Treasury Advisory
Quarterly Fall 2014
Liquidity Management Services
Treasury and Trade Solutions
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Treasury and Trade Solutions
Credits
Authors:
Michael Botek
New York
+1 (212) 816-0283
michael.botek@citi.com
Anita Suen
New York
+1 (212) 816-2275
anita.suen@citi.com
Cindy Yung
Singapore
+1 (212) 816-4844
cindy.yung@citi.com
Acknowledgments:
We thank all our clients and our
colleagues who shared their
insights without which this would
not have been possible.
Editors:
Ron Chakravarti
New York
+1.212.816.6909
ron.chakravarti@citi.com
Jennifer Sariano
New York
+1.212.816.1861
jennifer.sariano@citi.com
Treasury transformation, global liquidity management, and
managing trapped cash have been recurring themes in our
client discussions over the course of this year. In this edition we
summarize research by INSEAD, conducted in collaboration with
Citi, on the shareholder value of treasury transformation; provide
an update on trends in global liquidity management based on
what our clients are doing today; and propose a framework for
dealing with trapped cash.
Please contact your Citi representative for more information on
any of these topics.
The editors invite your comments and feedback, including what
you would like to see in future editions of this quarterly.
Treasury Advisory Quarterly Fall 2014 Edition
3
Table of Contents
Treasury Transformation: Does It Create Shareholder Value? 4
“To pool or not to pool?”, that is not the question. 7
Trapped Cash: Not To Forget the “Other Side” of
Liquidity Management 12
Must Read 16
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Treasury and Trade Solutions
Treasury Transformation:
Does It Create Shareholder Value?
By Ron Chakravarti and Cindy Yung
Corporates often undergo treasury restructuring out of necessity.
Such was the case for Tyco International, Lenovo and Roche, for
each of which treasury transformation was considered a success.
But does effective treasury centralization result in shareholder
value creation? An INSEAD study, in collaboration with Citi, set out
to find the answer — a matter of relevance to CFOs and Treasurers.
Following a decade-long acquisition spree, Tyco’s large debts came due in 2002 but its cash was locked in
subsidiaries, inaccessible by headquarters. Following a landmark bond offering that solved the company’s
urgent liquidity needs, Tyco swiftly set up a global cash management structure to ensure that most of the
subsidiary cash is available centrally in its Swiss in-house bank (IHB). In doing so, Tyco also achieved efficiency
by reducing partner banks and number of bank accounts.
An immediate challenge post Lenovo’s acquisition of IBM’s PC business in 2004 was to establish financial
processes and cash pools for its international business — when Lenovo had no experience in managing global
treasury. Lenovo, with the help of IBM, eventually established a combined treasury center and re-invoicing
center that allowed automated, daily concentration of cash from all its international subsidiaries into
Singapore. Funds were then used to settle outstanding trade balances, alleviating the need for intercompany
lending, which is costly and often complex. This setup lowered operating cash required, eliminated withholding
tax on interest, and reduced cost of capital by ~US$23-48 million annually.
Roche posted a consolidated net loss of CHF4 billion in 2002 due to changes in international accounting practices
and a plunge in the value of its equity holdings. Realizing the need to overhaul its financial processes, Roche
created an award-winning IHB that made treasury services cheaper and more relevant to business. Even before
full completion, Roche’s IHB had already saved the company CHF10MM in net interest, bank fees and FX fees.
In each case, centralization clearly brought rewards. INSEAD’s study went further, looking at data from Citi’s
Treasury Diagnostics global benchmarking survey to identify linkages with corporate performance metrics that
“matter” to shareholders.
