Banks Face Challenges in Central and Eastern Europe
The economic environment in Europe has changed dramatically over the past few years. Following the collapse of the Soviet Union, many former COMECON states have gone through a long and difficult transformation from a socialist economic system to a market economy. The introduction of the euro and the single euro payments area (SEPA) on 1 January 2008 have only accelerated the efforts these countries are making to move closer to Europe, as shown by Bulgaria and Romania, which have now joined the EU. Business enterprises have also reacted to these changes and spotted the opportunities for exploiting new markets and production possibilities.
These new markets and the introduction of the euro as the common currency of the future European internal market have also brought about fundamental changes as to what companies require of their banking partners. Initially the needs of corporate clients were relatively straightforward and did not have much to do with comprehensive cash management. Many companies were chiefly concerned with ensuring that they had basic banking services in these countries, provided by a reliable banking partner. The emphasis was on linking the accounts opened in different countries with the parent group. Hence the first step focused on implementing traditional electronic banking programs that also gave the parent group access to account information and to the new accounts in, for example, Poland and Hungary. As the range of specific country modules in various ERP systems increased rapidly, many firms quickly incorporated very wide ranging and generally proprietary applications for electronic banking into their systems architecture, with different procedures and high maintenance costs.
Cash management procedures have been influenced by the increased compliance requirements for listed companies, as well as the introduction of the euro. Numerous changes in legislation (Sarbanes-Oxley Act, EU regulations, etc.) have resulted in stricter controls on the documentation of cash management and treasury procedures. Other new buzzwords such as ‘in-house banking’ and ‘the payment factory’ have pushed customer requirements further towards centralised, inter-company liquidity and payments management. This coincided with the recognition that the extensive M&A activity in the past had to result in a consolidation of existing bank accounts if synergies were to be fully captured. Previously, many newly acquired subsidiaries had been granted ‘concessions’ allowing existing bank accounts to be continued in order to keep people happy during the integration.
So how have the banks risen to these new challenges in cash management in central and eastern Europe? Before we tackle this question we shall have to take another quick look at cash management in general and its current state in central and eastern Europe.
Cash management refers to all measures relating to a company’s short-term financial arrangements, and covers all the tasks and measures that ensure the provision of liquidity and enhance efficiency in payment transactions. The emphasis is on optimising cash flows to maximise profitability and minimise potential risks (e.g. in FX transactions).
For companies that operate internationally this can be summed up in three points:
The emphasis is always on gaining the broadest possible overview of all the group’s local and global cash movements and managing deposits and lending in all group accounts.
The situation in central and eastern Europe is determined by a range of different parameters centring on the following issues:
When first opening an account it is important to check carefully if the subsidiary is to have resident or non-resident status, since this could lead to restrictions on effecting subsequent payment transactions, as well as having tax consequences. Direct debits are a prime example of this: in most eastern European countries these can only be made by resident companies.
There is also a very wide range of procedures and varieties of direct debit, such as refundable and non-refundable. Bank transfers are equally varied. In many eastern European countries transfers from non-resident companies to resident beneficiaries must be reported to the local central bank. Cash pooling of accounts is also an area that is very mixed: it is still not possible to set up cross-border pooling arrangements in some European countries (e.g. Romania), because foreign exchange regulations do not permit it.
These examples show that cash management projects in central and eastern Europe are generally complex issues for companies and need professional support from suitable banking partners, from the very beginning. This is crucial to ensure that the key relevant factors in each country are spelled out at the beginning.
For banks that offer their clients cash management products, the focus of every company cash management strategy should be an in-depth analysis of the current situation at the parent company and the subsidiaries that are to be involved. The major questions are:
These considerations are basically nothing new for established banks offering cash management products. What is new is the ability to deal with these issues even better than in the past thanks to an overall concept, and to support companies’ new requirements with this concept by means of appropriate improved valued-added services on the part of the banks.
One example of new services is in the area of country-specific electronic banking programs. As mentioned above, recent years have seen uncontrolled growth of different programs in some companies. Cash management banks are breaking new ground in an effort to control the number of solutions on the market. For example, SWIFTNet for Corporates is a service aimed at multinationals, chiefly targeting companies with the highest requirements for security, availability and independence from proprietary country standards and banking software packages. This service is particularly interesting for energy and telecommunication companies with high volumes of payment transactions across Europe. SWIFTNet gives customers direct access to the SWIFT network, which was previously the sole preserve of the banks. Payment instructions and account and sales information can be transmitted via SWIFT using a uniform standard. High availability, reliability, security and standardisation are the chief reasons customers choose this solution. A further argument in favour is the significant potential for saving money on the proprietary systems and electronic banking programs multinationals previously had to maintain to stay in contact with local banks in a wide range of countries.
