Published: November 01, 2009
In January 2008, PPG made their largest-ever acquisition by purchasing the Dutch-based SigmaKalon from financial sponsor Bain Capital. This acquisition differed from previous M&A activity as the two organisations were of comparable size in Europe, but with very different business models (figure 1). However, in order to leverage the full potential of the new organisation, and optimise cash concentration for the repayment of corporate debt, Treasury needed to combine the cash management activities of PPG and SigmaKalon in an efficient manner.This article outlines some of the challenges and considerations in achieving this.
In addition to the company’s organisational complexity and geographical diversity, most of the 13 business units are organised around a Principal Structure. Essentially, a Principal Structure is a corporate business model where raw materials are purchased by a principal entity, delivered to local warehouses owned by the principal, then processed by consignment manufacturers (factories) on a toll fee basis. Finished goods are then sold by local sales companies at cost plus a fee. To facilitate this business model, the company’s principal is located in Switzerland. However, PPG Finance BV, its in-house bank, is located in the Netherlands, a country with the most extensive network of tax exemption treaties, but also where notional pooling is well established and where the provision of security confined to a right of set-off instead of general cross-guarantees is also accepted.[[[PAGE]]]
From a treasury perspective, to enable cash management operations to be centralised efficiently and to maximise the amount of cash available to the group, PPG needed to streamline and harmonise the former PPG and SigmaKalon cash management structures. PPG Treasury now has responsibility for all treasury and cash management activities of the combined group in 36 countries across 145 locations, incorporating 75 legal entities, 27 currencies and more than 700 bank accounts.
The PPG legacy cash management model was initially designed to be monitored from the US in a cash-rich B2B environment. Local accounts were maintained in key countries for collections and non trade disbursements, and the European SSC based in the Czech Republic managed most European trade payments, primarily through disbursement accounts (figure 2). These accounts were funded either from local liquidity or cash held on deposit with a treasury centre located in Dublin. In addition to the payments and collections accounts was an overlay pooling structure in euros only, established with an overlay bank. Liquidity was zero balanced manually to local concentration accounts held with the overlay bank on a daily basis, and then swept automatically to a euro master account in Ireland. Any FX positions arising from non-euro denominated inter company current accounts were typically hedged using numerous FX swaps.
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In contrast, the SigmaKalon cash management organisation had been established on the basis of its pan-European B2C business model and a highly leveraged structure. The company operated a notional cash pool with ABN Amro in the Netherlands, now The Royal Bank of Scotland (RBS). With a few exceptions, SigmaKalon entities maintained local accounts, either with a branch of ABN Amro or a local bank, with pooling accounts in the Netherlands. The local in-country accounts were zero balanced on a daily basis to the respective pooling accounts in the necessary currencies. Payables and receivables were processed locally through the in-country accounts and liquidity was concentrated in the cross-currency cash pool (figure 3).
PPG Treasury faced the challenge of combining these two cash management structures, with the following objectives:
i) optimise the funding of working capital with a ‘zero float’ structure
ii) Provide parent company with visibility on cash generation on a daily basis
iii) Reduce costs by minimising bank costs, standardising and automating processes
To achieve these objectives, PPG paid particular attention to fixed costs (such as account maintenance and zero-balancing costs), ensured that the structure would refund the full cash pool benefit, streamlined the payment processes with as few exceptions as possible (e.g., for tax reasons, as in Italy and Turkey) by notably overhauling the existing payment factory and the inter company netting process. PPG also leveraged the RBS banking network inherited from ABN Amro in order to enhance cash visibility on more than 500 bank accounts, with the exception of a few local entities (e.g., equity ownerships) in which Treasury has no control over liquidity.
The new structure combined elements of the former PPG structure, such as a centralised SSC maintaining a payment factory, and of SigmaKalon, an in-house bank at the heart of a cross-currency notional cash pool. The group’s headquarters in Pittsburgh was supportive of the project as Treasury was able to outline and to quantify how these objectives would be achieved.[[[PAGE]]]
Balances are concentrated across the region using an automated sweeping mechanism. On each value date, balances are notionally converted to the base currency in order to determine the compensated balances. RBS then calculates the interest amount based on the compensated balances. The pool benefit can be paid either to a Benefit Settlement Account owned by the in-house bank or split across participating accounts.
