Why Netting has Failed to Catch on

Since the concept was first developed more than 30 years
ago, netting products have evolved from rudimentary calculation models based on
paper to cutting-edge web-based computer programmes.

Their value is
well attested. Netting products give treasurers more control and oversight by
centralising foreign exchange (FX) exposure, funding and liquidity requirements.
For example, companies dealing daily with thousands of invoices in different
currencies can see their total FX positions and mitigate their risks through
netting tools.

They can help corporates optimise their cashflows,
ensuring working capital is available when required, or freeing up idle cash to
maximise the interest rates that can be achieved.

The fundamental
principle of netting is simple to understand. It is based on the fact that
prevention is better than cure.

Reducing the number of physical
transfers across a universe of corporate financial systems should be considered
a first step to simplifying complexity. A cash pooling structure can then be set
up to achieve more efficiency in the remaining flows and balances.

The advantages of netting apply regardless of what is happening in the broader
economy. It can help treasurers handle political and economic instability when
it flares up around the world, and slice through layers of organisational
complexity.

Moreover, its effectiveness increases exponentially the
more widely it is used across large, multinational corporates (MNCs). The more
subsidiaries that are involved, the more money that can be saved. Modern netting
systems can even include third parties, such as suppliers.

Reasons
for Slow Growth

Yet for all the clear benefits, netting has never
achieved strong, double-digit annual growth since those first paper-based
systems appeared in the early 1980s.

There are several reasons why,
including the following:

  • How subsidiaries work within an organisation:
    Although money can be saved by including them and their suppliers within the
    netting system, many subsidiaries operate independently and are reluctant to
    participate in a centralised netting structure. Often selling the idea falls on
    the corporate treasurer. The problem is, this does not form part of their core
    responsibilities.
  • Central bank restrictions: Full netting may not be
    allowed in all countries where subsidiaries are located. Some central banks
    refuse to allow any form of offsetting, while others only allow netting to take
    place in a limited form. In other cases strict reporting is required.
  •  Technical restrictions: The third main barrier to netting; frequently not
    all subsidiaries are set up on the same Enterprise Resource Planning (ERP)
    system, in other cases do not use such a system at all.

By far the
worst reaction for companies looking to adopt a netting structure is to leave
subsidiaries out of the structure. It means the remaining structure suddenly
looks much less attractive.

Overcoming these challenges requires
sensitive negotiations and a detailed approach. The trick is to select a netting
provider that offers different netting levels, full reporting capabilities and
the expertise to help setting up the best system for each country and
subsidiary.

These can be adapted to suit the most stringent of
central bank requirements, and can range from full netting, where all
transactions are converted to subsidiaries’ home currencies, to gross netting
where transactions are not converted and not netted. This simply subtotals
payments and receipts separately for each currency.

Elements for
Success

A successful netting structure needs much more than a
calculation tool. Crucial components include active reconciliation and follow
up, agreed inter-company procedures, a netting calendar and execution of
settlements. Many companies find it amazing how much time and resource are spent
on these operational activities. They prevent corporate treasury departments
from focusing on the areas where they can add most value.

Efforts to
introduce netting have been boosted by the rise of standardised technologies,
which help to achieve a more controlled environment. Many netting technologies
now have to be certified to meet international standards. They can also be
dovetailed in with other liquidity management techniques.  

By being
relentless in trying to include all subsidiaries and third parties in a way that
fits best with their individual circumstances, companies will improve the
efficiency of netting dramatically. Outsourcing operational activities alongside
a flexible netting and reporting tool can significantly reduce risks, save costs
and boost trade. It is clear that a spreadsheet or an ERP tool is no longer
enough.

It takes a banking partner who has the expertise to
understand a company’s working capital cycle to provide a successful solution.
Once companies get to grips with the issues, then netting will be well placed to
grow more strongly.

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