The research revealed three benefits of sophisticated treasury centralization:
1. Reduced cost — cash is costly, and companies with centralized treasury typically run at 5% less cash1
2. Higher stock valuation: Market-to-book 2 value improves by 10%
3. Enhanced operational efficiency — return on assets is 1.44% higher
Centralized treasury management clearly has substantial impact on a company’s valuation and financial
results. The takeaway: management teams of large companies can enhance shareholder value through
effective treasury transformation. ¡
1
2
As measured by a firm’s cash-to-market value ratio (e.g. from 20% to 15%)
As measured by Tobin’s Q, defined as the market value of a firm’s existing assets divided by its book value
Treasury Advisory Quarterly Fall 2014 Edition
Centralized treasury
management clearly
has substantial impact
on a company’s valuation
and financial results.
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Treasury and Trade Solutions
Multinationals continue to amplify
the use of cash pooling around
the globe to reduce funding
and FX costs, enhance visibility
and control over liquidity, and
increase operational efficiency.
Treasury Advisory Quarterly Fall 2014 Edition
7
“To pool or not to pool?”, that is not
the question.
By Michael Botek and Anita Suen
“Hats off” to the latest list of multinational corporates being
recognized for their innovations in global liquidity and risk
management. At Citi, we are very happy to have had a part
to play in their successes. As many companies restructure
their global liquidity and currency management, we are often
asked about corporate trends and practices. In this article, we
summarize some of the most frequent questions.
Global Corporate Trends
While cash pooling has become prevalent in many markets, the scope and automation of pooling
structures varies greatly, leaving plenty of opportunities for improvement in organizations that have
not reassessed global liquidity management for a year or more. Corporate benchmarking data from our
Citi Treasury Diagnostics (CTD) survey suggests that companies are acting on this.
CTD results reveal that, where pooling is allowed by regulations, 78% of our survey respondents report
daily cash aggregation in a centralized pool. For larger corporates, the percentage increases to 83% —
the bigger the company, the more actively it uses cash pooling.
Frequency of Cash Concentration
Daily Cash Concentration by Revenue
While the majority of survey participants
(78%) reported daily concentration of cash
into a central pool …
… large firms were significantly more likely
than their smaller counterparts to concentrate
cash on a daily basis
5%
47%
9%
8%
68%
82%
78%
83%
Daily
Weekly
Periodically
Monthly
<$2bn
$2-10bn
$10-25bn
>$25bn
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Treasury and Trade Solutions
… and automation is highly preferred.
Pooling Automation
Most companies (77%) reported either fully or partially
automated pooling processes
Structures Used
While Citi offers physical or notional pooling (or both) in many
centers across the world, we find most large multinationals
center their global liquidity management around a few locales.
Historically, this has been London. More recently, we see
the emergence of new regional (as opposed to purely local)
centers. Among the new regional centers Singapore clearly
leads at present, although we see emerging regional activity
in other locales in Asia Pacific, EMEA and Latin America.
23%
77%
Fully or Partially Automated
For a more detailed discussion, please refer to our prior
publication Cash Pooling & Netting: Best Practices.1 The
key point is that physical or notional pooling can be used
independently or combined in a customized solution to
enhance cash management across multiple accounts,
entities, countries, currencies and banks.
Manual
Types of Cash Pooling
There are two main types of pooling — physical and notional.
• Physical Pooling, also referred to as target balancing or
cash concentration, occurs when funds are physically
moved into one bank account, with a single entity
taking ownership of the funds. Since cash from multiple
entities are commingled into one entity, this results in
intercompany loans.
Given the sheer volume of structures in London today, to
provide further perspectives on global trends, we reviewed
client liquidity structures with header accounts of physical
pools or participating accounts in notional pools there. We
focused on non-financial corporates, excluding financials
(e.g. asset managers and insurance companies) as they are
often regulated and behave in specialized ways.
The data shows that only 12% of liquidity structures are
multi-entity notional pooling structures, where funds are not
commingled. The balance are physical pools; this includes
structures that have single-entity multi-currency notional
pools “on top of” the physical pools.
