• This article reviews some key regulatory hurdles in regional liquidity management structures, and a few key issues that can enable treasurers to minimise the impact of these hurdles and maximise their company’s regional liquidity.
• Some of these hurdles include non-convertible currencies, controls on foreign exchange and offshore accounts, and restricted automated cross-border cash concentration links.
• Successful strategies include a centralised treasury structure, choosing the right banking partner, knowing how to leverage the company’s trade flows and favouring electronic payment means over traditional paper instruments.
• Companies making these critical choices will maximise the benefits of these strategies. Choosing Hong Kong or Singapore as the location for a regional treasury centre will further minimise hurdles for treasury operations
in Asia Pacific.
The current uncertain economic environment we face makes the case for efficient liquidity management more compelling. It also reinforces the need for the treasurers to shake up the status quo to make the company’s cash work harder.
A Regional Landscape Still Full of Hurdles
In the aftermath of the 1997 Asian crisis, hopes were high that the need for reforms across most Asian economies would lead to deregulation and a gradual easing of the traditional hurdles preventing the implementation of efficient liquidity management structures in the region. A few changes did take place, such as the interest rate deregulation that took place in Singapore and in the Hong Kong Special Administrative Region, the development of entrusted loans and the recent authorisation granted to some local and foreign banks to offer overdraft facilities in China. However, none of this has made the treasurer’s task of managing liquidity on a regional basis any easier:
• Key regional currencies such as the Chinese renminbi and the Indian rupee are still not fully convertible.
• Foreign exchange controls preventing the free flow of funds for non-trade-related transactions remain as prevalent as ever. Restrictions are still in place in China, India, Korea, Malaysia, the Philippines, Taiwan and Thailand.
• Automated cross-border cash concentration links are available from large institutions such as HSBC. However, many countries and markets such as China, Korea, Malaysia and Taiwan still restrict or forbid them.
• Similarly, the opening of offshore accounts and access to offshore overdraft facilities that would facilitate the inclusion of subsidiaries into a notional pool structure are often restricted. The enforceability of the multilateral right of set-off, without which banks cannot offer notional pooling, can also be problematic.
• With the notable exception of Hong Kong, most countries in the region apply withholding taxes on cross-border interest payments.
• Hong Kong and Singapore are still the only viable alternatives for the establishment of a regional treasury centre. Shanghai has ambitions in this area and we will see more multinationals moving their regional headquarters there. Nonetheless, Hong Kong and Singapore should retain their edge, owing to the more established and stable banking and regulatory environments that they can offer.
Faced with such a difficult environment, it is nonetheless possible to implement successful strategies to manage liquidity regionally. Devising and implementing such strategies requires the company to make certain critical choices, such as creating a centralised treasury structure, choosing the right banking partner, knowing how to leverage the company’s trade flows, and favouring electronic payment means over traditional paper instruments.
The End of the Centralisation vs Decentralisation Debate
Centralising or decentralising treasury-related decisions? The answer will vary from one company to the next, and will depend not only upon the company’s culture, but also its level of development and maturity.
However, for companies that are at the stage of considering the opportunity of managing their liquidity regionally, few will argue for a decentralised structure. The pendulum has swung very much in favour of a centralised treasury function. The objective of managing the company’s regional cash position as a group resource implies the need for the underlying subsidiaries to relinquish control, at least partially, over the underlying balances to the regional treasury team.
On the other hand, one would expect the regional treasury team to be located within the region, typically in Hong Kong or Singapore. Some companies do try to manage their regional treasury operations from outside of Asia Pacific. In some instances, this may be a perfectly valid choice, driven possibly by cost considerations and the necessary critical mass to justify the implementation of a fully-fledged regional treasury centre. However, one would argue that this is a compromise and that such a solution is suboptimal for cash management:
• Time-zone differences will make it difficult for treasurers to maintain adequate contact with subsidiaries and banks.
• A treasury team operating outside the region will have difficulties fully understanding the idiosyncrasies of running a business in Asia and will face problems recruiting treasury staff with the necessary local market expertise.
