Deregulation has eased barriers to entry in local markets, created

Transcription

1 Global working capital optimisation an art or a science? By Niko Havoutis, JPMorgan, New York Deregulation has eased barriers to entry in local markets, created increased scope for capital flows, and delivered growth opportunities in the world economy. Cuts in interest rates have aided globalisation by reducing the cost of capital and making the financing of this growth economically viable. Economic convergence events like the creation of single currency environments (e.g. the euro) have helped consolidate multi-currency exposures and therefore reduced the cost of FX hedging. A global macroeconomic environment is now in place to support increased foreign direct investment. In an increasingly global environment, competitive emphasis must be on strategic differentiation. Differentiation, apart from product, marketing and branding, is further accentuated by operational and financial efficiency. Maximising shareholder value requires that all scarce corporate resources be optimised. Treasury activities, once seen as local payables and receivables matching, are now being used in the pursuit of value for the transnational corporation. Working capital optimisation creates favourable internal rates of return, lower cost of funding and maximum yield for extremely valuable cash and near cash resources. Global liquidity management is a major new industry trend. International borders are now crossed in the pursuit of idle liquidity that needs to be optimised. Cross-regional applications make the shift of surplus resources even more valuable if they are destined to cover local deficiencies. Is liquidity management an art or a science? Before we reply, let us review how it is practised. OBJECTIVE SETTING Effective liquidity management has to be a fundamental objective of the corporate strategy. Any organisation that operates with shareholder value in mind must establish these goals: Global cash flow matching and netting. Reduction of excess cash. Minimisation of external borrowing. Lower cost of funding. Maximisation of investment yields. Inward foreign direct investment US$bn Avg European Union US East & South East Asia Latin America & Carribean Source: UN Conference on Trade & Development 6

2 7878 p6-11 Legal Global working 29/8/01 4:03 pm Page 7 These are the pillars of global working capital optimisation, and will create improved returns on capital employed. flows is an arbitrary process. That is why they are sometimes called unpredicted cash in treasury management circles. GLOBAL MINDSET One of the most important aspects of liquidity management evolution over the last few years has been the internationalisation of liquidity solutions. The introduction of the euro has furthered this trend. Maximisation begins by taking a broad view of global group operations, currency exposures, funding requirements and surplus positions. RESOURCE IDENTIFICATION Three key dimensions of working capital dynamics are: Cash. Accounts receivable and payable. Inventory. Cutting the average receivable days outstanding is critical. Cash is king. Once this principle is established, a series of actions can assist in cash conversion. Receivables can be enhanced through business process re-engineering, securitisation and other methods. The average number of days in the receivables cycle must be constantly reduced. The process of receivables reduction has to be benchmarked against industry standards. This process will then define the payables cycle, and the combination of the two efforts will set the objective for optimum cash flow. CASH FLOW RECOGNITION While systems like intra-day reporting services for cash balances help track cash positions, anticipated streams of cash are equally important in cash forecasting. Treasury management systems can generate quite accurate forecasts of predicted flows like FX settlements, maturing capital and money market instruments, coupon and dividend payments. Certain industry events like Continuous Linked Settlement create advanced predictability and availability of FX-related payment flows, and potentially other instruments, on an intra-day basis. However, cash forecasting cannot be totally complete without incorporating net commercial receivables. Invoice settlements can be particularly difficult to predict. This difficulty is compounded when the forecast timeframe shrinks and its frequency increases (e.g. daily). Making educated guesses requires a time series model that incorporates sales cycle and client behaviour. Results of such models can vary sometimes wildly as a result of external interest rates and other factors. Prediction of commercial CASH FLOW NETTING To lessen corporate exposure to FX, transaction and funding costs, inter-company flows should be recognised and netted against each other across all financial instruments and methods of settlement. According to Greenwich Associates a leading consulting firm approximately 10% of US corporate treasurers are looking at multi-lateral netting to help offset inter-company exposures. MOBILISATION OF NET CASH RESOURCES Globally operating organisations encompass a large number of operating entities, some in cash surplus, some in deficit. It is fundamentally important to offset deficit positions with internally- generated surplus cash. Especially in the case of locally operating subsidiaries, funding can be costly. The industry has developed particular cash concentration products that are currently evolving, both cross-border and crosscurrency. These services come in a wide variety of products that can accommodate the balance sheet requirements of the underlying users. For example, pooling defined as the notional aggregation of balances aiming at interest reduction is particularly suitable to high-growth entities. Sweeping defined as a set of physical liquidity movements has balance sheet offset elements and therefore reduces asset expansion. The benefits of liquidity concentration are eye opening. Liquidity solutions can add tremendous cash fluidity, reduce the cost of funding and improve the return-on-capital employed. Industry studies show increased use of pooling and sweeping techniques by multinational corporations. However, these solutions do not come without restrictions. Some relate to local regulations (prevention of pooling in certain areas). Others are imposed by financial institutions themselves, limiting availability to clients of certain credit ratings to prevent misuse. Liquidity concentration mechanisms were designed to enhance cash flow and optimisation, but never to be used as funding tools. INVESTMENT POLICY Once positions are consolidated, net liquidity can be further optimised through investment management programmes. Net liquidity can be invested in a wide array of instruments with a variety of returns. It is critical to have a liquidity and investments policy dictating investment parameters, the range of instruments and counter-party exposure 7