Other new services in this area are ‘central’ forwarding and conversion, which banks have been offering more and more for some time now. Here too, the aim of these services is to reduce the number of country-specific banking programs needed and to support customers in producing the required format for each country where payment is to be received. Alternatively, if the customer is already able to produce the required format using an in-house ERP system, services can transmit this to the beneficiary without the customer needing any additional electronic banking software for the destination country.
Let us take the following example: the parent group (in Germany for example) wants to debit the account of its Polish subsidiary and credit the transfer to a supplier in Poland. Previously it was necessary to have a Polish electronic banking system installed and connected to the parent group, but banks’ central transfer and conversion services are opening up new possibilities. Corporates have a choice of ways to carry out a payment instruction:
Option 1: the parent group has the Polish country module of SAP, Baan, or similar, and produces the payment instruction in Polish PLI/PLA format. The instruction is then forwarded for execution in Poland within UniCredit, without an additional Polish electronic banking program being necessary.
Option 2: the customer sends a payment instruction in either SAP-IDOC, MT101 or UN-EDIFACT format. Here too the instruction can be converted, if the customer requests this.
Clearly, customers can use central services to meet their individual requirements, either by using the forwarding function or taking advantage of the conversion functionality. Advantages include no additional implementation of country-specific formats, direct access within a banking group and low-cost processing of all payment transactions domestically and abroad using straight-through processing (STP). Many banks offer a further enhancement to this service by crediting transfers within the same banking group more rapidly.
A further point relating to companies’ changing requirements for bank cash management services is in-depth local knowledge in each country. Implementing a cash management product can no longer be seen as just gradually manually linking up subsidiaries’ pooling accounts in individual countries, one after the other. Companies expect an overall product that deals with all the relevant issues, including legal aspects, tax, and foreign exchange regulations. Banks that provide cash management products must therefore have very detailed knowledge of the local markets in each country and offer additional services that address the overview a parent company requires, such as fiduciary interest calculation and interactive cash pooling tools.
A prime example of in-depth knowledge of local markets is stamp duty, which applies in countries such as Poland (Civil Law Activities Tax), Austria, Portugal and Greece. Stamp duty is a fee on legal transactions; in other words, it is charged not upon creation of a cash pool or on the subsequent interest payments that arise from this, but upon the conclusion of an intra-group agreement on payment transfers between parent company and subsidiary.
As well as detailed explanations on what stamp duty is and when it is due, corporate customers now expect their banking partners to come up with proactive solutions to avoid tax disadvantages. This requires the banks to look very closely at legal and taxation issues, so as to spare corporate customers unpleasant surprises when setting up cash pooling arrangements. The advisory services of banks must however clearly be treated as supplementary and provisional, and in no way replace a conclusive examination of the taxation or legal implications by external taxation advisers and auditors.
Providing customers with information is a key factor in success. Many banks deal with this by issuing their own publications on cash management. These give the customer a broad range of information for each country in central and eastern Europe on topics such as the basics of opening an account, payment transactions, direct debits, clearing systems, electronic banking and pooling.
While we are talking about services, we should also mention fiduciary interest calculation and interactive cash pool tools. These now form part of the standard repertoire of professional cash management. Fiduciary interest calculation is mainly important for the recognition of payments between parent and subsidiary companies under tax law and company law. It is important to observe the arm’s length principle, which states that payments between parent and subsidiary must take place at near-market terms and conditions if they are to be recognised for tax purposes.
The final point to mention in connection with new bank cash management services refers to cash pooling tools. These are generally web-based online packages that aim to give staff working in treasury or accounting the ability to see up-to-date cash management information on their pooling positions.
It is safe to say that corporate cash management requirements have risen steadily in recent years as a result of the changes in Europe. Banks that are following companies into these new markets have to totally overhaul their idea of customer service. In years gone by the focus was on distinct issues and products, such as payment transactions, hedging, or financing, but nowadays companies operating internationally expect their banking partners to offer customised total solutions in cash management.
For banks to form successful partnerships with this target group, it is essential that, as well as having in-depth knowledge of local markets, they are always prepared to proactively identify, develop and offer tailor-made and, if necessary, brand-new services for these customers.
The extent to which banks will follow this advice will be seen in the results of the future competitive struggle when further eastern European countries introduce the euro, as Slovenia did on 1 January 2007, and corporate customers look for qualified partners in the region.