Arturo Pallardó: Cash Management is very present in your day-to-day job. What role does it play in the Corporate Financial Value Chain?
Mustafa Kilic: As a CFO and former Treasurer, one of my main responsibility is to translate the components of the business cash cycle into solutions that result in optimized cash flow, cost savings and investment options. That’s why, in the Corporate Financial Value Chain concept, we usually break down our current financial processes into four main components: purchasing and sales; cash and risk management; financing and investment; and payments and collections. In practice, a number of processes are involved in resolving a specific issue and the most significant improvement opportunities are identified when reviewing the whole chain.
For instance, from a cash and risk management standpoint, it’s quite critical to identify under-the-radar risk factors and keep updated risk-related KRIs and KPIs. Especially after 2008 crisis many multinationals updated their risk policy and its metrics; a tough job that took considerable amount of time to implement but it pays off. Having clear structures, sophisticated techniques, efficient reporting and extensive systems integration are the cornerstones of this kind of process. As financial professionals, our goal is to generate value by optimising net positions, working capital and, consequently, cash flows. Best practice often dictates a distinct – and frequently centralised – process. So again, as Treasurers and cash managers, our aim is to optimise processes dealing with net positions and cash flows.
And what about the other processes you mentioned besides cash & risk management?
Regarding purchasing and sales, much of the associated administration is integrated into the cash management concept. Streamlined administration has a direct effect on both cash flows and working capital. Just by examining how invoices are processed, my previous experiences proved administrative savings of 60% or more in comparison to mainly manual invoicing processes through a direct collection and payment system.
And regarding cash management, a hybrid cash pooling solution would be alternative for many multinational to reduce the number of transactions and currency exchanges involved.
What are the main risks we face in the current macroeconomic environment?
I have a growing concern over emerging economies. Devaluation of many emerging currencies resulted in sharp fluctuations in global markets. Also, the intensifying concerns about the slowdown in the Chinese economy would affect global growth adversely and cause global risk sentiment to deteriorate.
So, from the regional standpoint, I’m more concerned about currency risk, economic growth risk and credit risk, while globally I’m more worried about the failure of national governance (e.g. corruption, illicit trade, organized crime, impunity, political deadlock, etc.), interstate conflict with regional consequences, as well as state collapse or crisis (e.g. civil conflict, military coup, failed states, etc.).
You put a lot of emphasis in geopolitical risk…
Absolutely and mainly because geopolitical risks can have cascading impacts on other risks. As state structures are challenged by conflict, the risk of the failure of national governance and state collapse or crisis can increase in areas where current state boundaries do not necessarily reflect popular self-identification.
Failure of national governance features strongly this year, as one of the most likely risks across the global risks landscape. This risk area captures a number of important elements around the inability to efficiently govern as a result of corruption, illicit trade, organized crime, the presence of impunity and generally weak rule of law.
Are companies taking enough actions to be protected against such political risks?
Firms have increasingly focused their attention on financial, market and operational types of risk, especially since the economic crisis of 2008. However, recent large-scale risk management studies have found that most companies neither measure nor manage political risk. They tend either to accept (or ignore) these risks or to avoid situations that seemingly pose large political risks altogether, even when those risks are accompanied by significant opportunity.
Unfortunately, many companies miss that an effective management of political risk can enable them to enter and navigate new markets and business environments, providing a potential for competitive advantage. Underestimating such risk is a serious mistake, especially since these political risks are taking new and different forms. It is common that the instruments used by many organizations are simply too blunt for the changing, complex political environment in which they operate. Political risk may have different characteristics than other types of risk, but it can – and should – be managed.
And how should companies effectively manage such risks?
They can integrate political risks into existing enterprise risk management (ERM) systems, yielding potential benefits such as lower risk management costs (through more rational hedging and insurance purchasing); new revenue streams from markets that would be too risky to enter without risk management support; better performance of existing businesses in emerging markets; and loss mitigation through improved business continuity planning and crisis management.
And what happens once risks have been identified and measured?
Then, they should put in place an effective system for active political risk management. The first element would be mapping potential risk management methods against the priority risks.
Once the organization establishes a course of action, the risk management team can assign responsibilities and establish a schedule for consultation, reporting and review, as with other risk controls. Companies actually have multiple options for addressing identified risks. A company operating in a country where there are signs of corruption in trade practices, for example, may seek to review its overall code of conduct and step up local training activities to ensure that all rules are thoroughly understood.
And what would you say are the main benefits from this?
Effective management of political risk can enable companies to tap new revenue streams through access to markets and joint ventures that, without careful management, might seem too risky.
Besides, clear identification, measurement and management of risk can facilitate organizational buy-in for growth strategies that target emerging markets and “frontier” markets, while improving the performance of existing businesses.
You used hybrid hedging and cash pooling approaches that gave big advantages against the backdrop of the economy and fluctuation in currency flow. Why did you approach this hybrid technique?
One of my main priorities has been unlocking liquidity, which can become a pretty challenging task in some markets. In complex environments, cross-border movements and ability to hold offshore and FCY accounts are highly regulated, and local regulations often restrict inter-company movements or require central bank approval and reporting. That’s why treasurers are continuously seeking a better platform where to strategically manage the entire cash management process to increase the intrinsic value of the business, and it is not feasible to have one approach for all countries when it comes to cash and treasury management due to different jurisdictions.
The common approach taken by many multinational companies has been the so-called cash pooling solutions (liquidity management techniques whereby funds are physically concentrated or notionally consolidated into a single cash position), especially ‘notional pooling’ and ‘cash concentration.’ However, some entities may not be permitted to participate in cash concentration or a notional cash pooling agreement. And also, cash concentration and notional cash pooling often give rise to complex legal, regulatory, accounting and tax considerations.
That’s why I opted for a hybrid cash pooling technique.
What does the solution consist of?
“Hybrid cash pooling” is a system that uses two or more distinct cash balancing engines to maintain credit and debit positions of various accounts on the books of the service provider bank.
In short, the solution offers that cash in excess of working capital at the local level no longer remains “trapped” or subject to local investment vehicles. Furthermore, we can access short-term funding in the currency of our choice without the traditional reliance on inter-company loan structures.
Of course this strategy has to meet a few criteria to work. It needs freely convertible currencies; legal entities that must be allowed to open a local and foreign currency bank account outside its country; and a financial institution to provide the service.
So, what are their main benefits?
There are multiple ones: It creates efficient ways to consolidate liquidity with better geographic coverage. It eliminates local borrowing needs while reducing corporate guarantees for local credit lines, bringing economies of scale in financing conditions with incremental income statement improvements. Additionally, it enhances control of cash balance and increases its visibility.
Moreover, Treasury can overdraw in the currency of their choice and maintain local bank accounts to serve local needs; eliminate intercompany loans while creating new funding vehicle; reduce or eliminate both FX and swap transactions to offset the debit positions of the accounts and the number of operational transactions and its cost; and eliminate the need for either physical movements of funds across entities or accounts at the header account level and as well as the change in the ownership of cash. And all this with no additional hardware/software on the user side.
Are there are any drawbacks?
The main one would be that hybrid cash pooling is prohibited or may be subject to restrictions in some countries. Also, some entities may not be allowed to participate in hybrid cash pooling agreements. It may also require the occasional physical movement of funds across accounts as well as the parent company guarantee.