3 7878 p6-11 Legal Global working 29/8/01 4:03 pm Page 8 Commercial banking sweep account assets Source: Treasury Strategies Inc Commercial ing Sweep Account Survey limits the organisation is authorised to take. This policy normally comes from the Board of Directors. Investment management also requires a detailed understanding of the underlying duration of the net cash flows per currency. Cash can have operational (day-to-day), business cycle, balance sheet (acquisition/disposal) or regulatory orientation. Each cash category has a different duration. For example, nuclear power companies might be required to maintain sinking funds for facing potential disasters. This has different maturity from net cash generated from the daily business cycles, which needs to be ploughed back into the business process the next day. By nature, regulatory cash has a long-term orientation. TIMING AND INVESTMENT INSTRUMENTS Timing of investment execution impacts the types of instruments available. Market liquidity of traded instruments becomes thinner as the day goes on due to a lack of sufficient late day counter parties. Finally, any investment programme has to recognise the risk and yield factors associated with each underlying instrument. The risk of overnight bank deposits varies according to the credit rating of each bank. Commercial paper has different yield patterns than a Treasury Bill investment, even if the maturity is the same. Rated Money Market Mutual Funds tend to be good proxies of balanced synthetic investments because they contain a variety of investment instruments. Their short weighted average maturity (under 60 days), combined with their ratings, provide good investment instruments that tend to match Treasury requirements. Investors should be particularly attentive to shifts in the yield curve caused by interest rate movements, as returns of the different instruments change. SOLUTION STRUCTURES Because various organisations have different structures and objectives, Global Working Capital Optimisation can be delivered in many different ways. Each case requires specialised treatment. Finding the best appropriate solution starts with careful account structuring. Legal entities, currencies, tax and accounting rules, and inter-company relationships must all be blended correctly to create fluid structures offering regulatory compliance and high shareholder value added. These are now offered by banks that can blend the following components to achieve the client s objectives for optimising their working capital: The ability to conceive products. The creativity to devise solutions. The geographic depth to be holistic. The technological platforms to ensure optimal, error-free delivery. IMPLEMENTATION Global Working Capital Optimisation is not possible unless conceptual design is translated into actual practice. This does not happen in a 8

4 7878 p6-11 Legal Global working 29/8/01 4:03 pm Page 9 Overnight fed funds yield % Q1 00 Q2 00 Q3 00 Q4 00 Q1 01 Q2 01 Averages Source: The Federal Reserve Board federalreserve.gov Money market yields June % ON FF 7 day CP 30 day CP 60 day CP 3 mo T Bill 6 mo T Bill 1 yr T Bill Instrument Source: The Federal Reserve Board federalreserve.gov day. Devising a solution is one thing, delivering it is another. Programmes require attention to detail and sufficient resources. Traditionally, the banking industry has been responsible for delivery. However, the best results have come from joint projects in which the client and its bank work together. Optimisation programmes normally change current practices from local, to regional and global. Deficient operations are financed by internal surpluses. Local operating entities that actively invest might now have to deposit liquidity in an in-house bank structure instead of playing the market. Success depends heavily on the degree of global participation. Therefore, it is important that the benefits of the programme are shared by the participating entities. The best operational solutions come from Central Treasury operating as a global service center that coordinates and refines the Group s liquidity to maximise shareholder value. Cash deficient entities benefit from lower funding rates, even while they strive to fix any local issues. Meanwhile, surplus entities can share a higher proportion of the enhanced yield. The right chemistry is everything. OVERLAY OPTIMISATION Overlay optimisation is a technical term for the period after the optimisation programme is up and running, its practices relatively established and the benefits already visible. Optimisation, like quality in all its forms, is a never-ending road in the sense that further benefits can be achieved. Once working practices are normalised they can be outsourced to reliable service providers under service-level agreements, providing economies of scale and scope. The areas of benefit are execution and technology-oriented: Premises. 9

