High increase in efficiency and considerable cost savings with multilateral netting

Project: Introduction of multilateral netting in mechanical engineering I Development of best practice treasury standards I Creation of a comprehensive treasury policy

Tags: | Significant cost reduction I Payment discipline I Liquidity optimization I Balance sheet reduction I Uniform billing process I Central invoice management

Treasury follows suit

The client, a Swiss engineering group with sales of around CHF 1 billion, is setting an impressive operational pace. Treasury processes and treasury IT are becoming increasingly central to financial efficiency and security. The potential of the existing treasury system “Coupa” was exploited with the introduction of a highly efficient multilateral netting system. Along the way, decisive improvements were made to the basis of a Group Treasury. At the same time, an inventory of all previously decentralized banking relationships was carried out and, following an analysis of the data, decisive improvements in security and banking costs were implemented. A financial contract based on the ISDA standard and answering all questions was also introduced with all Group companies. This also lays the foundation for future expansions such as cross-border cash pooling and basic standards for mutual financial agreements of all kinds.

Netting reduces payment volumes by over 90% and cuts costs enormously

29 subsidiaries from East-West Yokohama to Sao Paulo and North-South Stockholm to Johannesburg generate an annual internal payment volume of several hundred million CHF with individual invoices in the double-digit thousands per year. This volume has been reduced by 93% and the number of payments has been cut to less than 100 per year. This led to an enormous increase in efficiency and resulted in an upper 6-figure reduction in costs per year. No more people were hired or new systems purchased.

The cost savings resulted from

• the drastic reduction in the number of payment orders and thus the elimination of payment transaction costs;
• no more expensive exchange of smaller and larger individual amounts in a total of 16 currencies;
• reduction of the workload by 70% for all internal invoices, which corresponds to several thousand hours.

This was made possible by transferring the internal invoices once a month with a file upload from the local ERP to the treasury management system “Coupa”.

Questions of principle

In this project, I first looked at the entirety of the existing treasury landscape. In other words, which processes are in place, in which countries are operations taking place, how many funds are on the balance sheet and where (bank / IC receivables / third party receivables / financial assets / IC liabilities / third party liabilities / financial liabilities), which IT systems are in use where and for what.

This procedure is essential in order to give the basic strategy of introducing a new process the necessary justification. In this specific case, the question arose as to whether it might not be better to take the direct approach of an in-house bank instead of multilateral netting or bilateral netting. Or whether cross-border cash pooling would not be just as useful for the main currencies.

The answer to this question was that netting would first release all previously frozen liquid assets in the IC creditor accounts, which in itself means a considerable reduction in group FX risk and, above all, a considerable reduction in total assets, which in turn leads to significantly better key figures. Take the equity ratio as an example: the higher the balance sheet total, the lower the equity ratio. Not to mention the tied-up liquidity, which ends up being concentrated at the parent company instead of the subsidiaries in the form of unpaid IC creditors in multilateral netting.

The same applies to cash pooling, but first the balance sheet should be cleaned up in a well thought-out treasury strategy and only then should the rest of the liquidity be concentrated in this efficiency measure at Group headquarters.

Evaluation of project profitability and project feasibility

In order to avoid the risks of high project costs and also to find out what is actually possible within the existing group structure, I carried out a preliminary project. In this preliminary project, which was carefully equipped for 2.5 months with all the usual best practice project reports, project controlling and risk calculations, I was able to calculate the expected net profits with a high degree of probability. In addition, the introduction of multilateral netting was segmented into a first part with “low-hanging fruit” and a second part for more difficult countries. This phase two should then be integrated into bilateral netting within a year with careful regulatory clarifications.

Phased implementation 

Like most global corporations, my client has subsidiaries in various countries. For this netting project, I segmented the subsidiaries into the following matrix:

Category A changes can be implemented immediately. All that is required is an internal contract. All other categories also take part in the overall monthly reconciliation, which in itself brings many advantages. However, these countries in categories B to D require an individual setup to execute the netting payments. The Phase II sub-project will show to what extent it is worthwhile to involve the respective countries separately for the payments in this final process.

Good preparation is the key to project success

The preliminary project with the detailed evaluation took 40 days. But it was worth it!  Even the first rough estimate was exceeded by far, with an internal rate of return > 200% (i.e. the entire project costs are amortized after just six months), the initial steps for project implementation were planned precisely.

It required framework data from each subsidiary. The query was therefore expanded to include additional data in the clear Excel questionnaire form.  For example, which accounts exist at which banks and which authorization method is used for these accounts. In addition to these additional questions, which proved to be very useful for further processing, the master data to be parameterized individually was also queried. The well-structured form then also had a good response rate within the specified time.

In addition to these queries, further workstreams were set up in the project organization: IT, compliance/legal, accounting, training and testing. The participants were brought on board promptly and an overall team was set up with a positive drive. The risks and hurdles of the project were qualified in the respective teams and recorded in a project tracking tool. At the end of the preparation phase, a clear roadmap was produced that no longer left any answers unanswered.

