the wake of the recent financial crisis, applies to treasury centers. Nor is it clear how some soon-to-be-adopted regulations in other countries will apply. (See The Regulatory Issues.)
There is also the matter of expense. All this value and efficiency comes with a price tag. The upfront costs to establish a center for some can be material, particularly with regard to the technology that must be put in place.
But during the feasibility phase of the ITC design, both the quantitative and qualitative benefits of a well-conceived center should become obvious.
These benefits will defray the cost of setup and implementation as well as enable additional efficiencies in the business areas that treasury supports.
The simple fact is, in many cases, the cost of not establishing an ITC — inefficiency, limited process standardization, control weaknesses, lack of scalability of treasury resources — may far exceed the expense of building one. Given that reality, for many companies the time to make the evolutionary leap is now.
Robert J. Baldoni is a partner and Global Treasury Services leader with Ernst & Young LLP.