Top Jurisdiction of Incorporation for Single-Entity
Structures in Citibank NA London Branch
• Notional Pooling occurs when funds are notionally
aggregated by the bank, into one net position, to achieve
interest efficiencies. In simple terms, the bank “looks
through” the individual account positive and negative
balances (which remain as they are) to the overall net
position across all accounts in the pool to determine
interest charges. A Multi-entity Notional Pool allows
a company to achieve that single net position without
commingling funds across entities, alleviating the need
for intercompany loans. A Multi-currency Notional Pool
allows a company to simplify management of positions
held across different currencies; these pools may be
multi-entity or single-entity.
Michael Botek, Eva Carey. (January 2013) Cash Pooling & Netting: Best Practices. Treasury and Trade Solutions
1
1. England
2. Netherlands
3. Switzerland
4. Ireland
5. Luxembourg
Treasury Advisory Quarterly Fall 2014 Edition
Notional Pooling Mix
9
Broadening Currency Mix
2007
Non-G10
26%
MCP
41%
SCP
59%
Other G10
26%
USD,
EUR, GBP
48%
2014
Non-G10
30%
USD,
EUR, GBP
38%
Other G10
32%
SCP=Single-currency Notional Pool
MCP=Multi-currency Notional Pool
• The high preference for physical pooling appears to be
driven by the greater transparency and efficiency from
clear transfer of cash ownership between entities. This is
despite that, when entity ‘A’ lends money to entity ‘B,’ the
considerations often include transfer pricing, withholding
tax, and thin-capitalization. Not coincidentally, we find the
entities where cash gets concentrated tend to be domiciled
in tax-favorable jurisdictions.
This table displays the top jurisdictions of the entities
(often designated as In-House Banks) to which cash is
concentrated. Whatever the reasons companies are
selecting these, it is worth noting that England has
one of the widest double tax treaty networks, while
the Netherlands and Luxembourg have zero percent
withholding tax for interest and royalties paid. Additionally
these two countries have extensive treaties to support
zero or reduced withholding tax when paid to these
countries. Tax specialists have suggested that we may see
future changes in the top jurisdictions of incorporation,
as initiatives such as the OECD’s Base Erosion and Profit
Shifting (BEPS) become catalysts for shifts in
tax considerations.
• Multi-entity notional pooling structures remain alive and
well, even if less common. The principal reasons cited for
preferring multi-entity notional pools include that they
allow treasury departments to capture the benefit of
“organic” liquidity with less internal change. Participating
legal entities retain ownership of their cash, making it
easier for treasury to gain business buy-in when the
corporate culture favors less centralization. And, there
is less to deal with in administrative and tax considerations
of intercompany lending that necessarily arise with
physical pooling.
• Multi-currency notional pooling structures are on the rise.
Since 2007, Citi has observed a 77% compounded annual
growth in the number of its multi-currency notional pools.
Today, nearly 41% of notional pools are multi-currency
(MCP in the diagram). Often these are single-entity
structures, used with physical pools. A single-entity multicurrency notional pool is set up after concentrating cash
into a series of currency header accounts owned by the
In-House Bank. Here, the principal reason cited by clients
is the value of easing management of liquidity across long
and short balances across currencies without needing to
perform frequent FX swaps.
The currency mix of multi-currency notional pools has also
broadened since 2007, from a time where a majority included
USD, EUR and GBP to now including a much larger range of
currencies. And this broadening is not limited to developed
market G10 currencies. Today, a frequent request is to
incorporate Chinese Renminbi.
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Treasury and Trade Solutions
Case Study
The diagram below illustrates a typical sophisticated structure.
In this example, the company has Regional Treasury Centers in
Singapore and Europe to manage treasury functions, including
liquidity management. However, it also wished to optimize
liquidity at a global level.
With the Singapore structure (#1), all poolable cash is
concentrated in the name of one entity across various
currencies, with a single-entity multi-currency pool on top.
For the Europe-based structure (#2), cash is held in the name
of each legal entity incorporated in various jurisdictions,
with a multi-entity multi-currency pool on top. Periodically,
the financial coordination center transfers liquidity from one
regional cash pool to another, based on cash forecasts, to
optimize global positions. There is also non-poolable cash in
highly regulated markets and, using what is called an Interest
Optimization structure, the bank improves interest benefits
for the company on this cash as well.
