The Reality of Virtual Liquidity Management

TMI260 DB.qxp_Layout 1 04/06/2018 16:05 Page 40 The Reality of Virtual Liquidity Management By Vanessa Manning, Head of Liquidity and Investment N ever ones to accept the status quo, Vanessa Manning and Paul Cuddihy, Deutsche Bank, talk to Eleanor Hill, Editor, TMI, and explain how virtual accounts can fall short of expectations, and the need for virtual ledger management (VLM) to truly transform the way treasurers manage their liquidity. Solutions, Global Transaction Banking, Deutsche Bank and Paul Cuddihy, Structuring Head for Global Solution Development in Cash Management, Deutsche Bank Eleanor Hill (EH): What major liquidity management challenges are corporates still struggling with, despite advances in technology and initiatives such as the Single Euro Payments Area (SEPA)? And what additional macro trends are shaping the way treasurers approach liquidity management today? Vanessa Manning (VM): Cost and transparency are still significant barriers to efficient liquidity management. In spite of the hype around potential post-sepa consolidation benefits, very few corporates 40 have reaped the promised rewards. We estimate that multinational companies (MNCs) with considerable EU positions have only achieved, at best, circa 30% of the anticipated account rationalisation and simplification efficiencies. As a result, finding the next generation of cost-savings, simplicity and working capital optimisation, is high on the corporate agenda. And given market developments such as instant payments, treasurers are increasingly seeking solutions that will deliver real-time information, real-time liquidity, and real- TMI ISSUE 260

time risk management and decisionmaking. Achieving these goals may well require a fundamental re-engineering of treasury workflows and even architectures, however. So, more and more treasurers are asking the question: what liquidity structures should I be building to ensure my treasury function is fit-for-purpose not only today, but also tomorrow? Paul Cuddihy (PC): Additional drivers behind the current trend for re-thinking liquidity and concentration structures are FX and interest rate volatility not least the desire to manage negative yield, which still has a two-to-three-year outlook across the Eurozone. The rising dollar is yet another factor here, together with money market fund (MMF) reform in the US and Europe. A simplified account structure, combined with real-time information to support better risk management, is the order of the day. Elsewhere, the treasurer s expanding remit and growing commercial focus is feeding into new liquidity management requirements. Take the impact that a company s collections model has on customer experience through e-commerce channels, for example. By making the collections process as seamless as possible, the treasury department can demonstrate how it can directly support revenue growth. VM: Treasurers also want to become better strategic partners to the business, which means they have much higher expectations for automation and standardisation in their liquidity management. In this digital age, no treasurer wants to spend their time simply managing payments and investments or tackling straight-through processing issues. Treasury has moved on; and so too must liquidity management. Often, though, this is easier said than done. Many corporates, especially those that have recently undertaken M&A activity, have huge challenges with respect to their IT infrastructure, and how fragmented it is. With multiple systems operating side by side, corporates are struggling to standardise and automate. Budgetary constraints are only exacerbating the issue. Therefore, treasurers are increasingly turning to their Box 1: Virtual accounts: a refresher The term virtual accounts is often used (sometimes erroneously) to refer to different solutions that fall under the same umbrella. To clarify, what many banks and treasurers call virtual accounts are in fact virtual IBANs. Meanwhile, the term virtual accounts is also sometimes used to refer to administrative subaccounts of one physical bank account, usually known as the Master Account. Under the Master Account, corporates can open, close, and modify as many virtual accounts as required by the business. They can also organise account hierarchies as they see fit. Since the Master Account forms part of the cash management bank s ledger, this kind of solution is increasingly known as Virtual Ledger Management (VLM). One of the main benefits of VLM is that cash can be earmarked as belonging to a particular virtual account. This means that corporates can allocate funds without needing to segregate them physically. VLM can also help with overcoming some of the challenges associated with payments/collections on behalf of (POBO/COBO) structures. banks in search of new solutions to support their transformation and optimisation journeys. PC: Alongside these liquidity management trends sits a growing desire among treasurers and banks to overcome cumbersome corporate-to-bank processes around bank account opening, management and maintenance. Knowyour-customer (KYC) workflows remain a particular headache. Corporates are looking for much swifter processes, in a self-service environment, whereby they can easily open accounts as required and react to the needs of the business such as quick M&A support. This is leading treasurers to look towards virtual account solutions, as well as emerging virtual cash management tools. EH: Could you explain what virtual accounts actually are and what benefits they deliver? How do they differ from the other virtual cash management solutions out there? PC: Used across Asia for some time, virtual accounts in the guise of virtual IBANs (see box 1) are now growing in popularity across Europe and the US as banks roll out a market standard. In a nutshell, these are dummy IBANs issued by the bank which re-route payments to a real IBAN and then into the underlying physical bank account associated with that real IBAN. Virtual IBANs can help corporates to Treasurers are increasingly turning to their banks in search of new solutions to support their transformation and optimisation journeys. TMI ISSUE 260 41

