10-02-2013, 10:08 AM
Amplify Efficient Treasury Practices with Netting
Mike Zack, GTreasury - 27 Sep 2013
Netting is a treasury management technique used by corporations to actively manage intercompany cash flows. This process is accomplished by allowing payable values and a receivable values to offset, effectively cancelling each other out. As this article outlines, when executed correctly netting can lead to significant savings related to the transfer of funds and the reduction of foreign exchange (FX) trades.
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
![[Image: netting1.png]](http://lucky.myftp.org:8181/pics/news/netting1.png)
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
![[Image: netting2.png]](http://lucky.myftp.org:8181/pics/news/netting2.png)
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 Netting
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 adopted.
•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
Many 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.
Mike Zack, GTreasury - 27 Sep 2013
Netting is a treasury management technique used by corporations to actively manage intercompany cash flows. This process is accomplished by allowing payable values and a receivable values to offset, effectively cancelling each other out. As this article outlines, when executed correctly netting can lead to significant savings related to the transfer of funds and the reduction of foreign exchange (FX) trades.
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
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
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 Netting
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 adopted.
•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
Many 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.