Multi-regional Cash Pooling Structure
2
Multi-currency Notional Pool (London)
Acme
NL
EUR
Acme
NL
GBP
Acme
NL
USD
1
Legal
Entity
EUR
1
Single-entity NP
2
Multi-entity NP
Legal
Entity
GBP
Acme
SG
USD
Legal
Entity
USD
Acme
PH
FCY
Citi
Citi Non-Resident Account
Citi
Citi Resident Account
3rd
Acme
VN
FCY
Multi-currency Notional Pool (Singapore)
Acme
HK
USD
Acme
SG
USD
Acme
JP
USD
Acme
TW
USD
Acme
MY
USD
Acme
AU
USD
Acme
VN
LCY
Acme
CHN
LCY
Acme
CHN
FCY
Acme
TW
LCY
Acme
MY
LCY
Acme
IN
LCY
Auto Cash Concentration
3rd-Party Bank
Acme
SG
SGD
Manual Cash Concentration
FX
Acme
SG
NZD
Acme
SG
HKD
Multiple
options to
concentrate
cash from
3 rd -party
banks
Acme
SGD
Acme
NZD
Acme
HKD
Notional Pool
Interest Optimization
Treasury Advisory Quarterly Fall 2014 Edition
11
When Does It Make Sense To Pool?
The benefits of pooling are a function of governance, complexity and return. The optimal structure maximizes
governance and returns while minimizing complexity.
Improve Governance
Reduce Complexity
• Align liquidity management
with Treasury strategy and
organization structure, while:
• Considerations in adopting a
centralized legal entity for the
in-house bank
—— Centralizing control over
cash positions
• Change management (usually
across treasury, business units
and Shared Services)
—— Increasing automation
—— Pooling cash to the highest
level possible allowed
by regulations
• Connectivity and integration
with banks and treasury systems
• Incremental accounting, tax
or regulatory requirements
Maximize Return
• Quantifying the value:
Reducing External Financing:
— Debt: Notional (Cost of
funds — foregone returns)
— Bid/Ask Spreads on FX
Improving Investments Returns
Opportunity costs of onshore
local currency investments
Tax leakages
Incremental pooling costs
= Total returns from pooling
DID YOU KNOW? On a cross-border basis, it may not always be advantageous to move funds offshore.
Apart from “trapped” currencies in highly regulated markets that must be managed onshore, even
liberal market currencies may have access to better rates in the (home market) currency center, apart
from better cutoff times. Defining the optimal solution for a company requires analysis of the costs and
benefits of the change.
The Future
Multinationals continue to amplify the use of cash pooling around the globe to reduce funding and FX costs,
enhance visibility and control over liquidity, and increase operational efficiency. In the process, companies
have greatly expanded the range of legal entities, countries and currencies, and new pooling centers have
emerged in Asia, EMEA and Latin America. What has not changed is that effective solutions are based on
a sound analysis of the economic and ergonomic impacts, in concert with a bank account rationalization
strategy. A good strategy will allow the structure to evolve over time as corporate needs change, markets
liberalize, and banks advance their capabilities for clients.
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Treasury and Trade Solutions
Trapped Cash: Not To Forget the “Other
Side” of Liquidity Management
By Ron Chakravarti
Globalization has dramatically changed the economic landscape.
New markets have opened up and new capital has been made
available for expansion in emerging markets. Many that were initially
largely manufacturing sites have begun to transform into consumer
markets, increasing their attractiveness for multinationals.
Emerging economies also learned from the currency crisis of the 1990s and more easily weathered the
most recent global financial crisis than many developed markets. Despite challenges, they seem likely to
continue to manage their exchange rates and protect their tax bases to preserve competitiveness, even
as they scale the ladder in building economies based on higher value-add than low-cost manufacturing.
Ultimately, with more favorable demographics than developed markets, emerging markets should be
able to consolidate their growing economic power.
