Published: June 01, 2010
As multinationals accelerate their strategies to further globalisation and expansion into the emerging markets, they continue to invest in major capital expenditure projects that are key to establishing and building out local manufacturing and production facilities. These critical investment projects are designed to enhance competitiveness by improving productivity, optimising cash generation, and driving increased cost-effectiveness. In the highly competitive global business environment every company needs to prioritise its investments, mitigate project risk and ensure that financing is aligned with forecasted returns. As such, Citi’s Global Transaction Services business is a key partner to its clients throughout the project lifecycle - from development, construction to operational phases - providing customised solutions to assist its partners in ensuring a successful outcome of their investment. This article looks at some of the techniques in which treasurers and their teams, corporate and/or project finance managers can leverage innovative transaction banking services to support capital projects whilst remaining aligned with the company’s balance sheet and working capital objectives.
The role of treasury has changed considerably since the global financial crisis. As the events of late 2008 and early 2009 unfolded, treasury’s role became pivotal in ensuring sufficient working capital during a period of cash flow and income volatility. CEOs and CFOs became much more cognisant about recognising treasury’s value in managing market, counterparty, sovereign and concentration risk.
Capital projects typically do not have a single owner within a company, with project finance, internal venture capital, the commercial business, corporate finance, treasury and strategy groups all represented. Although the treasury implications of capital projects have always been considerable, financing costs and liquidity implications have become more relevant in the overall budget and cost benefit analysis given the shifts in bank funding and capital markets. Treasurers are therefore now playing a more leading role on project committees to align project risk mitigation, financing and operating cash requirements with the wider strategic agenda.[[[PAGE]]]
As figure 1 illustrates, every project goes through a series of phases from inception through to production. Although the order, materiality and specific activities involved in each phase will differ across projects, each phase brings a changing spectrum of risks, financing and cash flow requirements. Each element of financing, liquidity and risk management is frequently addressed on a transaction by transaction basis. However, as financing costs have increased, risks have become more apparent and market access has become less assured, this approach could bring considerable risks. In contrast, by working with a bank with the right geographic footprint, breadth of transaction banking solutions, and ability to design holistic solutions across the project lifecycle on a consultative basis, treasurers are in a position to anticipate, design and deliver the right financial solutions to manage risk and secure appropriate financing within budgets and time scales.
During the initial planning stages of the project, issues such as project feasibility, budget and cost benefit analysis are typically considered, alongside operational decisions such as location, government/ regulator permissions and licensing. For many companies, project finance costs are a material element in the budget. In addition, ensuring cost predictability is an important consideration as part of the cost benefit analysis process. Furthermore, project committees need to mitigate their supplier and contractor risks up-front, which includes ensuring their ongoing viability, without compromising the company’s working capital position, as well as putting in place performance guarantees to ensure delivery.
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There is a variety of transaction banking solutions available to support the project development phase. Supplier financing programmes can provide valuable financial support to suppliers and contractors whilst enhancing the company’s own working capital position. Trade instruments such as export letters of credit reduce counterparty credit risk and ensure a documented process for the delivery of goods and services. A vitally important consideration at this stage of a project is to secure supplier and contractor performance commitments in order to support project time scales and budget. Consequently, Citi provides comprehensive solutions for issuing bid and performance bonds/guarantees, including process automation through CitiDirect, and employs specialist teams to ensure that instruments are tailored to meet the individual needs of each project.
The project development phase also introduces financing needs which can be supported through internal cash, bank funding or as we have seen in the last few years, via export credit agency financed programmes. As the credit markets have shrunk, export credit finance has become an increasingly important way to guarantee bank finance, supplier finance, and/or provide direct loans in a cost-effective way, transforming usually non-investment grade borrowers to AAA / AA assets. These financing arrangements, whether tied (i.e., directly linked to the procurement of goods) or untied (i.e., linked to development or promoting foreign direct investment), provide a diversified source of funding without affecting bank loans. As complex structures, with diverse onshore and offshore elements and sophisticated security, registration and disbursement requirements, export agency financing requires an experienced banking partner with considerable breadth and depth of services.
Project finance raised at the start of the project, which may not be required immediately, can be invested in term deposits with maturities aligned with project deliverables when payments are due, or in money market funds.
Many of the corporate financing needs during the construction phase of a capital project are an extension of those required during the development phase, such as the need for performance bonds, escrow services and other risk management solutions. The construction phase is an intense period for project-related cash flow, such as payroll and supplier payments, which may require offshore project accounts and comprehensive payment services that take into account country-specific regulations and cross-border complexities.
“In addition to providing considerable local and cross-border payment expertise," notes Michael Guralnick, "Citi provides WorldLink Payment Services to clients. This is a convenient, multicurrency payment solution that eliminates the need for foreign currency accounts, with the associated costs, potential for ‘trapped’ cash and time-consuming reconciliation. The service is available in over 100 countries and 135 currencies, covering a wide variety of payment types, both electronic and paperbased, enabling companies to respect the payment conventions in their countries of operation without creating process complexity or inefficiency.”
Once the project has reached live operation, companies need to meet the ongoing working capital needs and manage the expectations of stakeholders. While the requirements are diverse, they are inter-related, emphasising the importance of an integrated cash and liquidity management approach. For example, in addition to providing payment and collection services, companies need local and head office visibility over cash, using a tool such as Citi’s TreasuryVision, the ability to invest, enabled by CitiDirect, and the flexibility to centralise or repatriate cash, using cash pooling and other liquidity management solutions.[[[PAGE]]]
Maintaining the resilience of the supply chain remains an ongoing requirement, so establishing solutions such as supplier financing become more important, as illustrated by Philips in Case Study 3. Trade services solutions such as letters of credit, both for imports and exports, may also be significant in managing counterparty risk.
The financing, liquidity and supply chain requirements of major capital projects across the globe are all critical components in ensuring project success throughout the various development, construction and operational stages. Every project has diverse requirements depending on its nature, location, financing and cash flow dynamics. By working with a global partner with on-the-ground expertise and ability to design customised and integrated solutions, companies can meet their financing, risk mitigation and ongoing working capital objectives taking into account the needs of the range of stakeholders. As Swati Mitra concludes,
“Citi has invested significantly in our solutions and expertise to support the capital projects that enable our clients to become more efficient, innovative and competitive. By providing integrated solutions that address financing, counterparty, supply chain, liquidity, payments and location-related risks, we ensure timely and successful project execution and ongoing cash flow management. Citi sees itself as a strategic partner to clients in the world of projects.”
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