Cash management’s evolution: centralisation is key

Cash management is the starting point of treasury management and among its core activities and responsibilities. The past decade has seen a clear trend towards centralisation to gain visibility and control over cash balances on a daily basis. The aim is to improve liquidity planning and attain a more efficient use of the company’s financial resources. Cross-funding of subsidiaries enables a reduction of expensive debt, or even more expensive equity financing.

In general, modern treasuries have established structures that allow them to centralise a major portion of the cash balances held worldwide. Hence discussions today are often around the future target operating model (TOM) and where a treasury organisation can add further value to the company. The basis of such discussions should be a critical and comprehensive self-assessment to understand where the organisation stands today. Based on the outcome, treasurers can determine further optimisation potential in terms of governance structures, organisation, technology and processes. The trend is clearly to change the philosophy of treasury from the traditional cost centre to a value-adding service centre.

The following topics are the key drivers in discussing the evolution of cash management and payments:
• Streamlining and optimisation of process (straight-through processing (STP)).
• Enhancing the technological footprint to reduce manual efforts.
• Increase in cost efficiency.
• Optimisation of monitoring and controlling activities

Having optimised daily treasury operations, the time gained should be used to become a strategic partner to management and potentially assume more responsibilities in managing financial risks and steering the allocation of capital and funding within the company.

Among the key areas for treasury to significantly add value is the whole procure-to-pay (P2P) cycle. From a risk management standpoint treasury can support the supply chain to detect FX and commodity risks early on and apply respective hedging principles. From a cash management perspective, treasury is eager to evolve from a solely cash balance-controlled environment into a cash-flow controlled set-up. The aim for treasury is to get involved in the cash cycle within the organisation as early as possible and thus also support the optimisation of working capital requirements.

Payments- and collections-on-behalf-of (POBO/COBO) enable treasury to control and own the cash flows. Treasury can influence and anticipate flows before they are recorded on bank accounts. This facilitates cash-flow forecasting and short-term account dispositions.

Evolution of treasury and cash management

To visualise the evolution of treasury – and in particular cash management – it helps to understand certain dimensions. Our observations in the market uncovered different operating models for corporate treasuries in terms of their level of maturity, sophistication and centralisation. As functionalities, responsibilities and complexity become increasingly broader in the evolution of a treasury department, the higher the demand and recommendation for technological and IT developments will be.

We often observe that market participants have a different understanding of potential approaches when talking about payment factories or in-house banks (IHBs). The above chart is based on the following definitions:

A payment factory is a solution that streamlines and centralises the processing of payments for several (or all) subsidiaries within the same group. There are different specifications thereof:

Payment (shared) service centre: A shared service centre (SSC) with systems to process payments for subsidiaries. As an example, staff log in to the e-banking platforms of the corresponding entities and process payments therein.

Payment processing centre: A PPC offers a centralised infrastructure to the subsidiaries where all payments can be routed through the system provided and channeled to banks.This solution is often combined with a SSC with powers of attorney for the accounts of the subsidiaries, allowing the processing of payments in the name of the corresponding legal entity.

Payments on behalf of (POBO): In a POBO structure payments are not only routed through a central infrastructure but also paid from accounts of the owner of the payment factory which is under the control of treasury. Subsidiaries are debited on interest-bearing in-house bank accounts.

The key differentiators for a treasury to be designated an IHB are the following:
• IHB holds interest-bearing account(s) for the subsidiaries through which all cash-flows processed by the IHB (derivatives, payments, intercompany transaction, loans, deposits etc.) are settled.
• IHB offers individual loans and deposits to subsidiaries.
• In addition an IHB offers basic bank services (such as FX deals, overdrafts, corporate guarantees, etc.) to subsidiaries.

It should be stressed that these approaches or solutions should not be seen as clearly separated set-ups but show a smooth transition from basic cash management to sophisticated and highly centralised treasury operations. It goes without saying that most treasuries form a hybrid of the set-ups outlined above.

Where do treasuries stand today?

Based on our market observations, we see two different levels of maturity applied to approaches outlined – often also driven by emotional hurdles given a higher degree of centralisation.

On the one hand, corporations are already familiar with the topic having implemented a payment factory with POBO. Their future TOM intends to implement a collection factory in order to further increase the level of centralisation by implementing a COBO structure. These are often the top-tier corporations with a highly centralised and sophisticated treasury that already runs an IHB.

On the other hand, there are mid-sized and even large multinational organisations that are reluctant to implement POBO and COBO structures. The potential stumbling blocks include -but are not limited to – the following:
• Significant tax and legal implications that need to be analysed for every country to be included; these are costly and time-consuming.
• High investment and implementation efforts are needed particularly in terms of technology. Often the treasury and treasury-related IT landscape (enterprise resource planning (ERP), treasury management systems (TMS), related interfaces etc.) is not yet on a solid basis, triggering additional significant investments.
• Increased personnel resources for treasury are needed, while subsidiaries tend not to lay off personnel but rather give them other tasks (a controversial issue within business cases in terms of bottom line savings)
• Emotional hurdles might arise in subsidiaries reluctant to lose control over their cash flows.
• Reconciliation of cash flows – in particular for collections – is challenging.

Why “on behalf”-structures should still be the vision of treasuries

Despite the critical views and challenges described above, “on behalf of” structures on the payment or the collection side, nonetheless have a strong and ever increasing selling proposition for a treasury organisation. Key factors are:
• Improved operational efficiencies as every subsidiary no longer needs to have systems and staff to process and control payments.
• Enhanced security in terms of cyberattacks, which now poses a huge risk – particularly in cash management. With a centralised approach for payments (such as diminishing manual interactions, interfaces), an active defence strategy can be implemented more easily and efficiently throughout the company.
• Enhanced cash visibility and control early in the cash cycle empowers cash flow forecasting.
• High potential to reduce number of bank accounts at subsidiary level.

Some banks understand the issues as well as the potential and have reacted. They respond to the requirements of corporations and have created service offerings in terms of virtual account solutions that facilitate on-behalf-of payments and collections. In addition, virtual accounts have the potential to displace traditional (physical) cash pools. This is a particularly interesting development, as under Basel III banks might no longer offer (notional) cash pools to corporate clients – and virtual accounts could be a valid alternative to consider.

Outlook – what next in the evolution of treasury management?

A treasury needs to have a vision for the next five to seven years. We observe and facilitate discussions with larger corporate organisations that contemplate setting up a bank in the form of separate financial services units. This has proven to be a particularly successful model in the automotive industry. Many of today’s car manufacturers not only sell cars, but also offer the related financing to their clients through car leasing agreements. We are seeing similar developments with other organisations in the retail and consumer goods sectors.

Questions today therefore are more often why not:
• Use available liquidity to finance clients or suppliers through offering customised financial services?
• Secure liquidity through access to the interbank and central bank markets?
• Create additional revenues?
• Become less bank dependent?

In today’s low or even negative interest rate environment (Switzerland, Denmark) corporations often face the challenge of investing their liquidity without paying interest. A “bank-in-a-box” model could be an interesting option and solution to consider.

About the authors:

Roger Disch joined EY in 2012 to lead the treasury services competence in Switzerland. Sven Göggel joined EY’s treasury services team in 2013.

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