Return of Cash: The Case for Treasury Centralisation

“Today the overriding concern is the return of capital, rather than the return on capital,” says Andrew Reid, director, head of corporate cash management sales, UK & Ireland, Deutsche Bank, succinctly summing up the impact of the global credit crisis on the world’s corporate treasurers.

Multinational companies are feeling the squeeze to improve their control over cash flow and working capital in order to free up internal resources, now that the days of ‘easy credit’ are over. Because, at the end of the day, “the best counterparty for a corporate is the group itself”, according to Pierre Boisselier, international treasurer at Publicis, a global advertising network, speaking at BNP Paribas’ Cash Management University in October.

A centralised model enables better cash and working capital management, as well as helping to manage liquidity and funding risk in a more proactive manner. Particularly in geographical areas where liquidity has dried up quickly, most companies without a centralised treasury department, or with a low degree of centralisation, have encountered difficulties because they can’t access internal cash fast enough to avoid gaps in short-term funding.

Many corporates are centralising everything that it is possible to centralise. Yet there are also drawbacks to a centralised treasury structure, such as the lack of local/regional knowledge, understanding and relationships. Does centralisation make sense for all corporate treasuries?

Advantages of Centralisation

The trend towards treasury centralisation has gained momentum over the past 10 years. Some corporates, such as jewellers Tiffany & Co, have always operated a centralised treasury, while others, such as BT, are in the process of centralisation. In Tiffany’s case, a centralised treasury model was chosen because its retail and production operations are staffed primarily for operational and compliance needs and it did not want to add unnecessary cost/burden to these locations.

Michael Connolly, vice president – treasurer, Tiffany & Co, US, lists three advantages to centralisation:

  1. Control/consistency – maintaining procedures, standards, and best practice.
  2. Experience/career growth – centralised staff are trained in multiple disciplines and areas.
  3. Efficiency – procedures are generally completed faster, since there is less need for confirming communications; less duplication, whether that is IT systems or people, and therefore cost reduction.

Carlos Negrão, manager, corporate treasury and contract management, BT Global Services, based in Brazil, focused on the first bullet point: the importance of control and consistency through best practice. BT is in the midst of fully centralising its treasury; the process has been implemented in most countries in Europe and US and is currently under implementation around the world. Negrão explains: “BT understands that the control of centralised treasury will help to achieve all its committed targets. The process aims to turn each regional treasury into a centre of excellence/intelligence, with one shared service centre [SSC] taking over most back office operations.”

“A centralised treasury operates as a centre of excellence,” agrees Roger Blackburn, treasury management, Kellogg’s Europe, Ireland, “whereas treasury activities in the former country-specific model tended to be carried out by generalists for whom treasury was just one of their responsibilities. A centralised treasury also facilitates cross-border solutions to cross-border issues.” Kellogg’s is a US multinational food company, with its head office in Michigan. The European head office is in Dublin and provides front office treasury and cash management services for the group’s operations in Europe and the Middle East. The Dublin office is supported by a back office function based in its European financial SSC in Manchester, England.

Obviously, cost reduction has been – and will continue to be – a main driver for centralisation. On the financial side, a company can rationalise its account structure, which should give it liquidity and cash management benefits. Deutsche Bank’s Reid says that many treasuries are aggressively driving projects to rationalise bank providers and systems. They are also looking to optimise commercial interfaces, particularly account structures, against the backdrop of significant regulatory change with the roll out of the single euro payments area (SEPA). The SEPA project will provide new opportunities for corporates to reduce the number of physical bank accounts through the adoption of techniques such as ‘on behalf of’ payments.

On the operational side, Andy Ponsford, head of cash product capabilities, Europe, Middle East and Africa (EMEA) for JPMorgan, details efficiency advantages through economies of scale via reduced head count, contingency planning, lower operating costs, etc. “Another important consideration is the cost of technology,” says Ponsford. “If done well, this is an opportunity to create a single place where the firm is doing technical development and then applying it, which again creates efficiency.” Ponsford also agrees that SEPA, particularly SEPA Direct Debits (SDDs), might be a reason why there is a resurgence in people considering centralisation.