• Currency markets, and particularly those dealing in Asian currencies, will not be as deep or competitive outside of the region.
A caveat to the above would be that the implementation of a centralised treasury model in Asia Pacific should be carried out sensibly. Purists of the centralisation model may argue for the concentration of most treasury functions to the centre. However, the specificities of key markets such as China or India call for the maintenance of some on-the-ground expertise and decision-making capacity.
Choosing Your Regional Bank: A Strategic Decision
In Europe, companies will often differentiate between the regional overlay bank and the banks chosen to handle their domestic cash management needs in individual markets. Such a model is rarely seen in Asia where local idiosyncrasies, the relative unpopularity of third-party banking arrangements, and the absence of a common regional payment infrastructure would often hamper the timely transfer of funds between the overlay and the domestic banks required to enable the daily management of cash balances. The relative strengths and credit ratings of local banks are another reason why multinational groups will often want to avoid direct relationships with local institutions.
The choice of a banking partner to implement a regional liquidity solution will therefore not be limited to an overlay structure. It will impact both the company’s regional and domestic banking arrangements, as one is required to consolidate the company’s cash management business under a single roof with a single institution or to move it to the local banks with which the chosen regional service provider has established specific alliances. The special characteristics of the Asian market reinforce the need for the regional treasury to be given a strong mandate to support the regional implementation, combined with sufficient communication with the local subsidiaries to ensure their buy-in into the final decision.
With the implementation of an efficient regional liquidity management structure comes an implicit objective from the treasury team to outsource most of the underlying day-to-day processes. Doing so involves a high level of commitment from the cash management bank in terms of resources, regional reach and technology such that it is able to:
• understand the company’s business and modus operandi;
• devise and customise a solution that meets the company’s objectives and needs;
• have the product suite that supports the proposed solution; and
• have the regional and domestic implementation resources combined with appropriate market expertise to ensure a timely and efficient implementation process.
The above considerations should drive the treasurers towards a vigorous selection process to identify the institution with the best potential fit with the company. The provision of cash management products is a value-added service for which price cannot be the sole consideration. Treasurers need to assess the potential bidders in terms of service quality, advice and consulting skills, geographical reach and fit with the company, technology, coherence of the regional product suite, and its integration with the required delivery channel.
The options opened to treasurers are actually relatively limited. Only a handful of global or regional institutions have the capabilities required to support the implementation of a regional liquidity management mandate. Although treasurers have a duty to come to the market every three years or so, they should really seek an institution with which the company will comfortably be able to develop a long-term and mutually beneficial partnership that should quickly outgrow the traditional limits of cash management.
Leverage Your Trade Flows
The regional liquidity management solutions that banks can offer will invariably be based upon a combination of notional pooling and/or domestic and cross-border cash concentration. These solutions are well known and provide clearly identified benefits. They have also well defined drawbacks:
• the implementation of cross-border liquidity structures may generate complex tax considerations, such as withholding taxes, which can significantly reduce the benefits of the solution implemented; and
• the need to track and account for the inter-company loans that such structures may generate results in an accounting and administrative burden that some companies cannot handle.
More importantly, the use of notional pooling and/or cash concentration remains tightly regulated and is either restricted or simply not allowed in many countries around the region. This situation, combined with the prevalent foreign exchange restrictions, often turn specific markets into liquidity traps where the only options to get cash out of the country are through the payment of dividends or the settlement of import transactions.
Companies often approach banks seeking solutions for making use of the surplus cash they hold in markets such as China, Korea, the Philippines and Taiwan. Apart from paying credit interest on such balances (where allowed), there is often little that the banks can do to help.
On the other hand, treasurers can do a lot to help themselves. They can simply leverage the underlying inter-company trade flows generated by the company’s subsidiaries across the region and implement leading and lagging. “Leading” is paying early to a cash-poor subsidiary, thus saving the subsidiary from drawing on its overdraft facility. “Lagging” means paying cash-rich subsidiaries later. Doing so will effectively move liquidity from the cash-rich to the cash-poor entities with little or no tax considerations, as the underlying transactions will, under normal circumstances, not be treated as inter-company loans and will not require the payment of interest.
