Multilateral Netting Reloaded

Multilateral netting is one of the most underestimated ways to optimise intercompany payments and group performance. In this Executive Interview, Eleanor Hill, Editor, asks Martin Bellin, Founder and CEO of the BELLIN Group, to explain why multilateral netting deserves a little more attention, and how treasurers can make the most of it.

Eleanor Hill (EH): First things first: what exactly is multilateral netting and why should treasurers be interested?

Martin Bellin (MB): In simple terms, multilateral netting is the evolution of bilateral netting – and involves group treasury running a netting centre to handle all intercompany payments. This acts as a reconciliation hub across the entire group: information about payables and receivables is delivered by the respective group companies to the netting centre and settled for the eligible subsidiaries by the netting centre. This avoids direct payments between the different subsidiaries, increases transparency and visibility and vastly reduces the number of intercompany payments within the group.

EH: So, is multilateral netting an accounting topic or a treasury topic?

MB: That’s a good question, because any process that begins with the reconciliation of every single invoice issued within the corporate group is an accounting procedure. But as a result of that reconciliation, it is possible to run a multilateral netting process straight away, which is a treasury responsibility, because treasury has to cover the interest on any positions caused by unreconciled and unpaid invoices as well as the associated FX risk. 

As such, multilateral netting is a cross-functional effort – and seeing it this way is one of the key ingredients for success. So, if the treasury function wants to implement a multilateral netting process, they should get accounting on board. Buy-in from both sides is essential and both accounting and treasury stand to benefit.

Interestingly, the fact that multilateral netting is a cross-functional challenge is also a factor in why netting is not always considered important. Treasury tends not to see the value in optimised reconciliation; and accounting often won't mind the unfair interest allocation and the associated FX risk because there is nothing for them to book. 

Furthermore, because multilateral netting primarily serves to reduce the number of bilateral payments between subsidiaries, groups that have an insignificant volume of such intercompany payments often don’t see the value of multilateral netting. But intercompany netting is merely one step in a longer process chain – and, when implemented successfully, it can lead to optimisation opportunities across the entire chain.

EH: With that in mind, what are the potential benefits of performing multilateral netting? What efficiencies might treasurers see?

MB: If implemented successfully, there are benefits on many different levels. But to give you an idea, I always say that a company which is not performing multilateral netting must be able to afford it!

On the foreign exchange (FX) side, one benefit sits with subsidiaries’ sales organisations. Often, they are supposed to buy their products at the group level and then sell them in the local markets. As a result of this activity, they are frequently exposed to FX risk because they are invoiced in foreign currency. And understandably, these subsidiaries are typically unequipped with the resources or knowledge to mitigate that risk effectively. 

This leads to a tremendous uncontrolled risk within the group, which is the last thing a CFO wants. To address this, there are two choices a company can make: either change the invoicing currency, or implement netting. Implementing netting is arguably much easier as it does not require any change in invoicing procedures. In addition, multilateral netting allows for the FX risk to be transferred from the subsidiaries to the group company, which is in a far better position to manage this risk. In fact, in many corporates, it is the netting centre itself that manages the entire FX risk of the group.

Another benefit of multilateral netting can be found in intercompany invoicing and the level of visibility over cash flows. Subsidiaries tend to make bulk payments at regular intervals to settle intercompany invoices – and for each payment day in every company, the treasurer has to check if there are any intercompany financing issues, because many companies are funded by the central treasury. 

But when these bulk payments are concentrated into one or two days a month, it is not easy to predict when cash is available, or when cash is needed, at a subsidiary level. With multilateral netting in place, the treasurer can check the status of each subsidiary every single day – and the financing of the subsidiaries becomes much more efficient for both sides. 

In short, multilateral netting can significantly reduce treasury’s workload around intercompany financing, improve cash visibility, and lead to more effective management of FX risk. And there are also benefits for accounting, such as automated posting for intercompany invoices. 

EH: What about the interest side of things when an entity does not pay its intercompany invoices on the due date? How can multilateral netting help here?

MB: This is a key issue for treasurers. If subsidiaries get into the habit of paying intercompany invoices late – because they are not being charged interest for doing so, this can turn into a significant problem further down the line. For example, subsidiaries may consider the ‘free credit’ to be a saving which they can transfer through to their pricing for their customers. And eventually, the group could suffer from reduced profit as a result of unexpected funding costs due to unpaid invoices. 

By implementing multilateral netting, these issues are eradicated. Treasury can see exactly how much a subsidiary is supposed to pay on the due date, and if they don't - they get a loan from the central treasury, on which they pay interest. This ensures that the allocation of interest costs is fair across the group.

EH: Should multilateral netting be a receivables-driven process, or a payables-driven process? Or is there a better way entirely?

MB: In the past, netting has tended to be driven by either payables or receivables. While this might seem logical, there are challenges and loopholes that can lead to the solution becoming less effective. In the case of payments-driven netting, for example, subsidiaries can compromise the system by accidentally, or intentionally, failing to enter invoices. Meanwhile, in a receivables-based netting process, group companies could potentially enter fictitious agreements and receive payments that aren’t actually due to them, at least from the counterparty point of view.

What this means is that the netting centre is effectively operating blind – it simply relies on what the subsidiaries say. There is no true visibility and no effort is put into finding out the correct sum to be settled. This creates uncertainty among the group companies and can lead to poor practices such as shadow bookkeeping.

It does not have to be this way, though. At BELLIN, we prefer an ‘agreement-driven approach’ to netting. This offers the best of both payables and receivables-driven processes and provides central treasury with even greater visibility and accuracy of information.

It is essentially a self-clearing approach to settling intercompany trade. The TMS provides an automated invoice matching process with a unique dispute workflow for intercompany disagreements. Disputes between subsidiaries are reviewed by the netting centre, which acts like a referee, applying the company’s agreed rules. By taking this approach, all participants are engaged in the process and it is in their best interests to play by the rules. 

In turn, this promotes transparency and enhances the benefits of multilateral netting. In fact, agreement-driven netting can easily save one or two man-days of time per month, per group company. 

EH: Why is it worth treasurers taking another look at multilateral netting?

MB: Many companies fail to recognise the true potential that multilateral netting offers – not only for optimising cash management, but also for improving workflows within the company and creating a transparent operating environment. Knowing this, how many treasurers really want to continue with old, inefficient intercompany trade processes?

And if treasury carries on operating without an efficient multilateral netting system in place, it is probably going to cost – each month – an amount that is equal to or higher than the entire implementation cost of a multilateral netting solution. That’s a powerful incentive to pay a little more attention to multilateral netting.