The trapped cash burden
The shift in the global economy towards emerging markets has tangible consequences for treasury
departments. The change in the geographical distribution of cash flows has made optimization of
internal liquidity a challenge because of regulatory and tax constraints and the increased breadth of
companies’ operations. These mismatches can result in a company facing unnecessary working capital
funding needs. Similarly, capex or acquisitions could prove more expensive because of an inability to
use internal liquidity effectively.
Trapped cash represents an asset that is underutilized and potentially creates a need for “unnecessary”
liquidity. As a result, it is a burden on the balance sheet of a company.
For purposes of this article, we define trapped cash as both:
• Lazy cash, i.e. idle “non-earning” local cash balances in excess of day-to-day operating requirements;
• Constrained cash, i.e. cash that can be moved but at a cost and with time constraints.
Treasury Advisory Quarterly Fall 2014 Edition
Trapped cash represents an
asset that is underutilized and
potentially creates a need for
“unnecessary” liquidity. As a
result, it is a burden on the
balance sheet of a company.
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Treasury and Trade Solutions
Decision time: When to free trapped cash
When regulations restrict the convertibility and offshore
movement of funds, companies are forced to redeploy and,
preferably, invest the cash locally as effectively as possible to
retain value until repatriation.
The spectrum of regulation, ranging from FX controls to
central bank reporting, may directly affect the amount or the
frequency of cross-border movements. These constraints
set the boundary of what may be possible to extract from
a particular market. However, the options may be further
reduced by other considerations. Tax leakages, for example,
often prevent companies from using trapped cash.
The primary distinction between regulatory and tax
considerations is that while regulations enforce operating
policies on cash movements, tax considerations do not
restrict cash movements but instead result in a financial cost.
Each transaction must undergo a cost/benefit analysis to
determine whether it is in the best interest of the company.
Just a few of the tax considerations to be taken into account
when evaluating a liquidity strategy include:
• Withholding taxes: sometimes mitigated by foreign
tax credit
• Thin capitalization: maintaining tax shields
Execution: Strategic and tactical approaches
Extracting trapped cash usually requires consideration of
both structural and tactical approaches.
Structural, or more strategic approaches, may involve the
deployment of legal vehicles that allow companies to stretch
trade payables and shorten trade receivables terms.
One solution is to lead (pay early) on payables out of a
restricted jurisdiction — releasing cash from the subsidiary
— and lag (pay late) on receivables into that country. This
strategy delays payment into a trapped cash environment
and optimizes the company’s working capital. However,
local regulatory and tax oversight, as well as market FX
movements, must be taken into account.
One of the best ways of eliminating trapped cash is to avoid
trapping it in the first place. A potential solution is to use an
internal intermediary located in a free market to buy from
restricted jurisdictions and sell to the rest of the world. Given
the intercompany nature of the underlying trades, transfer
prices should be on an arm’s length basis and trade terms
set in a way to avoid possible characterization of receivables
as loans. Through similar intermediaries, management fees
can be paid to the parent company as compensation for
management support and knowledge. Some of the frequently
used structures include:
• Stamp duty tax
• Deemed dividend issues
The cost/benefit analysis should also incorporate internal
factors such as the cost of funds. The following depicts a
deliberately over-simplified formula to gauge the benefits of
using freed cash as an alternative to third-party financing,
assuming no access constraints:
• Procurement center
• Re-invoicing center
• Netting center
• Investment fund linked to internal securitization
arrangements
Cost/Benefit 1 = {[Notional Amount x (Cost of funds — Foregone returns)] — [Tax Leakages]
— [Other Incremental Transaction Costs]}
Where:
• Notional Amount = freed cash
• Cost of funds = marginal cost of borrowing assuming constant capital structure
• Foregone returns = Opportunity costs of local currency onshore investments
• Other Incremental Transaction Costs = FX Bid/Ask Spreads, bank transaction fees, etc.
