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Why Netting has Failed to Catch on - stephenkhoo - 10-02-2013 09:56 AM
Why Netting has Failed to Catch on
Michiel Ranke, RBS Global Transaction Services - 1 Oct 2013
There has been much talk about the numerous advantages of netting as a liquidity management tool. However, as this article notes, to date the words have failed to translate into anything more than sluggish market growth.
Since the concept was first developed more than 30 years ago, netting products have evolved from rudimentary calculation models based on paper to cutting-edge web-based computer programmes.
Their value is well attested. Netting products give treasurers more control and oversight by centralising foreign exchange (FX) exposure, funding and liquidity requirements. For example, companies dealing daily with thousands of invoices in different currencies can see their total FX positions and mitigate their risks through netting tools.
They can help corporates optimise their cashflows, ensuring working capital is available when required, or freeing up idle cash to maximise the interest rates that can be achieved.
The fundamental principle of netting is simple to understand. It is based on the fact that prevention is better than cure.
Reducing the number of physical transfers across a universe of corporate financial systems should be considered a first step to simplifying complexity. A cash pooling structure can then be set up to achieve more efficiency in the remaining flows and balances.
The advantages of netting apply regardless of what is happening in the broader economy. It can help treasurers handle political and economic instability when it flares up around the world, and slice through layers of organisational complexity.
Moreover, its effectiveness increases exponentially the more widely it is used across large, multinational corporates (MNCs). The more subsidiaries that are involved, the more money that can be saved. Modern netting systems can even include third parties, such as suppliers.
Reasons for Slow Growth
Yet for all the clear benefits, netting has never achieved strong, double-digit annual growth since those first paper-based systems appeared in the early 1980s.
There are several reasons why, including the following:
•How subsidiaries work within an organisation: Although money can be saved by including them and their suppliers within the netting system, many subsidiaries operate independently and are reluctant to participate in a centralised netting structure. Often selling the idea falls on the corporate treasurer. The problem is, this does not form part of their core responsibilities.
•Central bank restrictions: Full netting may not be allowed in all countries where subsidiaries are located. Some central banks refuse to allow any form of offsetting, while others only allow netting to take place in a limited form. In other cases strict reporting is required.
• Technical restrictions: The third main barrier to netting; frequently not all subsidiaries are set up on the same Enterprise Resource Planning (ERP) system, in other cases do not use such a system at all.
By far the worst reaction for companies looking to adopt a netting structure is to leave subsidiaries out of the structure. It means the remaining structure suddenly looks much less attractive.
Overcoming these challenges requires sensitive negotiations and a detailed approach. The trick is to select a netting provider that offers different netting levels, full reporting capabilities and the expertise to help setting up the best system for each country and subsidiary.
These can be adapted to suit the most stringent of central bank requirements, and can range from full netting, where all transactions are converted to subsidiaries’ home currencies, to gross netting where transactions are not converted and not netted. This simply subtotals payments and receipts separately for each currency.
Elements for Success
A successful netting structure needs much more than a calculation tool. Crucial components include active reconciliation and follow up, agreed inter-company procedures, a netting calendar and execution of settlements. Many companies find it amazing how much time and resource are spent on these operational activities. They prevent corporate treasury departments from focusing on the areas where they can add most value.
Efforts to introduce netting have been boosted by the rise of standardised technologies, which help to achieve a more controlled environment. Many netting technologies now have to be certified to meet international standards. They can also be dovetailed in with other liquidity management techniques.
By being relentless in trying to include all subsidiaries and third parties in a way that fits best with their individual circumstances, companies will improve the efficiency of netting dramatically. Outsourcing operational activities alongside a flexible netting and reporting tool can significantly reduce risks, save costs and boost trade. It is clear that a spreadsheet or an ERP tool is no longer enough.
It takes a banking partner who has the expertise to understand a company’s working capital cycle to provide a successful solution. Once companies get to grips with the issues, then netting will be well placed to grow more strongly.