Cash & Liquidity ManagementCash ManagementNetting/PoolingAmplify Efficient Treasury Practices with Netting

Amplify Efficient Treasury Practices with Netting

A netting centre incorporated across your organisation can
allow for the best method of creating a single cash flow, to or from each
participant, which increases intercompany efficiencies. There are four types of
netting processes analysed in this article: bi-lateral netting; multi-lateral
netting; re-invoicing; and netting in conjunction with an in-house bank (IHB).

Figure 1: Before

GTreasury Netting Figure 1

Most organisations will begin by settling their
obligations with each entity through multiple cash flow transfers. Not only is
this workflow inefficient and costly, the company loses visibility on currency
shortfalls, which leads to increased FX trades. By introducing a netting system,
currency exposures are adequately monitored and consolidated. This allows for
internal borrowing to be the first method of settlement (economically cheaper
than external borrowing).

Figure 2: After

GTreasury Netting Figure 2

Using a netting
system, each participant pays or receives a single currency balance to or from
the netting centre. This centralises the control and monitoring of all cash
flows, which is essential to the treasury department.

Types of

Depending on the complexity of your organisation, one of four
netting methods may be deployed (bi-lateral netting; multi-lateral netting;
re-invoicing; and netting with an IHB).

  • Bi-lateral netting is the
    settlement of cash flows domiciled in the same currency. For example, entity A
    bills $20 to entity B, and entity B bills entity A $15. Since both participants
    operate in the same currency, the settlement will be exchanged in US dollars
    (USD).  The netting centre will aggregate this information and distribute $5 to
    entity B in a single transaction. This saves the organisation from fees
    associated with additional transfers that would be required if netting was not
  • Multi-lateral netting is the technique used to manage
    intercompany transactions, usually involving multiple counterparties resulting
    in a single receipt or payment. For example, entity A receives invoices from
    both entities B and C.  Instead of having entity A engaging in the settlement
    between each counterparty, they will in the end pay a summed amount to the
    netting centre. Then the netting centre will accumulate all payable settlements
    across the company and streamline the distribution to each receivable entity in
    their appropriate country (as outlined above in Figure 2). This leads to
    substantial savings related to the condensed volume of transfers and the
    reduction in cross-border charges.
  • Re-invoice netting is an
    arrangement where all intercompany transactions, billed in multiple currencies,
    are centralised.  Foreign currency payables and receivables are netted with a
    single settlement to the re-invoicing centre, essentially moving the invoice
    exposure to a single collection point (netting centre). For example, entity A’s
    functional currency is in USD but is billed by other entities in euros (EUR),
    sterling (GBP), and yen (JPY).  Instead of having entity A engaged in FX trades
    to settle with each entity in their appropriate functional currency, entity A
    pays the equivalent amount of their local currency (USD) to the netting centre.
    This will eliminate their FX exposure to only one currency, their functional
    currency. Then, the netting centre will gather all currencies across the company
    and make a single decision on what currencies they are long or short. Once an FX
    trade decision is executed, the distribution of cash flows is issued to the cash
    positive entities. This leads to substantial savings related to the condensed
    volume of transfers, the reduction in FX trades executed, and FX risk associated
    with the netting centre, and is not a liability of the individual entities.
  • Netting with an IHB is a process that includes similarities
    of bi-lateral and multi-lateral netting, but instead of tangibly settling with
    each entity in the appropriate currency, the amount is rolled into the IHB where
    they may receive or pay interest on their funds. It is essential to note that
    the netting centre and IHB work cohesively together, but are still determined as
    separate tasks in relationship to each other. The netting centre needs to
    aggregate all transactions first and then decide what method of settlement will
    take place; creation of an intercompany loan, cash, etc. There are many inherent
    benefits that go along with this method. It allows for the functional currency
    to stay in the appropriate country, bypassing any fees or legal requirements
    associated with moving funds out of that region. This will also decrease the
    fees associated with the transfer of funds to each entity. Essentially a virtual
    payment is created, increasing or decreasing the in-house balance where interest
    is calculated based on their credit risk (also dependent on defined cycle,
    monthly, quarterly, etc.).

Forward Looking

operations are in dire need of a netting system to manage the input of
intercompany transactions, interim netting rates, trades, and trade rates. The
benefits that are delivered to a corporation with a netting solution are:

  • A central repository of intercompany transactions.
  • Less
    systematic/settlement risk exposure.
  • Less currency accounts required.
  • Ensures security of the company’s cross-border payments by controlling the
    distribution on behalf of the subsidiaries.
  • Enables headquarters to
    efficiently manage currency exposures and netting cycles.

Netting is
fundamentally a very simple process once the required structure and protocols
are established. 

When looking for a sophisticated solution, make
sure robust reporting is available. Also ensure your company can establish
different payment methods – such as single euro payments area (SEPA), Federal
Reserve Wire Network (Fedwire) and automated clearing house (ACH) – that
security persists throughout the application with sophisticated controls around
what entities versus the clearing house can see, and intercompany activity can
be imported manually or through file upload.

Regardless if your
objective is to forecast hedged cash flows in conjunction with intercompany
invoices, create a lending programme, or simply use the solution as a third
party disbursement structure, a netting centre has numerous intrinsic advantages
that will substantially increase your company’s profitability while centralising
treasury operations.

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