Are Regional Treasury Centres Redundant?

Global treasury is needed to create policy and to ensure that money is managed efficiently throughout a group as a whole. Local treasury happens because that’s where the money comes in and goes out. The question we pose relates to regional treasury. In the age of globalisation and centralisation, is regional treasury management now redundant?

To answer this question, we need to identify a simple but solid business case to quantify a regional treasury centre’s (RTC’s) benefits or lack thereof. Since we couldn’t find a standard template in a reference book or on the internet, we have created one here. In this article you will find:

• a standardised template for a business case (the ‘template’), into which you can enter your own company’s figures to see whether you should have an RTC or not; and
• an analysis using this template, of whether an RTC is (generally) valuable in today’s Asian environment or not.

Quantifying the RTC Business Case

There is already a good way of measuring the effectiveness of an RTC. Banks and professional money managers have been told by their regulators to calculate their risks using certain specific criteria – the Basel I and Basel II rules. A treasury centre can be measured in the same way, by calculating its contribution to the improvement of:

• credit risk;
• market risk; and
• operational risk.

In our case, we will compare this to its cost of operation as the basis of our approach in the following analysis.

What Should a Good Business Case Cover?

In our experience a good business case covers:

1. Definitions of key (but not necessarily well-known) concepts that are used within the business case.
2. A quantitative analysis, including:
• reasonable base data and estimates, backed up by benchmarks or other evidence where available;
• a business case type that is appropriate to the result to be obtained (e.g. a decision on whether to use break even analysis, return on investment made, return on risk adjusted capital, etc.);
• the analysis itself; and
• an assessment of the impacts if the base data and estimates are changed.
3. A qualitative analysis to make sure the quantitative conclusions make intuitive sense (i.e. a “sense check”).
4. An overall conclusion.

Key Concepts

One company’s RTC is not necessarily (or even usually) the same as another’s. Who does what, when, where, why and how varies dramatically. Broadly though, two extremes can be identified and analysed. If we can show that both of these extremes have value, we can reasonably suggest that any in-between situations are worth having as well.

At one extreme is the “prudent” centre that is geared only towards controlling what is happening in the operations (geographic or functional). Its personnel are not asked to “make things go right”; they are there instead to “make sure things do not go wrong”. For convenience, we will call this type a regional treasury co-ordination centre (RTCC).

At the other extreme is an “aggressive” centre that is not only asked to “make things go right” but also positively add value to the results of the company, whether by saving costs or increasing income, now and in the future. For convenience we will call this type a regional treasury business unit (RTBU).

Base Data, Benchmarks and Estimates

In Figure 1, we summarise the assumptions used in the business case, from which, using the template, we draw conclusions about the value of an RTC. We include the figures, their source and/or the reasoning behind the figures. If you use the template for your own company, please replace the figures with your own.

Business Case 1: The Regional Treasury Centre Co-ordination Centre

Purpose of RTC

Control over treasury operations, not value addition.

Nature of business case

Since the centre is not tasked to make a profit, it would not be right to measure it on its profitability. The question instead is whether the centre breaks even, so that management is not paying too much to sleep soundly at night.

Quantitative analysis

1. Credit risk benefit calculation
• Annuity equivalent of a US$5m credit loss every 25 years at an interest rate of 5 per cent. Benefit: US$0.1m
• This is the amount that the company should be willing to pay to make sure that the banks’ creditworthiness is tracked by expert, dedicated staff near the markets where the banks are used.
2. Market risk benefit calculation
• This kind of centre is not allowed to take positions. Therefore it can only determine (through improvement of the associated processes) the intra-day timing and number of FX transactions.
• US$750m flows subject to FX risk with a 0.0050 intra-day FX variation and a 20 per cent improvement on existing process. Benefit: US$0.7m
• This is looking at FX improvements only.
3. Operational risk benefit calculation
• Fraud reduction: Annuity equivalent of a US$5m fraud loss every 25 years at an interest rate of 5 per cent. Benefit: US$0.1m
• Operational error reduction: 1 per cent reduction in errors on a real cash flow of US$5bn (US$500m x 10:1 real cash flow/sales ratio) and a two-day average turnaround of errors. The interest saving is calculated on a 360-day basis. Benefit: US$0.3m
4. Total benefit achieved: US$1.2m
5. Total treasury centre cost: US$0.2m

Is breakeven achievable? Yes, clearly. With these assumptions, the business case is proven. A control oriented RTC can easily be justified in Asia.

Business Case 2: The Regional Treasury Business Unit (RTBU)

Purpose of RTC

Value-add to the success of the business.

Nature of business case

This treasury centre is tasked with making a profit. Therefore, it is fair to review whether it achieves the same or better kind of return than a normal business unit. A return on capital used or a return on capital at risk business case would be best. For this, however, we would need to clarify how much capital the centre had available and what the risk management policies were. In order to keep the example straightforward, a simple return on investment type of business case is used instead.