Virtual IBANs can help corporates to increase their reconciliation rates, improve days sales outstanding (DSO) and unlock working capital. increase their reconciliation rates, improve days sales outstanding (DSO) and unlock working capital. Additional benefits include the ability to rationalise bank accounts and sweeping structures, delivering a certain level of automated cash concentration. VM: Virtual accounts are just one piece of the puzzle, however. Because of the drivers and trends that we talked about earlier, corporates are increasingly looking to rethink their treasury and operations processes to cater for instant payments and instant liquidity, as well as accelerating their account rationalisation reviews. At the same time, they are seeking more efficient ways to operate their in-house banks (IHBs) and are therefore starting to explore new hybrid models. Consequently, some corporates are now beginning to look beyond virtual accounts to the possibilities of virtual cash management, with virtual ledger management (VLM) starting to come into its own. EH: What exactly is VLM? How does it work? What are the benefits for treasurers? And what types of corporates might be interested in VLM? VM: For those not familiar with the concept, VLM is essentially an outsourced IHB; provided by your bank. From a technical Fig 1 Efficiencies gained through Virtual Ledger Management perspective, VLM encompasses a real life master account, with the ability to reserve, self-determine and open as many clientdefined virtual accounts underneath. The VLM set-up facilitates on behalf of (OBO) payments and receivables, liquidity and investment management, intercompany loan management, interest and margin posting, as well as forecasting and FX swaps. The benefits also include being able to reduce bank accounts and external bank movements. As such, VLM will quickly become the go-to hybrid IHB model. There are no real limitations on the type of organisation that could benefit from VLM. For those corporates who are finding it too technologically challenging to set up an IHB themselves, VLM is a great option. It overcomes many of the fragmented IT infrastructure issues that we touched on before because it is easier for the bank to integrate with the various ERP systems across the company, through a VLM solution, than it is for the corporate to do so themselves. And for corporates that already have an IHB, VLM is a means to simplify the set-up even further, whilst reducing costs. Even corporates that are running SAP s In-house Cash (IHC) and have an IHB set-up, could still benefit from VLM since it is possible to replicate the corporate s structure in IHC in the account structure with the bank. This means that no manipulation is required between bank exports into SAP IHC; both are fully synched with no intervention or data transformation needed. The result is hands-free integration and automation. PC: Moreover, VLM is an effective way of outsourcing intercompany accounting to the bank, as well as the reporting that goes with a consolidated IHB architecture. The accounting point is particularly important because very few enterprise resource planning (ERP) and treasury management solutions (TMS) solutions are able to perform the accounting associated with OBO structures. Even when a technical solution is available, deployment is often prohibited due to implementation costs and/or the challenge of connecting to multiple ERP systems. However VLMs, provided via bank partners or directly by fintechs, promise a low-cost, flexible solution to these problems. 42 TMI ISSUE 260

EH: Tell us more about how VLM solves these OBO accounting issues. How does this work in practice? PC: In any OBO structure, the IHB must reflect the receipts and payments made on behalf of subsidiaries within intercompany accounts. The VLM solution posts the transactions processed by the IHB to the correct intercompany account and performs the required interest calculations, making the whole process much more seamless. VM: It s not just about VLM here, though. Virtual accounts (virtual IBANs) have a role to play too since they can be used to solve another problem created by OBO structures, namely the challenge of accounting and reconciling a very high volume of payments and collections going through a single real bank account. In effect, each virtual account acts like a sub-account of the real physical account. Each payment and receipt is routed through a pre-defined virtual bank account number. This essentially categorises payments and receipts to help automate the posting and reconciliation of payments and receipts. The VLM solution then uses the virtual account statements to post intercompany transactions, whilst subsidiaries can use the virtual account statements to apply cash to debtor balances in the accounts receivable (AR) ledger. So, by combining virtual accounts and VLM, the power of virtual cash management can be magnified. EH: How does VLM actually integrate with TMS and ERP systems, though? Will it actually bring more systems complexity to the table? PC: As discussed, VLM manages and accounts for intercompany transactions and balances between the IHB and subsidiaries. The IHB and treasury entities manage their liquidity and FX positions in the TMS. The treasury positions are a consolidation of both external and internal exposures and balances and the VLM provides the TMS with internal exposures and balances. On the other hand, the ERP captures the subsidiaries income statement and balance sheet. The ERP will need the VLM to provide intercompany transactions, balances and interest amounts. By bringing an additional system into the IT architecture, the VLM does increase complexity to some extent, but the benefits should outweigh any disadvantages. EH: It almost sounds too good to be true there must surely be other drawbacks of VLM? What questions or concerns should corporates looking to embrace VLM and virtual cash management be raising with their banking partners, for example? VM: Naturally, there are many considerations when looking to embark on a journey towards virtual cash management ranging from fiscal and legal concerns, to FX exposure management, OBO capabilities and ERP/TMS technology implications in a multi-banked environment. Furthermore, IHBs are always bank agnostic, whereas bank solutions are typically proprietary. It s important, therefore, that corporates ensure any VLM solution chosen as part of a virtual cash management offering is able to be bank agnostic and reflect the payments, collections and cash sweeps performed by all the banks used by the IHB. Another point to be aware of is that, typically, VLMs do not have the optimised payment batching and routing capabilities that payment factories provide. As a result, corporates may miss out on the opportunity to reduce bank fees through reduced payment volumes and cost-effective payment routing through local clearing. Vanessa Manning Head of Liquidity and Investment Solutions, Global Transaction Banking, Deutsche Bank Vanessa has headed Global Investment and Liquidity management for Deutsche Bank s GTB business since February 2018 and is responsible for building the next generation of real-time liquidity and investment optimisation solutions both for DB proprietary and marketplace ecosystems. Over the last 20 years, Vanessa has held a number of global and regional product P&L roles, most recently at Standard Chartered Bank, where she led Europe Product Management across all GTB Product Lines of Cash, Trade & Trade Distribution, Channels, Securities Services, as well as Regional Head of Cash for Europe and Americas. Prior to this, Vanessa was Head of EMEA Payments (including global FX) and Cash Management at RBS for all corporate and institutional clients, preceded by a variety of global / regional product and market management / liquidity advisory leadership roles in liquidity & investments, FI strategy and treasury outsourcing at ABN AMRO across Ireland, Hungary, the Netherlands, the US and the UK. In effect, each virtual account acts like a subaccount of the real physical account. TMI ISSUE 260 43

