Payment-on-behalf of (POBO): A Trio of Approaches
In simple terms, payments-on-behalf-of (POBO) and COBO cover a broad range of scenarios, where part of the payment value chain is executed by a third party. In the banking space, this business model has been around for many years through correspondent banking, or international payments, and indirect clearing membership relationships in various domestic schemes. Over the past decade, this market has matured and now offers significant value in non-traditional areas as well, so its relevance to treasury is increasing.
In the corporate treasury context POBO is often used synonymously with payment factories and shared service centres (SSCs), although its principles apply more broadly. This article will analyse three possible business models in the POBO space across a common context for assessment:
As always in payments, scale is a key driver of cost reductions. Scenario 1 is targeted at organisations with scale in cross-border payments; scenario 2 allows an organisation to achieve greater scale and scenario 3 allows those that enjoy a level of dominance in an industry vertical to support the end-to-end supply chains delivering to their customers’ demand. Below, we explore the latent value for the corporate/non-bank financial institution (NBFI) treasurer in three possible implementations of ‘on-behalf-of’ payments.
Three Value Areas
In general, POBOs provide value through:
Since the end of the Nineties, three enablers have opened POBO structures up to corporates and NBFIs and three drivers have supported the business case for change:
Key enablers of POBO in non-banks:
Key drivers for POBO adoption in non-banks:
Scenario 1: International Payments Simplification through POBO
This scenario demonstrates how global transaction banks have used POBO to develop innovative and cost-saving products for their clients. While showing how these products work, it also demonstrates to the treasurer the value in sourcing a product like this from your banking partner.
POBO allows global transaction banks to offer their customers the ability to make international payments in bulk, in a wide range of currencies. Banks with a global reach and strong transactional banking capability can reduce customers’ costs by routing a high percentage of the traffic through their own networks and ultimately through a domestic clearing scheme – where local regulation allows. In this case your bank may execute the final leg of the payment on your behalf (from the bank’s account as illustrated below) or your own account held in the local currency.
In simple terms think of this as the ‘Skype’ of payments, where the expensive international part of the transaction is replaced by a lower-cost alternative providing the same service. In the case of Skype it is Voice over Internet Protocol (VoIP), while in this particular scenario it is the bank’s internal network. This type of product should be considered by any corporate and NBFI making high volume cross-border payments. SWIFT is a further option.
Cost reduction (the opportunity is around 70% in execution cost reduction):
Simplification of bank account structures:
Improved risk management in:
Choosing the right partner: This type of product requires a high degree of maturity in transactional banking and, in order to generate the most value, a global branch network. For this reason, best practice is to engage your potential bank partners through a structured request for proposal (RFP) process for all payments, which can be serviced through this product. A small number of banks offer this service and your key consideration should be their global footprint; does this match the destination countries you are required to make payments? Depending on your current systems implementation, you may require the provider to convert the format you can output into local scheme compliant formats.
Ensuring reconciliation: This improves for both you as well as your beneficiaries, as the final part of the payments chain may be executed in a number of ways, including third parties and local schemes. You need to ensure that reconciliation information persists through the execution chain with each currency that you will submit to your banking partner. Best practice to avoid this issue is to ensure your bank explains any restrictions through the RFP process and that both you and your bank can migrate your payments traffic in a controlled manner and execute test payments with beneficiaries across each payment currency before moving all traffic to the new way of processing.
Scenario 2: Consolidating Corporate Payments Processing at Group Level (SSC processing on-behalf-of business units/subsidiaries)
While the benefits of using a POBO product in Scenario 1 are greater as your payment volume and complexity increases, this scenario describes how your organisation can consolidate subsidiary and business unit payment flows to make the most of your existing scale.
In a large corporation composed of a number of businesses and subsidiaries, there is an opportunity to consolidate payments processing into an SSC, payments factory or in-house bank (IHB) to enable the reduction and simplification of processing and relationships with the corporation’s financial services providers.