Quantitative analysis

1. Credit risk benefit calculation
• As before, the functions of an RTCC would normally, and logically, be part of the RTBU activities.
• Annuity equivalent of a US$5m credit loss every 25 years at an interest rate of 5 per cent. Benefit: US$0.1m
2. Market risk benefit calculation
• To make a profit, the centre would be allowed to take positions (within authorised and controlled limits). Generally, most companies are sensitive to trading positions over month-end (for accounting reasons); therefore, the business case uses an intra-month FX variation only.
• US$750m flows subject to FX risk with a 0.0250 intra-month FX variation and a 20 per cent improvement on existing risk management processes.
  Benefit scenario 1: US$3.7m With a 0.0350 intra-month variation and a 20 per cent improvement.
  Benefit scenario 2: US$5.3m With a 0.0250 intra-month variation and a 30 per cent improvement.
  Benefit scenario 3: US$5.6m
• This is still looking at FX improvements only.
3. Operational risk benefit calculation
• Annuity equivalent of a US$5m fraud loss every 25 years at an interest rate of 5 per cent. Benefit: US$0.1m
• 1 per cent reduction in errors on a real cash flow of US$5bn (US$500m x 10:1 real cash flow/sales ratio) and a two-day average turnaround of errors. The interest saving is calculated on a 360-day basis. Benefit: US$0.3m
4. Total benefit achieved:
   Scenario 1: US$4.2m
   Scenario 2: US$5.8m
   Scenario 3: US$6.1m
5. Total treasury centre cost: US$2m + (say, US$3m)
6. Return on Investment:
   Scenario 1: 40 per cent +
   Scenario 2: 90 per cent +
   Scenario 3: 100 per cent+

Is the return on investment comparable to a normal business unit achievable? Yes. Making these assumptions, the business case is again proven. A value-added RTC is also justified in Asia.

Varying the Assumptions

First, in calculating the value of the two business cases above we have made many assumptions. The treasury centre personnel are more expert than the local ones; they do their jobs well, and they are properly controlled. Recruitment, training and retaining is handled efficiently. Effective management, policies, controls, reporting and audit are in place. These assumptions are not unreasonable. In real life, examples of catastrophic failures like Enron and Barings are few when compared to the greater number of non-newsworthy, perfectly normal financial functions in companies worldwide. But the most telling argument is this; if a company really can’t control its treasury function in a regional location, why should it be any better at doing it in headquarters or in the local entities? Effective control of treasury has got nothing to do with location, just with the right knowledge and a sufficient number of resources.

Second, all of our assumed figures can (and should) be challenged. Our estimates can be changed upwards or downwards, big, infrequent flows have very different risk characteristics to small, frequent ones. Other items such as interest rates, commodities, trade finance, pension funds, insurance and other financial risks can be added in if significant. The centre can use its treasury and geographic expertise to work with the company to improve not just financial but other income and expenses (e.g. by varying terms of trade to increase sales). It can be made tax efficient. These items can be calculated too. In our experience, though, if most (if not all) of the significant items are added up, and the centres optimised to maximise the benefits, the resulting conclusions are usually the same, the centres remain valuable.

Qualitative Analysis

In general, our business case scenarios suggest that:

• Treasury centre costs can be fine-tuned to achieve the result required, whether that be better control or value-added. The rest of the company, locally or globally, can be used to complement the RTC to make sure it remains effective.
• The bigger the company’s turnover in Asia, the more likely it is to benefit from having an RTC.
• The greater the real cash flow/sales ratio, the more likely the company is to benefit from having an RTC.
• The more market risk of any type the company is exposed to, the more likely it is to benefit from having an RTC. (Far more so than operational or credit risk, which remain fairly static.)
• If the centre is well managed and controlled, benefits will be maintained as long as possible and problems fixed as soon as possible. New possibilities will also emerge. Therefore, in real life, the results achieved will be better than those shown in the business case.

If our modelling approach is correct, the following should also be true:

• Companies of any type with smaller turnovers would find it very hard to justify independent RTCs in Asia.
• Companies of any type with bigger turnovers in Asia should almost always be able to justify an RTC.
• Manufacturing and trading companies with medium turnovers (but high real cash flow to sales ratios) should benefit most from RTCs.
• Services and intangibles companies with medium turnovers (but smaller real cash flow to sales ratios) should have less need for RTCs.
• Single-currency companies with medium turnovers (e.g. global but US$-based electronics companies) should have less need for RTCs.

In our experience, companies with regional turnovers lower than US$200m do in fact tend not to have or need RTCs. Larger ones do (especially those with US$2bn+). In between, industry and common market practice matters (as do the company and management’s openness to new ideas, the geographic spread of operations and the company’s underlying needs).

Therefore, from a qualitative point of view, we believe our business cases match reality and passes a common sense check. However you do not need to take our word for it. All of these scenarios can be made more realistic and measured more accurately using more sophisticated business case techniques such as decision tree analysis or real-option theory.

Business Case Conclusion

We have demonstrated through our template and business case analysis that whether it is a control-oriented or aggressive profit-seeking entity, an RTC remains valuable in Asia, even in the face of globalisation. We end this article by answering our initial question: in the age of globalisation and centralisation, is regional treasury management now redundant? We believe that RTCs should not be shutting down. Far from it – more new ones should be starting up. Others left alone, refocused or expanded. This, however, is not the current reality. So, see what you think. Take our comments on board and take a look at our modelling technique. Put your own figures into our template and see what conclusions you draw about your own company’s situation. We see long-term value in RTCs for companies operating in Asia and across the world. Do you?

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