Effectively, the cross-currency notional cash pool enables PPG to manage its liquidity as if it had a single account in one currency. Bearing in mind that PPG actually have 176 accounts in 17 currencies in this structure, this has been a major achievement, and PPG now have far greater control over the funding of working capital. The tax characteristics of notional pooling in many jurisdictions are relatively well-known, but PPG also implemented the structure in ‘not so easy’ countries such as Czech Republic, Hungary, Romania and Poland.
In-house bankingThe cross-currency notional pool has proved to be a perfect fit with the FX management activities of the in-house bank. Key affiliates pass on their balance sheet FX exposures through approximately 25 internal hedges, which are effectively a kind of non-maturing synthetic forwards. PPG Finance BV, the PPG in-house bank then consolidates per each currency all these FX positions with outstanding current account balances and, instead of cancelling out these positions with FX swaps. PPG Finance BV then sells the currency spot and buys euros when it has a long position. The benefit of this approach is that the FX position is immediately squared within the pool, without the need for FX lines with the bank, FX margins or documentation.
The cross currency notional pool has proved to be a perfect fit with the FX management activities of the in-house bank.
PPG Finance BV can also use its bundle of accounts in 13 different currencies to make payments on behalf of an affiliate in a non routine currency. Dividends, interest and principal debt repayments are also paid from/to the pooling accounts, avoiding float and minimising lifting fees at each transaction. However, the main benefit of a cross-currency notional pool lies with multi-currency netting.
On the settlement date of each netting cycle, the net result for each affiliate is first settled through the current account in its functional currency. As local collections are zero-balanced to affiliates’ pool accounts, netting participants reduce their current account balances with PPG Finance BV from time to time by cash transfers inside the pool. Physical movements to settle intercompany transactions are therefore kept to a minimum.
There were two main reasons why PPG opted to work with ABN Amro (now RBS) to provide this structure. Although many banks offer cross-currency notional pooling, the combined RBS and ABN Amro had the widest network across both Western and Eastern Europe to sustain an extensive ‘zero float’ structure with minimal cost. RBS also took advantage of the existing multi currency pooling arrangement between ABN Amro and former Dutch based SigmaKalon.
A number of important factors were considered when setting up a cross-currency notional cash pool and rationalising two disparate cash management organisations:
Tax department involvement
The tax department needed to sign off on the proposed structure, to ensure that any transfer pricing and/or withholding tax issues were tackled. In principle, the arm’s length nature of the arrangement makes it robust, but it is recommended to avoid large and recurring borrowing (resp. lending) intercompany positions in parallel with positive (resp. negative) pooling balances. In countries such as Greece, Turkey and Italy it is advisable to have positive pooling balances only.
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Analysis of IT requirements
Implementing a new cash management structure has significant IT implications which need to be managed closely. The implementation team conducted a detailed analysis of business requirements, documenting new systems and processes and then testing the proposed solution, at the earliest stage. One of the issues was the IT development work required to migrate our payment factory to the RBS payment platform. It is fairly common for MT 940 messages delivered by banks to have variations which may complicate the setup of any bank reconciliation tool.
Local aspects
Although SigmaKalon had already made their legal due diligence a couple of years ago, there were as many legal requirements as there were countries within the scope of the project. The approval of a cash pooling arrangement always requires board approval and the provision of an intraday line for the daily sweep also sometimes requires a general meeting of shareholders. Regardless of the network of the bank, it should not be assumed that all the local branches of the preferred cash management have full capacity to effectively execute any country specific payments (VAT, pension and payroll etc.) in any country or local format.
Process change
Implementing new processes results in raised expectations but also concerns across the business. However, the project team needs to be self-sufficient in implementing them. It is certainly sensible to assume limited availability and resources from local organisations, notably when cost reduction is being applied to support functions. Like most centrally driven initiatives, Treasury had to overcome some concerns about the cost and quality of local cash management services provided by the bank, but the local teams greatly supported streamlined cash management processes and an anticipated lighter workload.
Accounting
Under the IFRS rule IAS 32, the set-off of notionally pooled credit and debit balances is only permitted if the account holder can demonstrate its intent to physically set-off such balances during any reporting period. Before its acquisition by PPG, SigmaKalon thus used to clean up its pooled balances and close out FX positions with one day FX swaps at quarter end. In contrast, under US GAAP (Interpretation 39), the set-off of financial assets and liability is elective, subject to master netting agreements, even in the absence of the intent of set-off. As a SEC registrant, PPG is therefore not obliged to make this tedious clean-up and merely has to report an aggregate negative pooling balance as a bank overdraft.
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