The existence of a regional treasury centre, which can also act as a reinvoicing or an internal factoring centre, facilitates the use of leading and lagging. Reinvoicing is a process where subsidiaries, in lieu of billing their own customers directly, will bill the regional treasury centre, which in turn invoices the customer. The latter may or may not be a subsidiary of the group. The treasury centre can thus implement leading and lagging by granting different credit periods to the cash-poor or cash-rich entities. Another key benefit of such a structure is the centralisation of the company’s foreign exchange exposure, as the subsidiaries will typically bill the treasury centre in their home currency while the treasury centre invoices customers in the customers’ home currency.
Internal factoring provides similar if not identical benefits. In a group that uses factoring, the subsidiary first bills its customer, but then sells the receivables to the in-house factoring centre. The discount is usually at a preferential rate, lower than the rate that would otherwise be obtained from a bank.
Go Electronic
The availability of timely and accurate cash flow forecasts is an essential requirement for regional treasurers to manage the company’s liquidity efficiently. The advance knowledge that funding is required gives treasurers sufficient time to look for the cheapest source of funds, whether through inter-company loans or from the market, thereby minimising the cost of funds. Similarly, knowing that a cash surplus will occur in advance enables treasurers to look for the most attractive investment opportunity, whether through termed deposits or money market funds.
Arguably, the growing availability of outsourcing solutions such as notional pooling and cash concentration could be considered as having reduced the need for cash forecasts. By automatically netting the underlying debit and credit balances, whether notionally or not, these tools ensure that the company is able to leverage its internal liquidity fully to minimise its funding costs.
Similarly, notional pooling and cash concentration facilitate the investment of the company’s cash balances by automatically aggregating cash surpluses. These surpluses can then be invested through an interest-bearing account or by setting up an automated two-way sweep into a money market fund.
The need for proper forecasting still remains. Although automated solutions such as notional pooling and cash concentration have reduced treasurers’ involvement in the day-to-day management of the company’s cash, treasurers need forecasts to understand the dynamics of the underlying cash flows and be able to determine:
• The true level of the company’s cash surplus, and therefore determine how much can be invested from the operational accounts. Without this information, the treasurers will not be able to communicate to the bank the threshold above which the automated investment sweep should take place.
• The size of the required credit facilities – a bank that bids for a regional liquidity management mandate will expect the customer to require credit facilities. However, for the liquidity structure to make economic sense for the bank, it will expect such facilities to represent the net borrowing need of the company. The treasurers will need to validate what this net borrowing need is and communicate it to the bank to ensure that enough flexibility is built into the regional structure.
Also, to move a cash surplus in one currency to fund a deficit in another currency, treasurers will often use currency swaps, which accurate forecasts regarding the availability of the surplus funds greatly facilitate.
Owing to the above considerations, one of key objectives of treasurers should be the elimination of potential sources of uncertainty that complicate cash flow forecasts and ultimately lead to unnecessary idle balances being left in the company’s accounts. From this perspective, the use of cheques as a payment instrument should be challenged whenever and wherever possible in favour of alternative electronic payment means.
Cheque float has long been considered a key tool for companies to hold onto cash for as long as possible. However, the uncertainty associated with the time of cheque presentation and the associated volatility in the company’s cash balance forces it to maintain a cash cushion, the impact of which may easily be greater than the benefits generated from cheque float.
Conclusion
Over the past year, the environmental difficulties associated with regional liquidity management have remained as challenging as before. However, this does not undermine the case for pursuing the optimum solution. Companies that are able to leverage their liquidity are able to achieve significant benefits either through reduced costs of funding or better investment opportunities.
The core of the solution is likely to rest on a degree of outsourcing such as notional pooling or cash concentration provided by a company’s chosen bank. However, the success of a regional liquidity management structure also depends upon the company’s ability to make a few critical choices, without which it may not be able to maximise the structure’s benefits.