Together, virtual accounts and VLM offer treasurers new possibilities at a time when old solutions simply repackaged or rebranded by banks or others will no longer cut it. Paul Cuddihy Structuring Head for Global Solution Development, Cash Management, Deutsche Bank This should certainly be a topic for discussion with your banking partner when considering VLM. PC: Corporates must also decide where currency balances are held and where they are converted. For example, should a subsidiary receiving a foreign currency payment reflect the amount in the virtual ledger/intercompany account in the currency of receipt or in its functional currency? Which subsidiaries, if any, should maintain multi-currency balances in virtual accounts and at what point should they be converted? These are important questions to ask. Also, corporates will likely rely on their bank to perform intercompany account management, as the providers of their outsourced IHB (the VLM solution). Nevertheless, it is important to remember that the corporate is ultimately responsible for accounting and reporting for transactions. To this end, treasurers must review the calculations performed by banks to ensure the numbers are complete and accurate. EH: There s a lot of hype in the marketplace about virtual being the new notional. What does this actually mean? Will virtual cash management tools replace notional pooling altogether? Or is that taking the Paul is a Director in the Product Management function where he is responsible for the strategic development and structuring of new cash management solutions for corporates globally. He is part of a Cross Products Solution team that develops new solutions and provides advice to clients across a range of topics including Treasury Transformation, Risk Management, In- House Banking and Cash Management. Paul is a qualified account (ICAEW) and corporate treasurer (FCT) and joined Deutsche Bank from KPMG in 2014. At KPMG Paul was head of the UK Treasury team providing advisory, audit and assurance services to corporate clients. He also has seven years corporate treasury experience at Diageo and Cadbury. He has significant experience helping clients develop and implement treasury and cash management solutions to achieve their financial and risk management objectives. point too literally and overlooking the wider argument? PC: In terms of replacing notional pooling, the short answer is no, but the argument is definitely more nuanced than that and virtual cash management is certainly a much bigger concept. That said, it can be useful to understand how virtual and notional solutions may compete or co-exist going forward. So, in theory, virtual accounts should be able to replace the need for multi-entity sweeping and notional pools; however, there will always be exceptions. Virtual account structures typically result in intercompany balances and so, for certain jurisdictions, they may not be viable from a local tax and legal perspective. In these instances, multi-entity notional cash pools may still be required since they avoid the need for intercompany balances. In addition, corporates will still initially consolidate liquidity on a currency-bycurrency basis. This means they will still need to convert multi- currency balances into the target currency prior to investing surplus funds or repaying debt. Some corporates may continue to prefer to use multi-currency, single entity notional pools to perform this task. Furthermore, physical accounts are required by law in certain jurisdictions such as Italy and Spain to make tax payments. Most clients will continue to deploy sweeping structures to fund these accounts therefore. VM: I agree with Paul that the notional pooling point is interesting, but as we have seen already, the wider potential of virtual cash management is far more critical, and exciting, in terms of the future direction of liquidity management. Together, virtual accounts and VLM offer treasurers new possibilities at a time when old solutions simply repackaged or rebranded by banks or others will no longer cut it. For me, the bottom line is that to overcome today s liquidity challenges, whilst preparing for tomorrow s headwinds, treasurers must embrace a fresh approach to liquidity management. Virtual cash management holds great potential in this regard and it is time for banks and treasurers to move the conversation onwards and turn talk into action. 44 TMI ISSUE 260