Full netting vs. virtual netting, system setup, tests

The task now was to feed the “Coupa” treasury system with the above-mentioned data from the questionnaire and the individual parameters. First, two netting categories were set up: one with real “full netting”, in which the result is also physically paid from the Group company to the netting center or vice versa after internal reconciliation and settlement, and a mathematical “virtual netting”. This involves the same steps as full netting, but without physical payment to or from the corporate netting center. Instead, these payments are paid bilaterally / gross / net / partial net, depending on the specific regulatory requirements in the various countries.

As mentioned above, the standardization prior to the actual payment for countries such as China, South Korea, South Africa, Brazil or India already brings major quantitative and qualitative advantages, so that these countries were also involved from day 1.

The settlement currency was then stored, which corresponds to the functional currency (which does not have to be the same as the local currency), as well as the standard bank account per company (only one per company!). The various relationship structures were also stored in a mapping. In addition to other parameters, the central control element has also been replaced: the reconciliation calendar and the netting calendar. These two calendars control the entire reconciliation and netting process.

Once the process had been parameterized in the treasury system, extensive tests were carried out in a separate test system with a target/actual comparison. This revealed small details that then had to be adjusted.

Essential: training all those involved before the go-ahead

As the saying goes: every chain is only as strong as its weakest link. Following this principle, I set up an extensive training program. Starting with a briefing in the pre-implementation phase, where all 100 or so participants were informed in three MS team meetings adapted to the time zones about what was at stake and what they would be facing and when. Three training workstreams were therefore created: APAC/ME, Europe/Africa, North/South America.

The essential work catalog was carefully prepared in the form of a comprehensive and precise Netting Working Instruction according to internal corporate standards. At the end of the project, this essential guideline became an integral part of the Group Policies.

This was followed by detailed group training in MS teams for each workstream. Experience has shown that one group training session is not enough, especially not for a completely new process. For this reason, a dedicated individual training session was held with each individual country company over the following two weeks. The response in these individual training sessions was many times greater than in the first group training session.

A few days before the planned go-live, the project steering committee was convened, which then gave its final approval for the launch with great satisfaction at the smooth progress of the project and the significant benefits to be expected. On the same day, all of the 100 or so people involved received confirmation of what had already been extensively trained.

Important secondary objectives, treasury policy

As part of the new centralized internal billing process, some extremely important contracts and policies were also introduced or launched. For example, a comprehensive set of financial rules was introduced that clarifies all issues relating to financial obligations, late payments, payment processing, etc. This set of rules is based on globally recognized ISDA standards. This set of rules is based on globally recognized ISDA standards.

The existing treasury policy was fundamentally revised and adapted to a top standard that leaves no questions unanswered. This policy was then introduced step by step outside of the netting project. Parts of the Treasury Policy that were to be implemented immediately, such as the netting agreement for all participants, were already introduced beforehand as a partial publication.

Goal achieved, lessons learned

Thanks to the precise preparation and detailed training, the first netting run went as well as expected and even exceeded expectations. Receivables that had not been settled for years were paid in one fell swoop. Companies that did not have sufficient liquidity to pay the large accumulated accounts payable at once received an internal loan from the operating parent company, which is also the netting center.

As a result, all balance sheets were reduced, in some cases considerably, in a single day, liquidity was absorbed in the various countries, the unwanted free financing via creditors ceased and all this was achieved with just a dozen payments. In addition, it was possible to clarify cross-border differences in the understanding of accounting practices and cases of differences that had not been clarified for years were largely resolved.

The remaining minor stumbling blocks were then identified and clarified in a “Lessons Learned” communication.

The project in brief

Mission

• Objective: Introduction of a standard multilateral netting process
  
• Reason: the number of internal invoices reached a four-digit number per month, which involved considerable effort in reconciliation and led to high processing costs.
  
• Strategic fit: operational excellence, adjustment of administrative resources and costs for further operational growth
  

Quantitative Benefits

• Significantly lower payment transaction costs
  
• Reduced FX risk
  
• Reduced FX costs
  

Qualitative Benefits

• Better liquidity management
  
• Simplified reconciliation process
  
• Minimization of counterparty risk
  
• Better payment discipline, resulting in fewer liquidity problems, transparent financing, over-indebtedness problems becoming visible, better liquidity planning
  
• Better acceptance of IC invoices, resulting in simpler processing, central coordination and control, faster processes
  
• Optimization of liquidity at Group level due to release of unpaid debt and reduction of unnecessary "dead" capital
  
• Significantly lower risks due to fewer payments
  
• Better compliance with Group reporting
  
• Significantly improved strategic planning and forecasting
  
• Significantly better working capital management
  

Group netting significantly improves the financial processes in a group with little effort. Group netting should be one of the first optimization measures when it comes to professionalizing treasury tasks.