17 MarIntraday Liquidity. Inter-company transactions.

With new rules coming into effect on Jan 1 2015, this is the seventh in a series of posts on how banks and FI’s might adapt.  

News: the book is now available for Kindle : Cash & Liquidity Management, Mastering the Challenges of New Regulations and a Changing Marketplace. US Store: Click Here. UK Store: Click Here

Inside any large FI, there are a lot of internal transactions. These can be split into two discrete groups:

1. Intracompany: between any two trading books in the same legal entity

2. Intercompany: between any two distinct legal entities

Now, I am not exaggerating when I say that these transactions are evil incarnate. I do not know anybody who could tell you a good intercompany trade story with a happy ending. Maybe there is a Black Swan; please let me know if you see it. The evil here is that when these trades go wrong, there is nobody to blame or to try to blame. You own both sides of it.

Now, intracompany trades are neutral as far as cash and liquidity management goes. They are, however, a source of operational risk. For example, the equities team might need to book an FX trade with the FX desk. If those trades come from two different systems, they will need to be matched.

Intercompany trades are where the greater perils lie; it is likely that there are separate systems, maybe even in separate locations. Pages could be filled on the pitfalls and the controls that ought to be in place. However, there is room for a few key thoughts. If at all possible, all intercompany flows should be bilaterally netted. If that is cross-product, great; if not, then at the product level. If the netting mechanisms are not strong and the firm is self-clearing in CLS, then it should be possible to process all the intercompany FX through the infrastructure that supports the CLS process.

The current general standard of “fund to plan”, as a rule, finds itself coupled with the general ill of having far too many nostros. Too many buckets to tend to, and inaccurate numbers result in a large expense that often goes both unmeasured and unmanaged.

A rule of thumb, which I have seen hold true over the years, is that for every X dollars that can be saved in transaction costs by eliminating nostros and centralising them, there are another 4x dollars to be saved in funding costs from having either positive or negative balances at the nostro. In one project at a major bank that I am familiar with, we estimated that there might be savings of some $25 million across all accounts and currencies by consolidating nostros and having the intercompany payments move via the bank entity in the group. It turned out that this amount could be saved in just a few currencies and a few entities. I had been far too conservative!

Over three years, this major bank then used netting to reduce gross flows, externally and internally, and made use of its own bank to service group companies. They were able to chalk up success on three fronts:

1. Gross payments to third parties were reduced by 25%

2. Gross payments intercompany were reduced by 80%

3. In-house payments went up by 100%

Together, this reduced the payments moving in the real world by $100B per day.

The principal source of the savings was changing the way intercompany payments were dealt with. When the bank was actually able to measure everything, it made the rather startling discovery that 80% of the payment value being moved each day was actually intercompany payments, a whopping $200 billion out of a daily average turnover of some $250 billion.

Having too many nostros to look after also increases the burden for the cash management team and the operational risk that goes with that. The daily management task is both at the currency level and the account level. If you sell securities in Italy to generate Euros and then buy something in Euroclear in Euros, you may well be net flat Euros, but those Euros have to move as well. That has two timing problems: the sell side and the buy side. You might have to pay for the purchase before the sell settles. This is quite typical in a bond auction, which may have an extra wrinkle that requires the cash to be put up first, so there is not a DVP settlement. This will strain credit lines. There may be many variables in the settlement process, so offering a precise recipe to control all the challenges would be doomed to failure. Two control points do stand out; control at the account level is vital for the cash management team and for the securities side of the house, and there should be oversight of any free deliveries and payments, because as soon as the two components are divorced, that will strain liquidity.

Lessons Learned: In any financial institution, there are more inter-company transactions than you would think. Dealing with them is very time consuming. And, they are evil, because there this only downside involved in pressing them.

Inter-company trades need a strategy of their own and as part of that a priority must be to minimise any real world cash flows.

A personal request: Your support would be appreciated on two fronts:

Please subscribe to my newsletter, if you don’t already. The subscription thing is at the right of the Blog page.

Please share this with a friend or two and ask them to subscribe too.

If the comments are wide of the mark and not offering anything of use, please comment or make contact directly via E-Mail.


Leave a Reply

Your email address will not be published.

CAPTCHA, to Submit please solve this: * Time limit is exhausted. Please reload CAPTCHA.