Every component of the formula will be expressed in monetary terms; a positive final outcome indicates that using internal cash is
preferable to third-party financing. Note that this is not exhaustive and may omit factors that could materially impact its final outcome
including FX gains and losses, among other considerations.
1
Treasury Advisory Quarterly Fall 2014 Edition
These structures are multi-purpose as they can facilitate
other objectives, such as increasing the company’s
procurement bargaining power, FX management and
tax optimization.
Other episodic options could include local capital
reinvestment, M&A, business expansion and local sourcing.
More tactical options include:
• Cash Forecasting: an obvious, but effective, way to avoid
pumping liquidity into a country where it will be trapped is
to have an accurate cash forecasting process in place
• Optimization: domestic pooling structures across local
entities should be used wherever allowed and feasible to
help offset local cash requirements
• Yield enhancement: relationship interest enhancement
from bank deposit balances in restricted jurisdictions may
help subsidize borrowing elsewhere; other investment
options may include vehicles such as local currency money
market funds, commercial paper, government bills, etc.
• Funding: Funding local businesses with intercompany
loans from the parent company (or In-House Bank) instead
of capital injections
• Repatriation: Ensuring timely regular capital and dividend
repatriation within the limits allowed by each jurisdiction
Finding the right solution
Whatever the approaches employed, all options should be
vetted and compared with alternative solutions to determine
which produce the most value for the entire company on a
consolidated basis.
Citi’s Treasury Advisory team often works with clients to
help determine the best course of action for trapped cash.
We have found that using a decision-tree framework makes
it simpler to maneuver through different markets and levels
of restrictions in place. Using the decision-tree framework,
particular types of constraints may lead to particular actions.
By going through a series of ever-narrower filters, the
likely most appropriate solution can be found. Where local
restrictions make an immediate solution near-impossible,
alternative structural approaches aimed at changing the
underlying nature of targeted cash flows may be the
best approach.
Using this sort of decision-tree approach can be an
effective way for a company to determine an optimal
approach for adoption.
15
Holistic liquidity management
Internally generated funds will always be more competitive
than external credit lines. Effective liquidity management
can activate a virtuous cycle in which net financial changes
decrease and credit strength, ratings and valuation improve
(further improving credit spreads). Furthermore, by tapping
internal liquidity, a company gives itself greater flexibility
— either to respond to external shocks or to adopt more
opportunistic strategies.
Strengthening oversight of funding to subsidiaries in
restrictive jurisdictions, leveraging cross-border strategies
to manage working capital and funding, and effective
cash forecasting systems are essential components to the
approach. Advanced financial structures such as intercompany
netting, re-invoicing centers, in-house banks, and financially
efficient trading company models are the next step to help
companies overcome the problem of trapped cash.
It is essential for companies, especially those that have a
mismatch between where they generate and need liquidity,
which may be most companies these days, to have holistic
liquidity management strategies to prevent or release
trapped cash. ¡
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Treasury and Trade Solutions
Must Read
Please contact your Citi Representative for copies of the
Treasury by the Numbers: A Closer Look as well as Cash
Pooling & Netting: Best Practices.
Treasury by the Numbers: A Closer Look
In recent years, corporate treasury has experienced a unique
period of transformation. Broadening geographic footprints,
changing regulations, and advancements in technology are
changing treasury management. At the same time, the bar
is constantly rising — today’s treasurer must respond to
the challenge of doing more with less. To help navigate this
landscape, we provide some trends and themes gathered from
Citi Treasury Diagnostics, our benchmarking tool designed
to help companies assess treasury and working capital
management practices.
Cash Pooling & Netting: Best Practices
With continued focus on liquidity management among clients,
we re-issue an old favorite. This primer on the fundamentals
of cash pooling and intercompany netting explains how these
solutions can provide effective pathways to improve cash access,
reduce financial risks, and rationalize bank account structures.
We review business drivers, explain solution approaches, and
highlight some of the key considerations.
Treasury Advisory Quarterly Fall 2014 Edition
17
Treasury and Trade Solutions
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