A treasury operations manager at a large tobacco company, which is working towards the goal of a “truly global treasury function”, lists cost savings as his first consideration when moving to a centralised structure, but also adds: better control, leveraging purchasing power, standardising processes and systems, and improving reporting and risk management.

Risk has significantly grown in importance – a treasurer has to understand where the risk points are in the financial supply chain (FSC) with vertical- and horizontal-linked suppliers and counterparts. A head of group treasury at a hypermarket developer operating in the Middle East highlights risk as one of the reasons the company moved towards a centralised structure: “At the beginning of 2008, we created a group treasury with the objective to unleash the full potential through a centralised organisational model and high operational performance,” he said. “The main advantages we envisaged using this model were around improved risk management across the portfolio of businesses, as well as financial and operational synergies. Previously, the structure was more decentralised, with several treasury departments taking care of the different operational businesses. While this might have been a good model for the early stages of development of the group, it was no longer effective as the size and complexity of operations increased.”

“The treasurer is one of the few people in the organisation who really understands risk and how movements in markets and different factors can affect the business’ profit and loss (P&L). That is why we talk of this holistic cash and risk management – which, in itself, is a centralisation message,” says Andrew Woods, group vice president of treasury solutions at SunGard. “It is about centralising information and understanding the risks at a very basic level,” he says. “It is about getting the information out of the ERP [enterprise resource planning] system and understanding the exposures the company is running, because these can be lost in the balance sheets of overseas entities.”

He used the example of a US company with treasury headquarters in New York that has a European entity: the company may think that it has a euro/US dollar exposure only, but digging into the entities’ balance sheet, it realises that there is a factory in Poland. In order to mitigate the foreign exchange (FX) risk, the US company needs know that level of detail very quickly – i.e. in a day or two – rather than waiting for five days after the closure of the books to find out the translation exposures. “Until you have achieved that level of information, then you can’t begin to build out that risk management system to really understand and manage the risk,” says Woods.

At a recent UK corporate treasury conference hosted by Deutsche Bank, which attracted 125 corporates, risk figured prominently in a session on the upcoming treasury challenges in 2010. Reid says: “As we look into 2010, cost reduction has been superseded at a treasury level by the need to ensure sufficient and adequate funding for the organisation – in terms of unblocking the arteries and seeking out opportunities to internally generate liquidity in a more effective manner given the credit squeeze. But, equally, there has been a move from a risk awareness strategy to a more pure out-and-out risk management approach. It is not only about understanding where things are, but having counteractive measures, plans and models to deploy to ensure that the organisation – be it on a counterparty basis or a bank-to-corporate basis – is sufficiently hedged and managed for the long term sustainability of the business flow.”

Effectively, centralisation means ensuring that the risks are managed centrally and information is consolidated, so that a corporate can make the best possible use of its cash and rely as little as possible on outside finance.

Trade-offs: Centralised Versus Decentralised

The main argument against treasury centralisation is the lack of a local presence. What is gained in cost savings by having fewer accounts and a better visibility over cash may be lost in local expertise, focus, and relationships. Local banks can be vital for overseas businesses in terms of short-term lending because often these businesses are in other time zones, using different languages and cultural references.

“Centralisation makes it more difficult to stay in touch with each of the markets,” says Kellogg’s Blackburn, “and as a result establishing formal and regular means of communication is essential. Centralisation is also predicated on central staff having knowledge of local ‘banking customs and instruments’ (with the Mediterranean countries tending to be different from their northern European neighbours). You also really need to run a common ERP – SAP in our case – to make things connect.”

It no longer has to be all or nothing, as shown by the examples of BT and Kellogg’s which both have a centralised treasury structure but with regional offices or SSCs. The idea of a hybrid structure is gaining popularity. Deutsche Bank’s Reid explains: “It is clear that the need to have local excellence and expertise is the rationale for many corporates to maintain regional structures. There are a number of clients that have a global treasury head office an organisation where increasingly strategic decisions are made, but they are supported by regional infrastructures involving treasury dotted in the key markets, based on the business profile and the geographic outlook of the business.”

