Optimising Cross Border Liquidity

As companies expand internationally, the need to access, and make best use of cash held in different currencies and locations becomes increasingly important. There are a variety of ways to achieve this, but many treasurers believe that liquidity management techniques such as cross-border cash concentration (also referred to as cross-border sweeping or target/zero balancing) are accessible only to the largest and most sophisticated multinationals. While these corporations were often the early adopters of cross-border liquidity solutions (box 1), such techniques are accessible to companies of all sizes, enabling them to take more centralised control of cash positions across the business, and greatly enhance the management of funding and liquidity risks.

The cross-border dimension

Many treasurers are already familiar with liquidity management techniques in a domestic context, but there is substantial opportunity to extend these solutions further to reflect the needs of a multinational business, whilst taking into account the geographical dimension and the need to manage cash across different currencies. These two features: distance and denomination, create major administrative overheads for regional or global corporate treasury functions. For example, achieving 'just-in-time' availability of funding in each location requires accurate cash forecasting and the precise execution of cross-border fund transfers within the cut-off times in both the originating and receiving locations. Furthermore, treasurers often need to convert funds from one currency to another to meet these local funding requirements.

Exploring the value proposition

Working capital requirements and the associated liquidity can become increasingly fragmented as companies expand into new markets, operate in new currencies and deal with new suppliers and customers. In many cases, companies set up additional domestic banking solutions or relationships to meet these changing needs, which results in sub-optimal liquidity distribution, with idle cash in some locations and borrowing requirements in others. This problem is particularly acute when these domestic banking arrangements are managed locally without central treasury oversight or coordination. This situation is even more acute for companies that have grown through acquisition.

While liquidity may become fragmented for different reasons, however, the business case for centralising and taking better control over group cash is compelling for two key reasons:

1. Access to liquidity

Treasurers' ability to take hold of cash across the business has become even more important since the global financial crisis. Access to credit has become more limited, and both banks and corporations have become more selective in their choice of credit relationships. Consequently, the value of internal liquidity, i.e. liquidity held within the business, has increased substantially. By leveraging internal liquidity more efficiently, treasurers can minimise idle cash, and reduce the level of external borrowing. Furthermore, they can make more strategic decisions on how best to deploy excess liquidity or source financing. This allows treasurers to strengthen their balance sheet structure, as well as lowering borrowing costs and increasing yield on investments. They can also free up liquidity headroom to be used for more strategic purposes.

     2. Improved governance

Decisions on how to manage cross-border liquidity, and the degree of centralised control, has a fundamental bearing on the role and responsibilities of treasury in relation to business unit finance teams, and how the performance of each should be measured. While these issues are often overlooked in comparison to other priorities for improving cash management or yield optimisation, improved governance should be a major factor in treasurers' decision-making.

Related to this, by consolidating liquidity across locations, and establishing centralised control, treasurers are in a better position to manage a broad set of risks that extend beyond, but are correlated to liquidity risk. As an example, cross-border liquidity management techniques operate in harmony with the corporation's foreign exchange (FX) risk policy. Whether FX exposures are identified and managed at an entity or cash flow level, or with a more coordinated approach, liquidity management techniques do not alter currency positions or change exposure determination and hedging. On the other hand, some liquidity management techniques, in particular multi-currency notional pooling, provide a convenient way of administering multiple currency positions at a portfolio level, while seamlessly integrating with the company's FX exposure hedging programme.

Defining liquidity priorities

Within these two broad areas, the specific benefits of centralising and taking greater control over liquidity for each company will depend on its working capital cycle, cash conversion cycle, cash flow patterns and overall liquidity dynamics. More specifically:

1. Short cash. For a company that has large working capital requirements, with a long cash conversion cycle or the need for material structural or project-based external financing, the highest priority will be to consolidate internal liquidity as far as possible to reduce dependency on, and the cost of servicing, external debt.

