Cash & Liquidity ManagementCash ManagementNetting/PoolingMultilateral Netting: an Essential Cash Management Tool?

Multilateral Netting: an Essential Cash Management Tool?

Since the Sixties the core process of netting has
essentially remained the same. Settling intercompany invoices by netting has
been in the market for decades and remains a very popular cash management tool.
In its most basic form, a summary calculation is performed after all
intercompany invoice data have been entered in a netting programme. This
results in an overall position for each group company, which is then settled
with the netting centre. Having only one payment amount per month reduces
settlement risk and consolidates foreign exchange (FX) exposure with corporate
treasury. From a business perspective, netting creates a disciplined approach
to intercompany invoice settlement and allows group companies to forecast cash
flows with more precision. The classical benefits relate to reducing transfer
fees, loss of value days and FX transaction costs.

Recent years
have seen a shift in focus, from tangible to intangible benefits. In today’s
cost-conscious environment, the major driver is cutting cost within the group
while mobilising cash resources in the most efficient way. There is a clear
focus on improving payment discipline, creating a standardised process for
intercompany settlements and integration with other treasury processes such as
intercompany lending, cash pooling and FX exposure management. Handling
intercompany transactions does not affect treasury only; tax and accounting
also stand to gain. That’s why we are experiencing a dramatic increase of
involvement by all three stakeholders, resulting in a simplified and
profitable working capital process. There are advantages for all departments,
but only if and when they all chip in to get it right.

is the Added Value for Tax?

Many companies still do not
settle intercompany obligations frequently, on a regular basis. Some companies
even settle their positions annually. As a consequence, intercompany balances
accumulate on the balance sheet in the accounts payable and accounts
receivable (AP/AR) system of the group companies. If those intercompany
payables continue to grow over time, exceeding the normal payment terms, they
could be considered intercompany loans from a tax perspective. This might
induce tax authorities to impute an interest rate on that outstanding
intercompany balance, resulting in a negative profit and loss (P&L) and a
cash consequence. Such an intercompany loan from a foreign group company to a
US group company could even be considered a deemed dividend. A tax consequence
can be expected here too, the loan being viewed as repatriation of cash to the
United States. Multilateral netting can help corporate treasurers avoid
troublesome dealings with tax authorities.

Another area of great
scrutiny for tax auditors is in the area of transfer pricing, generally thought
of as a tax concept for the pricing of cross-border intercompany transactions
between group companies.  Netting, although rooted as a means to efficiently
settle intercompany payables, is no longer focused on trade payables
exclusively. It will also accommodate intercompany transfer pricing agreements,
whereby corporate overhead costs are allocated to group companies. These costs
can be related to global functions such as marketing, human resource (HR),
procurement, insurance, IT license fees and legal, to name just a few of the
most typical.

Often many of these global functions have been
outsourced to the most cost-effective locations around the world. This results
in a large number of multilateral intercompany flows that are typically settled
on a regular basis. Global tax and accounting departments need to work together
closely to document each settlement accurately to ensure compliance with both
local and foreign tax rules.  Bank Mendes Gans’ own multilateral netting has
proved to be very successful in tackling this requirement, and is generally
accepted by most countries around the world.

Netting Improve Intercompany Accounting?

In MNCs with no
formal netting process and no fixed intercompany payment terms, intercompany
invoices can easily get lost in the day-to-day flow. If so, treasurers and
others might wish to consider setting up an intercompany billing policy
similar to that of regular third party payables. Once the process is defined,
it needs to be designed and implemented efficiently so that group companies
will be able to create payable files from their own enterprise resource
planning (ERP) system. Even if various decentralised accounting systems are in
use, it is relatively easy to put netting in place. The key to success will be
a phased implementation that includes time for testing files in a dry run or
‘mock’ netting before going live. The next step is to build up experience with
a limited number of group companies, and analyse the automatic intercompany
reconciliation by matching open invoices against the payment file produced by
the netting process. Once all stakeholders are satisfied that the requirements
have been met and all transactions are processed and posted correctly,
additional group companies may join.

Ultimately accounting might
gain the most from having streamlined netting in place. Netting will drive
efficiency throughout the end-to-end intercompany accounting process. It will
also eliminate any discrepancies between the intercompany balances of the
group companies and those of the head office. Netting ensures you are
compliant; shows you are in control and will easily convince your external

Why is Netting Essential for Treasury?

Netting yields efficiencies and discipline around a set process,
schedule and payment term policy. The treasurer benefits from the ensuing
improved cash flow and working capital management. Netting feasibility studies
demonstrate that while payable transaction volumes might be relatively small,
the FX amounts can still be significant. A netting programme might therefore be
justified, even if there are relatively few intercompany transactions. By
managing FX exposures through a netting programme all group companies will
benefit from attractive FX spreads negotiated by corporate treasury.

Best practice studies show that MNCs which manage their FX exposures through
a centralised model tend to realise greater cost savings. The reason is that
all group companies profit from highly competitive bulk rates that no
individual group company could ever hope to bargain for alone. It is essential
to determine carefully which currency to use when invoicing a buying group
company; local currency might be best. This choice must be made in close
cooperation with accounting and tax.

Netting provides the
flexibility to perform multiple netting runs. This enables management to make
real time decisions on the basis of accurate and up-to-date data. The netting
settlement can be accomplished in many ways; through the group company’s local
bank account, via a simple payment transfer or a direct debit procedure or
settled automatically by way of centralised cash pool accounts. These options
give treasurers more control and visibility of cash movements than without a
centralised approach.

Will Outsourcing Achieve the
Sought-after Efficiencies?

Increasing numbers of MNCs
express their interest in adopting a netting process, either through a third
party service provider or managed in-house. Bank Mendes Gans has noted a
growing number of spin-offs, whereby new companies are being established with
integrated tax and treasury functions already working with outsourced AP/AR
partners. Current trends show that global companies’ high level objectives are
to make the most effective use of available resources while minimising the
additional staff required for non-value added processes. Often group companies
that are sold or spun off were participating in a global netting programme of
the former parent. Then management needs to evaluate, through a cost/benefit
analysis, whether a netting programme is warranted under the new structure. If
so, then additional cost/benefit analysis should decide whether the function
should be insourced or outsourced.

Through discussions with many
clients, we have learned that MNCs review existing netting programmes
regularly to ensure that they are still optimising efficiencies. Typical
questions include: can we substitute considerable manual workload by a fully
automated process? Can we replace bilateral settlements by multilateral
settlements? Can we implement a programme that allows for multi-currency
settlement versus single-currency settlement, for instance in US dollars

Finally, MNCs have a choice between in-house netting via a
treasury management /ERP system or an outsourced netting approach. With the
growing number of treasury projects on the roadmap, outsourcing transactional
processing tasks might redefine the roles of all departments involved.
Treasury, tax and accounting will be able to focus on monitoring and analysing
the extensive netting reports while still being in full control of the
end-to-end process. The mandate given to the selected service provider must,
of course, be evaluated periodically from both customer satisfaction and
performance points of view – such as are we sure that the external netting
programme delivers the promised added value and are we saving costs compared
to managing netting in-house?

If you want to keep improving the
intercompany invoicing process, our recommendation would be to meet regularly
with all stakeholders to explore opportunities. Watch for best practice, talk
to colleagues and share knowledge. Treasury is a rapidly evolving area. And
with the increased exposures that come with being a global company, it is
imperative to have a robust system in place that easily accommodates the
business process and yields control in the treasury environment.

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