Netting: The Key to Stronger Liquidity Management

Treasurers in multinational businesses are increasingly looking to global products and services that can provide their organisations with significant improvements in liquidity and cash control. Netting offers this by centralising foreign exchange (FX) exposure, funding and liquidity requirements. As a result, it is now an increasingly significant and integrated part of liquidity management strategies.

Economic and political instability can occur anywhere, and it is evident that a large multinational is often exposed to some level of country, counterparty or FX risk somewhere within their organisation. Even if that is not the case, within the company itself there may be additional layers of complexity that can result in higher costs and a lack of transparency.

For example, a company’s subsidiaries may be operating on a fully independent basis. This may cause them to have their own local IT infrastructure, along with local banking relationships and their own strategies on FX and liquidity management. As a result, treasurers and finance directors face a difficult task when addressing the liquidity and funding challenges in such complex organisations. As well as managing their interest rate and currency exposures, the entire supply chain requires monitoring and management.

There are a number of risks inherent within such business structures and any efforts to reduce them help to support a more balanced and consistent global corporate approach to liquidity.

FX Exposure

Invoices are often in a currency other than the paying or receiving subsidiary’s domestic currency and this generates FX exposure. The costs of purchasing and the potential profits of selling in various currencies are heavily affected by exchange rate fluctuations. In a competitive market place it is not easy to negotiate the most profitable terms for an import or export contract.

In part, the solution lies within the choice of banking partner that the company selects to provide consistent FX pricing and transparent FX rates irrespective of the transaction amounts involved. This is where a netting solution that is a real-time, global online system can assist by revealing the total currency positions and also offering corporate treasurers the ability to mitigate FX risk at a centralised level by using integrated FX hedging functionality.

Funding

Another risk occurs when working capital is not available to cover the purchase of raw materials or to fund manufacturing. This risk may be mitigated by offering suppliers a supply chain financing (SCF) option with facilities provided by the buyer’s banking partner.

A key way in which this risk can be mitigated to an extent is through the optimisation of cash flow throughout the company’s own structure. It is crucial that the chosen netting solution can provide insight into the cash flow requirements resulting from inter-company (and third party) payables and receivables.

Liquidity Risk

Funding efficiencies and a reduction in liquidity risk can be achieved by the implementation of centralised liquidity management. Global transaction banks can provide the tools and products to free up idle cash and maximise interest opportunities with cross-border, automated sweeping, third-party cash concentration services and notional cross-currency pooling. However, finding the most suitable solution and applying it successfully can be a challenge.

A clear strategy that can be introduced across all elements of a company is a consistent approach, as this can help to promote stricter control of procedures. Nevertheless, it’s clear that such challenges require an attempt to simplify complexity before anything else.

Netting

A considerable part of the supply chain often consists of the company’s own subsidiaries. Inter-company invoices often generate the same challenges as third-party invoices. These may include FX exposure driven by many small transactions, expensive processes, liquidity/funding deficiencies, dispute resolution, local hedging activities, or a lack of visibility at corporate level because of fragmented accounts payable (A/P) and accounts receivable (A/R) systems. Netting can help to alleviate some of these pressures. Introducing a netting system would also capture and separate the inter-company flow and help to minimise the exposed volume.

Such a netting system can be designed to offset payable inter-company invoices against receivable inter-company invoices, even in different currencies. This means that each participating subsidiary can end up with a single, netted position in their own base currency. At the same time, the aggregated FX volume reduces and can be managed at corporate treasury level, resulting in better margins.

When a netting system is a real time, global online system, such as RBS AccessNetting, a treasurer or finance director achieves full visibility of the inter-company obligations throughout the settlement period. According to the treasury manager of a well-known multinational healthcare imaging specialist, AccessNetting is a solution that “… met our priorities in terms of quickly establishing a global, robust and easy-to-manage netting system. Because of the outsourced nature of the solution, it requires few resources to run and allows us to settle transactions and manage FX across our global organisation.”

Netting can also simplify the invoice administration and payment process, reduce operational and financial risks and reduce internal company costs and bank charges, such as payment fees, float and FX costs. Netting is often implemented with the outsourcing of operational activities, such as active reconciliation, resulting in contacting the company’s subsidiaries to make timely, correct payments.

Outsourcing ensures that inter-company payment procedures are being adhered to and allows the company’s scarce treasury or accounting resources to focus on value-added activities.

The Heart of Liquidity Solutions

Although netting has been on the market since the late 1970s, it has become clear in the past few years that companies are looking for solutions that go beyond the core function of netting. One RBS client – a global charity company – adopted netting to consolidate its worldwide donations in favour of environmental projects around the globe. Using the outsourced netting offering for this very specific purpose helped the company to reduce both its payment costs and administrative workload drastically.

Netting itself is becoming more sought-after as a facility that can be combined with other liquidity management solutions. For example, currently we are working with a client to provide a netting solution where all subsidiaries are included in a cross-currency notional pool.

In a global, complex and diversified environment, there is no specific solution that will suit all companies. However, a carefully balanced mix of tailored advice, market-leading products and consistent support can significantly reduce risk and complexity, save costs or maximise profits and energise trade. Netting resides at the heart of liquidity management and it takes a banking partner who has the expertise to understand a company’s working capital cycle to provide a successful solution.

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