Treasury and Payments
Tailoring treasuries: Innovation drives comparative advantage for asset-based businesses
Asset-based businesses are using innovation to increase operational agility and gain a comparative advantage.
Firms that use asset-based business models are transitioning to in-house bank operating models that use virtual accounts. As a result, these firms are able to onboard new entities and open new bank accounts faster, and reduce their bank and account management operating costs. A case study is presented describing how an Adam Smith award-winning asset-based business applied banking innovation to achieve a highly efficient and scalable operational framework to reduce complexity and accommodate growth.
Segment characterization: businesses organized around special purpose vehicles
Asset-based businesses are firms predominantly found in the real estate, transportation, infrastructure or energy industries. These businesses have legal structures that are organized around their assets like aircrafts, vessels, properties or production plants. As such, these firms are dynamic, and they continuously form new entities—special purpose vehicles (SPVs)—as they acquire assets. Large numbers of SPVs are typically encapsulated within levels of holding companies to achieve key business and risk mitigation objectives:
However, from a cash management perspective the complex holding company and sprawling SPV legal structures result in a proliferation of bank accounts. And because of the significant KYC demands on each SPV bank account, it may take months before an asset can be incorporated and activated—impairing the asset-based business’ operational agility.
As account structures grow, so does the on-going effort required by dedicated treasury staff to manage bank mandates, account-level signatory cards and user entitlements. Such non-strategic administrative workload does not add value to a treasury organization. Finally, from a liquidity management perspective, optimizing working capital management—both funding and cash consolidation—across large bank account structures adds complexity and cost where cash sweeping is required to move balances between group companies.
In summary, while bank accounts per SPV are a useful tool to enable legal and operational segmentation, the model also elevates the cost of doing business, which impacts pricing, profit and loss, and competitive advantage for asset-based businesses. As a result, many firms face a perennial imperative to rationalize bank accounts to improve competitive positioning and control costs.
Historically, asset-based businesses have relied on secured financing to fund and capitalize asset purchases. Under secured financing arrangements, bank accounts for SPVs are often pledged to a financing party to obtain a security interest in the asset in case of a change in control. With SPV bank accounts so encumbered by third-party pledges, asset-based businesses have been limited in their ability to reduce bank accounts, yet they still comply with secured financing covenants. Moreover, traditional liquidity products, such as cash concentration or notional pooling, are often also unavailable, because they require transaction banks to waive their traditional set-off rights.
In recent years, however, financing models for asset-based businesses have undergone change, thereby presenting an opportunity to streamline bank account structures by introducing in-house banking techniques like on-behalf-of centralization. In-house banking represents a central method for organizations to simplify their banking structures. In-house banking, widely understood to be the centralization of financial value chain activities within the group treasury, includes key financial functions like managing transactions, the balance sheet, liquidity and risk. Sophisticated enterprises establish in-house banks to benefit from liquidity centralization, working capital optimization, process efficiency, risk mitigation, centralized control and reduced bank account management through adoption of the centralized operating model.
In-house banking frequently includes establishing payment and collection factories to improve control and reduce the number of bank accounts—a key objective of many firms, but especially for asset-based business models. A “collection factory” refers to the implementation of a receipts-on-behalf-of collection model, whereby a dedicated treasury entity processes all group collections on-behalf-of subsidiaries (SPVs) through one group bank account per currency. Similarly, a “payment factory” refers to the implementation of a pay-on-behalf-of (POBO) payment model, whereby a dedicated treasury entity processes all group payments on-behalf-of subsidiaries through one group bank account per currency.
Firms face a multi-year project with significant capital expenditure to select, license, implement and integrate vendor-based in-house banking software, frequently requiring considerable professional services consultancy, to implement infrastructure to enable on-behalf-of (OBO) operations. The change management impacts should not be underestimated.
However, in recent years financial institutions have made the significant investments in systems that enable organizations to realize treasury transformation and achieve on-behalf-of operations without the capital expenditure seen in traditional centralization projects. At the core of these bank-offered in-house bank platforms are clearing-routable virtual bank accounts.