It is now possible because the technology is there to support it. “There are tools and instruments available to have a ‘virtual set-up’, partly decentralised and partly centralised, using techniques like SWIFT messaging, in order to still have global visibility,” according to Sander van Tol, partner, Zanders. “The virtual set-up allows, on the one hand, for a company to aim for centralisation as the ultimate objective, yet, on the other hand, recognises that there are certain countries/regions that need local people.” (See Figure 1)

“For example, in China and other Asian countries it is very important that you have people on the ground that understand the regulations and are important players in the market. That is the ideal set-up: the overall objective is centralisation but you understand there are specific local requirements, and in those countries or regions, you set up a regional treasury centre,” he says.

Figure 1: Treasury Management can Create Shareholder Value

Source: Zanders

 

Conclusion

In rough times, the treasurer needs to act as a custodian of the organisation’s financial integrity to protect shareholders and other stakeholders. A centralised structure allows treasurers to have the required oversight – the policy- and decision-making – which can ensure that they are receiving the best possible benefits through economies of scale in terms of centralising investments, hedging, FX dealings, cash management, and development. They can also better manage their banking relationships, ensuring the reciprocity of support, and develop a holistic risk strategy.

But centralising doesn’t mean closing every office and bank account down, it just means making sure that the risks and information are managed centrally, and the company makes the best possible use of the cash in the business, relying as little as possible on outside finance.

As the senior head of group treasury at the hypermarket developer says: “There is no doubt that, as far as treasury is concerned, the move towards centralisation is irreversible. As companies are upgrading their IT infrastructure and the banking system becomes more and more integrated, there is less need of a decentralised treasury department. While regulatory, legal, and tax issues might still create friction the trends towards centralised liquidity management and financial risk management, centralised payment factories are gaining pace. Most of the corporate treasury department will still be cost centres but with a high value-adding content for the whole organisation in terms of product and process innovation.”

Mitsubishi Corporation: A Centralised Regional Treasury Structure

Mitsubishi Corporation UK is a 100% owned subsidiary of Mitsubishi Corporation (MC) in Japan. MC is a Japanese ‘sogo shosha’, which in Western terms means a general all-purpose trading company. In its simplest form the business involves undertaking import and export type transactions in a wide range of commodities, including those in the energy, metals, machinery, chemicals, food and clothing sectors.

The company has a global presence with offices and business investments in the major areas of the world. Business investments have become an important focus for the company to support its continued growth.

MC has four regional treasury centres in Tokyo, Singapore, London and New York. This structure helps support local offices as well as affiliate companies who are responsible for business investments. In London, the treasury centre currently serves the European area although potentially this could expand to the Middle East and Africa.

Gary Williams, general manager treasury, Mitsubishi Corporation (UK) explains the treasury structure: “Before centralising, we had a decentralised structure where each subsidiary was responsible for their own financing requirements which they undertook mainly through local/regional banks. That structure was inefficient as some subsidiaries had cash surpluses while others borrowed from banks and the funding cost from banks was much higher compared to what could be achieved in the capital markets. With a centralised structure we can utilise surplus cash from subsidiaries for the benefit of other businesses together with cheaper funding from the capital markets.”

Williams says that the company was looking to centralise treasury operations for some years and believes that the advancement of technology and systems made this more possible now. “Some banks that support the corporate treasury business have also moved to such a structure,” he says. “Furthermore, with increasing compliance requirements, it makes commercial sense to counter this by identifying and implementing more efficient processes. However, despite saying this, I believe that at a local level some form of treasury function or knowledge is still necessary, possibility in a wider finance function.”

One common theme to emerge from the global financial crisis is the need to improve the management of cash in terms of balances, sources of borrowing and cash forecasting. Under these circumstances, the centralisation of a company’s cash-flow forecast and identifying future requirements is of utmost importance. Williams believes that this aspect alone may lead some companies to consider centralisation.

Pros
  • Cost: Reduced running costs.
  • Cash: Potential for improved cash management.
  • Relationships: Improved management of banks and other service providers.
Cons
  • Country knowledge: Possibility of reduced local knowledge in terms of tax, banking, legal, etc.
  • Business knowledge: Will a centralised treasury understand the local business?
  • Language and culture: Even in these times it could be an issue in some areas of the world.

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