2. Long cash. A company with large surplus cash balances can bring financial and operational discipline by consolidating surpluses into a larger pool under the management control of an investment agency entity. By managing a bigger pool, treasurers can achieve greater diversification, access multiple investment and deposit products and distribute investment more efficiently across multiple investment tenors.

3. High cash flow volatility. A common challenge for many companies is to forecast future cash flow accurately across multiple business units and territories. While this remains an important objective, treasurers can leverage cross-border liquidity structures to create a larger and more stable liquidity position at a portfolio level.  With more stable cash balances, treasurers can make better liquidity decisions, including calculating the tenor and amount of external borrowings or investments more precisely, even in situations where the ability to forecast cash flow is limited. This approach offers considerable advantage when combining accounts domestically, but the benefits are even greater when extending the concept cross-border across multiple entities, business lines and currencies.

Summary: Cross-border liquidity solutions

Physical (i.e. cash concentration, sweeping, zero or target balancing)

This refers to the automatic, physical movement of cash from multiple accounts in different jurisdictions to a single master account domiciled in one location (the concentration location). In its most efficient form, the physical cross-border transfer takes place at the end of each business day, leaving either a zero balance or pre-determined balance on the accounts participating in this arrangement.

Many companies are accustomed to sweeping cash from accounts within a country, but this capability equally exists across countries (subject to regulations) for tradable/fungible currencies in Asia, including USD, SGD, HKD, AUD, NZD, JPY and offshore RMB (CNH). Given that the majority of cross-border trade in the region is denominated and settled in USD, the ability to pool USD accounts is particularly important, and complements the ability to concentrate other currencies across markets which permit cross-border financial flows.

Notional (i.e. multi-currency interest optimisation or notional pooling)

There are essentially two notional techniques. The first is a simple form of interest optimisation across a portfolio of bank accounts which reside in multiple countries and are denominated in several currencies. Interest optimisation is effectively a virtual portfolio pricing arrangement, where preferential pricing is applied to each account (subject to domestic regulations), but without, or with very limited, recognition of any offsets between long and short positions which are held in different locations.

The second technique involves bringing together balances denominated in different currencies into a multi-currency notional pooling arrangement. For this to operate as a cross-border structure, a combination of a multi-currency notional pool with cross-border physical cash concentration is required to transfer account positions to the concentration location, and then include them in the pool. In itself, multi-currency notional pooling cannot be considered a cross-border liquidity technique, but is a critical component of the hybrid solution that brings together physical cross-border techniques and domestic pooling.

A four-step approach to cross-border liquidity

Optimising liquidity on a regional or global basis is best achieved by taking a structured approach, as implementing a cross-border liquidity solution in isolation is unlikely to deliver the liquidity and governance benefits that treasurers require:

1. Account structure. The first challenge for many treasurers in consolidating liquidity is that cash is distributed amongst a multitude of banking partners and accounts. Treasurers should therefore review the account structure and associated flows, and potentially rationalise these structures before considering a cross-border liquidity solution.
    
2. Cash visibility. Establishing visibility over cash, across locations, banks and accounts is an essential prerequisite to taking control over this cash. However, with sophisticated technology now readily available from many banks, SWIFT and treasury management system/ ERP vendors, the obstacles to achieving cash visibility are far lower than in the past.
    
3. Solution definition. It is important to work with the bank to identify the most efficient channels for managing payment and collection flows, and any regulatory restrictions on the mobility of funds. On the basis of such analysis, treasurers can assess potential solutions and the specific value proposition of each one in relation to the specific needs of the business. Other important considerations during this phase include the appropriate evaluation of the tax and accounting implications from the adoption of a physical or notional arrangement, and the alignment with internal company policies on the changes in the ownership of the liquidity as a result of the design of the solution.
    
4. Implementation roadmap. Finally, treasurers should work with the bank to build an implementation roadmap for the chosen solution(s), including outlining the relevant regulatory and tax issues in each country, and internal implementation requirements, such as considering the implications of intercompany guarantees and indemnities, or the preference for intercompany lending.