Domestic Cash Concentration in Asia

Achieving Optimal Liquidity in a Sub-optimal Environment

Driven by the increasing pressure to improve profits, treasurers are looking to manage their organisations more effectively. There is an increasing trend worldwide that sees more and more organisations actively putting regional or global structures in place for both treasury and liquidity management. In Asia, the current low interest rate environment means that earnings on idle excess funds are far from optimal. The need to enhance yield management is a key driver for organisations with operations in the region to find ways to better optimise their funds. With effective liquidity management, cash flow forecasting becomes more critical, thereby enhancing profitability and maximising investment opportunities.

Liquidity management deals with the day-to-day management of short-term cash positions. The primary objective is to reduce interest costs and optimise the use of surplus funds, be it for investing, paying off company debt or daily operational needs. Liquidity management products that are readily available in the market include:

• Domestic or cross-border cash concentration/sweeping – involves the levelling of positive and negative balances via the physical movement of funds. Surplus funds in member accounts are physically swept to, and deficits are funded from a dedicated master account. A reverse sweep can then be effected on the following business day to reinstate the balances in the participating accounts.
• Notional pooling – an interest compensation scheme that offsets the debit balances against credit balances of accounts in a defined pool for interest computation. No physical movement of funds is involved.
• Netting – a service that allows companies to settle their obligations (payables or receivables) through a designated netting centre, usually managed wholly by the parent company. The service enables the netting centre to do netting computation and derive the final amount (net payable or receivable) that must be settled by each company to the centre.

The type of liquidity management tool that companies choose to implement depends on several factors. These include the currency type involved (domestic or foreign),whether the structure involves single or multiple legal entities, whether it involves resident or non-resident accounts, if the accounts are interest or non-interest bearing, and more importantly, the tax and regulatory environments.

The more common method chosen by treasurers in Asia is domestic cash concentration or physical sweeping. Apart from fulfilling the objectives outlined above, cash concentration provides enhanced monitoring and control of funds, making it ideal for companies that have operations and/or subsidiaries that are geographically dispersed within the country, and who have multiple banking relationships to manage. Benefits aside, the popularity of cash concentration solutions is due largely to the onerous regulatory landscape across the region that either prohibits, or makes difficult, the implementation of notional pooling, netting or cross-border cash concentration. In most cases, the complexity of the solution is also determined to a certain extent by local market practices.

To illustrate how solutions are often influenced by the local context they are set in, following are three examples of domestic cash concentration solutions developed by Deutsche Bank for three key Asian markets: India, South Korea and China.

India: Solutions for the single legal entity

In India, since multilateral netting and notional pooling are currently not permitted by law, Deutsche Bank offers cash sweep services within its branches in India for single legal entities as well as between entities belonging to the same group. However, the latter has numerous legal, tax and structural restrictions to consider. For example, there are limits to the amount for inter-company borrowing and lending and minimum guidelines on interest payments and related tax issues.

As it is very common for a single legal entity to open several accounts in each location for their operating purposes, doing business in India typically involves large volumes of paper-based transactions. This results in unwieldy, highly decentralised payment and collections structures.

Deutsche Bank provides a process that enables customers to consolidate their liquidity from accounts with different Deutsche Bank branches in India into a master concentration account on a daily basis (Figure 1).

Step 1: End-of-day sweep at individual branch level – balances of these accounts are zero-balanced and surplus funds are swept into a local concentration account

Figure 1: Deutsche Bank’s Inter-branch Cash Sweep solution for a single entity

South Korea: Solutions for multi-bank cash sweeping

There are no restrictions for sweeping within a single legal entity in South Korea, although inter-company sweeping is considered an inter-company loan and will be subject to tax. The majority of corporates in South Korea tend to open numerous collection accounts with their customers’ house banks to facilitate easier payments settlement for the customer. As a result, most companies have far too many local banking relationships that make the management of liquidity extremely difficult and inefficient.

Deutsche Bank developed the Multi-bank Cash Sweep (MBCS) service, which concentrates the surplus funds from the customer’s accounts with the various local banks into a single master account held with the Bank’s Seoul branch (DBSL) through a target-balancing arrangement. Cash concentration is achieved through checking the available funds in the participating accounts and making the physical transfer of funds using the respective local bank’s internet banking service (Figure 2).

Figure 2: Deutsche Bank’s Multi-bank Cash Sweep service

China: Solutions for inter-company borrowing/lending

One of the more highly regulated markets in the region, China has a variety of restrictions on lending and borrowing, be it intra-group or external to the group. Short-term credit facilities in Renminbi are only available through local and foreign banks that are licensed to conduct Renminbi lending business.

Structuring solutions for multiple legal entities is more complicated than that for single entities as direct borrowing and lending between companies is prohibited in China. These are permitted only if conducted through an entrust loan structure, where the lender (entrustor) will take the full credit risk of the borrower while the bank (entrustee) plays only an administrative role and acts as an agent. Figure 3 gives a simple illustration of the standard inter-company liquidity management solution for multiple legal entities in compliance with this restriction.

Entity A lends to Entity B where all accounts are held with the same Entrustee

Figure 3: Entrust Loan Structure solution

Evidently, the complexity of the liquidity management structure that a corporate implements will vary, depending on the local environment it operates in. It goes without saying that advanced technological capabilities and the ability to tailor solutions to the various local requirements are crucial for successful implementation of domestic liquidity management solutions. Underlying these are the ever-important local experience, capability and expertise of the service provider.

Asia has always presented a great challenge to corporates seeking opportunities for greater growth and higher profit margins through more effective treasury management. This challenge is amplified by the myriad of regulatory frameworks inherent in the environment.

Reprinted with permission from the October 2004 issue of Asiamoney magazine.

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