In this scenario, each business unit either making or receiving payments would submit their payment requests to an in-house SSC. The SSC can convert the payment request to an actual payment or execute an internal book transfer; deriving the optimal route, currency, debit account and credit account, enrich and format the payment appropriately and pass it onto a bank or clearing house as appropriate. Apart from payments execution, this scope of operation allows the SSC to make optimal credit sourcing decisions, reduce FX processing costs through bulk deals and provide a single view of corporate cash and liquidity.
Achieving this outcome and a service level equal to or better than that achievable by each business unit takes time, management skill and organisational commitment, and must be embarked upon with at least a medium-term view. While it requires a high degree of technological and operational maturity, the journey to consolidation can be segmented in a manner that yields your organisation the most benefit en route.
Cost reduction; a target of 50% cost saving in payments processing can be achieved through best practice:
Improved risk management by:
Challenges and Best Practice
While the term ‘consolidation’ automatically implies benefit, it is not always the best approach for every business unit in your enterprise. For example, the hours of operation, language requirements and complexity of technical connectivity to payments systems in non-strategic countries – for example a legacy small South American unit of a UK-focused business – may give rise to higher cost, with limited benefit to the group.
The level of regulatory and legal knowledge required to establish a compliant and efficient SSC is significant. It combines legal considerations across multiple legal jurisdictions – including location of the SSC, main corporate HQ, subsidiary HQ etc – and multiple legal domains such as data privacy/protection and payments legislation. Best practice in this aspect would be to ensure an on-going legal/compliance team as part of the SSC, staffed by the existing team as much as possible.
Scenario 3: POBO in Supply Chain Financing
In a number of industries, a large dominant player in the supply chain is able to achieve a higher level of logistics maturity than its smaller, and often higher margin, suppliers. To ensure the physical supply chain is as efficient as its internal logistics, the large player can support financing to the smaller player in a manner that they would otherwise not be able to access alone. This strategy ensures a better supply of product and higher margins than either the retailer or the supplier could achieve alone. Further, for the retailer, it provides a higher degree of ‘lock-in’ for that supplier to that retailer, and higher visibility of the downstream supply chain. While this function would be typically executed by a bank, the same service is often provided by a large ‘in house’ bank/SSC in larger corporations.
For example, a dominant retailer may find strong demand for a new consumer product from a new manufacturer. The new product allows them to make twice the margin gained on a similar product from an established brand. However, the retailer wants the product in order quantities which the supplier cannot fill without a significant level of investment in production facilities or raw materials inventory. The retailer is able to provide early payment to the raw materials producer for the significant order of raw materials (in exchange for a fee) to the manufacturer. This allows the manufacturer to deliver the required level of product to the retailer. In this scenario, the manufacturer acts somewhat like a business unit of the large corporate in Scenario 2.
Challenges and Best Practice
This type of initiative requires both a high degree of maturity in the treasury organisation of the large industry player and a high degree of trust between the retailer and manufacturer (and downstream suppliers). To minimise risk, the manufacturer should adopt a wider set of supply chain best practice from the retailer, as well as the specific financing arrangement.
The retailer rarely wants to be exposed to credit or delivery risk on an on-going basis so this type of arrangement should be entered into on a temporary basis only, with a requirement on the manufacturer’s side to demonstrate how they can establish security of their downstream supply chain.
The journey to drive maximum efficiencies in your organisation’s payments processing will include POBO, either to build scale (as in Scenario 2), reduce processing costs (in Scenario 1) or improve end-to-end supply chain reliability and speed (as in Scenario 3). Depending on your organisation’s structure and treasury maturity level, significant value may lie behind one or all three approaches.
With the march towards the single euro payments area (SEPA) in February 2014, the next phase of the real-time payments evolution in the UK, the payments infrastructure renovation in payments in Singapore, and shortly in Australia, the road ahead for payments is complex. For banks and their customers a robust dialogue around business benefit is necessary. Given this unprecedented change in the payments industry globally and the lead time required to mobilise resources to implement change now is the time for your business to engage in a conversation on how POBO can drive your payments operation towards simplification, cost savings and improved management of risk.