Path to Treasury Centralization

Globalization continues at a staggering pace and companies around the world are moving further afield, faster than they ever have before to drive business growth. For treasurers, this coupled with the imperative to do more with less, poses fundamental opportunities and challenges in how they approach risk management and enhance operating and funding efficiencies. Centralization may be an answer.

As the world's emerging and developed economies grow and expand, companies are venturing beyond their home markets and building their overseas business. These markets offer new revenue streams, efficiencies around production processes, geographic foothold and access to a growing client base.

For treasurers, this stepping-out may mean stepping-up vigilance and improvements across:

  • Risk management – management of counterparty limits and instruments
  • Financial management – alignment of capital structure to support corporate strategy
  • Capital markets – financing (debt, equity, trade), credit rating and investor relations
  • Cash and liquidity management – cash management operations, cash flow forecasting and short-term liquidity management

Operational Efficiency: Striking a Balance between Competing Objectives
Bank account centralization is generally undertaken as part of a broader change agenda and often linked to some organization wide improvement initiative. Typical objectives include improved visibility, operational efficiency, and increased control — all of which can be achieved with centralization. Pushing in the opposite direction are the needs to manage concentration risk and cater to local market nuances and requirements.

The Increasing Role of SWIFT for Corporates
Managing this balance while achieving objectives puts a premium on bank agnostic solutions, high availability, and standardization. For these reasons, Society for Worldwide Interbank Financial Telecommunication (SWIFT) is often an important part of the centralization story. Once the exclusive domain of inter-bank activity, SWIFT is now open to corporations. SWIFT’s security and reliability are second to none. It can be used across banks, and its standards such as ISO 20022, all facilitate centralization.

Beyond Standards to Common Understanding
Yet standards are not, in and of themselves, enough. To be effective, standards must also be interpreted in the same way. Banks like J.P. Morgan have therefore, been cooperating on initiatives like Common Global Implementation (CGI), which seeks to ensure that the same information and format can be sent to different banks yet still be used in the same way.

Making it Easy to Evaluate Capabilities
While most banks are SWIFT members, the degree to which they support the SWIFT for Corporates agenda varies. Treasurers asked for an easy way to assess a bank’s SWIFT capabilities. In response, leading banks, like J.P. Morgan, have supported SWIFT’s bank readiness certification program. With this program, information on banks’ SWIFT capabilities is readily available on SWIFT’s website.

Global Consistency, Local Reach
Individual market needs must be taken into account when implementing a centralization strategy. This is particularly so in Asia, where infrastructure, regulatory and legal frameworks diverge much more than, for example, across the Single Euro Payments Area. To have a fully ‘localized’ bank structure, a company could create its own network, connecting to different banks in each market. Yet this becomes burdensome, expensive, and difficult to manage from counterparty risk, connectivity and operational perspectives. So multinationals typically turn to global or regional banks for an integrated solution.
A treasurer must evaluate how well a global bank integrates its offering with that of local providers, thus optimizing the balance between local reach and global consistency. The most sophisticated global banks will devote considerable resources and technology to the management of their network.

Implementation: First, See Clearly
When it comes to implementation, companies usually follow a phased approach, starting with improved visibility. While SWIFT provides a common format and channel that can help achieve visibility, not all corporations are yet connected to SWIFT. They will therefore look to banks’ multi-bank platforms to integrate balance and transaction information across multiple banks into a single consolidated view that supports improved use of cash.

The next phase is typically payables, where standardization is more advanced and it is easier to control from a single point of origination. Centralizing receivables presents greater challenges, due to the higher variability of content, format, and structure across different clearing systems. To increase levels of automated reconciliation despite these challenges and reduce Days of Sales Outstanding, sophisticated matching engines are needed that can identify potential matches using multiple and flexible criteria. Linking such engines with an online front end to provide full visibility is a further step in using information and transparency to advance operational efficiency.

Integrating the Vision
J.P. Morgan’s experience working with clients has shown that centralization is a multi-phased journey which requires harmonization across liquidity, funding, financial risk, settlement and reporting. The end state vision should be treated as a means to an end and not as a one size fits all. During evaluation, it is imperative to understand the company’s current footprint and future expansion plans, to build a structure that is scalable and sustainable. As operations scale across borders, regulation (FX, pooling of funds), corporate income tax and withholding tax (dividend, interest) become important considerations that need evaluation by specialists in designing a centralized structure.

Centralization Structures
Contrary to popular belief, centralization structures do not always take the form of a separate legal entity. Many large companies have formed Regional Treasury Centers (RTC) as hubs for centralization without the need to incorporate a separate legal entity. In such instances, the role of the RTC is to manage cash, liquidity, risk and exert control on co-ordination of treasury activities such as managing bank relationships, account opening, closing and administrative activities like confirmation matching, settlement processing, account reconciliation, accounting and reporting.
Another variation of such a model is where the RTC acts as a ‘principal’ or ‘counterparty’. RTCs in such cases are separate legal entities which need to consider tax, legal and regulatory implications. An RTC is often referred to as an In-House Bank (IHB) that is highly efficient with high volumes of transactions across multiple legal entities and tax regimes. The IHB effectively acts as the ‘banker’ for the parent and the subsidiaries in an affiliated group. A technology solution is required to maintain in-house bank accounts (‘virtual’ bank accounts to track transactions executed by the IHB) on behalf of each entity. The IHB is viewed as a captive bank and at times requires the entity to be chartered and regulated while adhering to capital requirements. Often, the IHB requires agreements between IHB entity, parent and subsidiaries with the objective of providing:

  • deposits from cash long entities and making interest payments;
  • loans to cash short entities and charging interest;
  • entity and transaction level fund activity reporting based on ‘virtual’ bank accounts.

Implementation of an IHB structure is complex and requires careful consideration of regulatory, tax and operational implications.
Our clients today benefit via central coordination of debt/investments, management of group liquidity by pooling/sweeping, mitigation of FX exposures via netting and coordination of intercompany loan positions.
As they move through the centralization journey, treasurers are now seeking to push it a step further — operationally centralizing payables and receivables through a single account and paying or receiving for their operating units through a single account. While this approach offers obvious advantages in terms of liquidity and funding, there are significant challenges (tax, regulatory, operational) that must be considered before implementing such a structure. Corporations that navigate complex regulation and varied clearing systems have streamlined corporate systems that can share information seamlessly and are therefore able to centralize to this level of maturity.

The Finish Line
When we look at what the future holds for global companies, it is clear that many challenges remain on the horizon. The race for ever more cost-effective solutions to support centralization and attain operating and funding efficiencies along with enhanced control and risk management will likely continue. And companies are finding that bank partners with the knowledge capital and solutions that drive real and measurable results are the running mates that can keep pace towards the ‘future proofed’ finish line.

Thomas Wiles
Head of Payables, Receivables and Account Services, Asia Pacific
J.P. Morgan Treasury Services

Rohit Godara
Senior Advisor, Solutions and Advisory Sales, Asia Pacific
J.P. Morgan Treasury Services

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