Clearing-addressable reference accounts have been offered by banks for decades to assist with reconciliation of collections. However, virtual account solutions can now be applied to enable centralization of payables as well. This innovation offers an alternative method for achieving the holy grail of cash management for many treasuries—reducing bank accounts—through implementing on-behalf-of virtual account structures.
What makes in-house banking and on-behalf-of operations especially powerful with virtual accounts is that the treasury organization achieves real-time cash centralization without fracturing cash or requiring sweeping, whilst operational companies use decentralized and separate virtual account reporting for managing their collection and payment activity. This model enables treasury to devolve bookkeeping to the respective group companies and avoid costly TMS-to-ERP integration thanks to standard bank format reporting. This is not something that can be achieved with traditional vendor-based in-house bank platforms.
Difficulty funding and executing change management inhibits many asset- based businesses from realizing treasury transformation. A firm’s workforce, processes and systems are geared towards the status quo of legacy systems and legacy account structures. Traditionally the investment and project efforts required to unwind such setups understandably creates reluctance to implementing new operating models.
It is in partnership with a strategic and global banking partner, who is experienced in designing and implementing treasury transformation projects, that asset-based businesses can identify and execute an adoption approach that is right for its enterprise. J.P. Morgan works closely with our clients to provide such guidance using expert consultancy and a project-based methodology to achieve a dual mandate of realizing treasury’s objectives around funding optimization and the use of cash along with ensuring the highest levels of automation for local entities’ daily operations with the lowest cost.
From the perspective of reconciliation and bookkeeping, for example, an on-behalf-of operation powered with virtual accounts more closely resembles a decentralized physical account structure. With the standard bank format reporting of virtual accounts, each operating company applies separate balance and transaction reporting within their own accounting platform. This differs from traditional on-behalf-of solutions that require a centralized treasury management system or in-house banking platform to be integrated across the enterprise—a massive effort in project effort and cost.
Simultaneously delivering real-time cash concentration in a single bank account per currency and decentralized operations represents a breakthrough for many asset-based businesses.
Award-winning corporate case study
Acwa Power is one asset-based business that has used virtual accounts for its in-house bank project and saw significant value across treasury, operations and technology.
Prior to undertaking its treasury transformation, ACWA Power maintained a complex corporate structure that relied on hierarchies of legal entities and SPVs, to manage capital allocation and financing, as well as segregate operations and control risk. The account landscape across the group supporting the various “HoldCos” and “OpCos” comprised of about 600 bank accounts.
Group cash management at ACWA Power was equally complex due to the proliferation of bank accounts from its ever-growing corporate structure. Manually managing thousands of intercompany transactions annually for cash concentrations, equity injections, dividend disbursements, returns processing and management fees placed severe strain on a small treasury team. (They operate from Riyadh, Saudi Arabia and Dubai in the United Arab Emirates).
In 2019 the group treasurer, Abdul Majid Syed, drove an innovation agenda that transformed the firm’s treasury operating model. For this effort, they were awarded overall winner for the prestigious 2021 Treasury Today Best in Class Treasury Solution in the Middle East/UAE.
Summarizing the project, ACWA Power stated:
ACWA Power Communications Department
ACWA Power invited J.P. Morgan to introduce the innovative way clients were using bank technology based on virtual accounts. ACWA Power stated:
ACWA Power Communications Department
ACWA Power is proud of the market recognition by Treasury Today and believes the results they describe are available to others, stating:
ACWA Power Communications Department
Taking the next steps to treasury transformation
Transforming an organization’s treasury operating model can deliver tremendous value by introducing a highly efficient and scalable framework to reduce complexity and accommodate growth. Following a traditional path of centralization requires considerable capital expenditure. Banking innovations have emerged offering many organizations an alternative approach with certain industries such as asset-based businesses standing to see some of the greatest benefits.
Learn more about ACWA Power’s success.
The views and opinions expressed herein are those of the author and do not necessarily reflect the views of
J.P. Morgan, its affiliates, or its employees. The information set forth herein has been obtained or derived from sources believed to be reliable. Neither the author nor J.P. Morgan makes any representations or warranties as to the information’s accuracy or completeness. The information contained herein has been provided solely for informational purposes and does not constitute an offer, solicitation, advice or recommendation, to make any investment decisions or purchase any financial instruments, and may not be construed as such.