5 7878 p6-11 Legal Global working 29/8/01 4:03 pm Page 10 Accounting. Funding (mostly inter-company). HR and systems (Treasury, Investment, Accounting or Payment). Technology frontiers change very rapidly these days and the output is better, but a significant commitment in up-front costs is required. A core competency provider in this field can absorb much of this cost and release efficiency in the whole equation. In Asia, for example, a recent study by Greenwich Associates shows that, more than ever, North American multinationals are looking at outsourcing operating functions. Fully 20% considered outsourcing in the year 2000 compared to only 9% in 1999! Is Global Working Capital Optimisation an art or a science? The above discussion suggests it is a synthetic concept, and can be broken down into its components, which must be carefully analysed and planned. Areas that academia has elevated to a science include the study of: Historical patterns. Client and vendor behaviours. Business processes. Credit cycles. Corporate policies. Market and rate dynamics. However, blending these components into a viable and valuable solution or formula is an art. Shareholders must be satisfied that the organisation operates optimally against individual markets and industry benchmarks. The global contributing entities must feel they are part of a systematic approach that creates global value. Benefits achieved must be visible locally to accentuate local entity accountability. The system must have the fluidity to respond to changes in economic and business climates, redefining itself as the industry evolves. The following case studies are representative of two strategies that can be accomplished in a regulatory-friendly atmosphere. They can only be constructed within the parameters of the regulatory environment of your country. CASE STUDY 1 ASIAN ELECTRONICS COMPANY The euro has enabled an increasing number of companies to implement sweep structures that were not previously possible due to the multi-currency environment of the Europe/Middle East/Africa region. In this example, the solution involved centralisation of funds in a single -based account, via cross-border zero balance sweeps. These funds are then invested or repatriated to group headquarters in Asia. The in-country operating companies concentrate funds in incountry resident accounts. Funds are automatically swept from the multiple operating entities, on a daily basis, to the -based con- Sweep structure for Asian Electonics Company Company Head Office Asia Notional Pooling Europe Middle East and Africa Treasury Centre Concentration Account at Automated Zero Balancing Brussels Paris Frankfurt Milan Other Belgium France Germany Italy Other Domestic Flows 10

6 7878 p6-11 Legal Global working 29/8/01 4:03 pm Page 11 Pooling Structure for Global Financial Firm Fund/Drain US$ Pool Treasury Master US$ Account US$ Pool National Pooling for es with Reference Account for Subsidiary US$ Acct US$ Acct New York Cross-Border Automated Zero Balance H.O. US$ ref Insurance Sub H.O. US$ ref Broker/Dealer Sub Fund/Drain EURO Pool Treasury Master Euro Account E Pool National Pooling for es with Reference Account for Subsidiary US$ Insurance Subsidiary US$ Acct Broker/ Dealer Sub. E Acct E Acct New York H.O. E ref Insurance Sub E Acct Cross-Border Automated Zero Balance E Insurance Subsidiary E Acct Broker/ Dealer Sub. centration account owned by the in-house bank. The advantages of this structure include: Increased information and better management of cash flow from a regional perspective. Reduced overhead by elimination of organisational and functional redundancies. Avoidance of lifting fees. Consistent rates across the account structure. Centralised management of the funding and placement activities. FX netting. The opportunity to outsource the management of this structure. CASE STUDY 2 GLOBAL FINANCIAL INSTITUTION This structure was designed to provide a large financial institution with an overall liquidity solution that is globally consistent, and also centralises and automates funding for group entities per currency. The structure takes advantage of pooling long and short balances through a reference account structure per currency, for global branch and subsidiary positions. End-of-day positions are maximised per currency with global position management. The benefits of this structure require the establishment of a tailored banking structure that enhances the legal, tax and operating structure of the financial institution s own treasury and affiliates. Borrowing and excess cash have been minimised with a reference account structure, creating flexibility in pool drainage and funding from one central account. One centre now accurately monitors the global cash position on an intra- and end-of-day basis, thus minimising interest rate and FX risk. Excess cash is actively managed through intra-day placements with net end of day surpluses swept into automated investments. SUMMARY Global working capital optimisation is a major, modern industry trend. It is achievable through programs whose components require rigorous analysis and focus that is scientific in nature. The degree to which these components are integrated and blended to maximise shareholder value is an art. This article was written by Niko Havoutis, Senior Vice President, JPMorgan, New York, US. He is responsible for Global Liquidity, Investments and Agency Treasury. 11