Tg Mea TECHNOLOGY MANAGEMENTInternational Journal of TECHNOLOGY MANAGEMENT Journal International de la GESTION TECHNOLOGIQUE Internationale Zeitschrift fiir acc TECHNOLOGIEMANAGEMENT AYI-FY at NG x-FM AT FIIAG— rs 1996 Volume 12, No 1 ISSN 0267-5730 Editor-in-Chief: Or M A Dorgham, international Journal of Technology Rédacieur en chef: Management, The Open University, Walton Hall. Millon Herausgeber: Keynes, MK7 6AA, England, UK é BREe Publisher: Inderscience Enterprises Ltd, World Trade Center Verieger Building, 110 Avenue Louis Casai, Case Postale 308. Editeur. CH 1215 Geneva-Aeroport, SWITZERLAND RA Published with the cooperation and financial assistance of the United Nations Educational. Scientilic and Cultural | | [ i | ‘Organization (UNESCO) ) Copyright © 1996 Inderscience Enterprises Ltd Typeset in the UK by Inderscience Enterprises Ltd Printed in Great Britain by the Short Run Press, Exeter, UKInt. J. Technology Management, Vol. 12, No. 1, 1996 no International cash management for a multinational corporation Surendra K. Kaushik and Lawrence M. Krackov Lubin School of Business, Pace University, Graduate Center, One Martine Avenue, White Plains, NY 10606. Abstract: This.paper presents an analysis of broad and varied approaches 10 international cash management in terms of: (i) the differences between international cash management techniques and methods related primarily to domestic cash management. (ii) the scope of international cash management activities and those celated to domestic business. It also focuses on a variety of major activities and strategies. by outlining the integral relationship of ingernational cash management and overall financial planning for corporate needs. domestic as well as international, ino an overall perspective. Keywords: Cash management; funds transfers; financial strategies: financial investments; banking services; international cash: ieasury management. Reference to this paper should be made as follows: Kaushik, S.K. and Krackov, LLM. (1996) “International cash management for a multinational corporation’ Int. J. Technology Management , Vol. 12. No. 1, pp.110-125, Biographical notes: Surendra Kaushik is Professor of Finance at the Lubin ‘School of Business of Pace University. Graduate Centre, New York, Lawrence Krackov is a former Adjunct Professor of Finance at Lubin School of Buiness. Pace University, and Vice President and Treasurer of Sony Music Entertainment Inc. 1 Introduction 1.1L Purpose and objectives ‘The purpose of this study is to (1) analyze and demonstrate the breadth of approaches 10 international cash management in terms ot: (i) the differences between international cash ‘management techniques and methods related primarily to domestic cash management, (ii) the scope of international cash management activities and those related to domestic business, (2) focus on a variety of major activities and strategies, by outlining the integral telationships of international cash management and overall financial planning for corporate needs, domestic as well as international, into an overall perspective. Copyright © 1996 Inderscience Enterprises LidMembers of the Editorial Board Umberto Agnelli Vice Chairman, Fiat Group. and Chairman of Fiat Auto Spa. Italy Professor Pierre Aigrain ‘Sciemifie Counsellor of the President. Group “Thompson: former Secretary of State for Research and Industry; former Délégue Général Ala Recherche Scientifique et Technique, French PM's Office, France. Professor Ali A. Al-Shamlan ~ Minister of Higher Education; and Director General, Kuwait Foundation for the Advancement of Sciences (KFAS); Kuwait. Dr. Adnan Badran Deputy Director General, Science, UNESCO, Panis, France. Jordan Baruch Formerly Assist. Secretary of Commerce, USA. Dr. Jean-Louis Befta (Chief Executive Officer, Saint-Gobain Group, France. Peter Benton Director General, British Insitute of, Management, UK. Dr. Frederick Betz [National Science Foundation, Washington DC, Usa. Dr. Peter Cann Vice President for Research. and Chief ‘Scientist, Rockwell International, USA. Professor Kim Clark Dean, Harvard Business School. USA. ‘Viscount Etienne Davignon Chairman, Société Générale, Belgium. Robert Eaton Chairman and CEO. Chrysler Corporation, USA. L.Emmerij President, Organization for Economic Cooperation and Development (OECD), France. Professor Bela Gold Claremont Graduate School. California, USA Dr. RJ. Hermann Vice President, Science and Tachnologies, United Technologies. USA Derek Hornby (Chairman, Rank Xerox (UK) Lid, UK. Dr. K.K. Kappmeyer ‘Vice President - Technology, United States Steel Corporation. USA. George H. Kuper President, industrial Technology Insitute, ‘Ann Arbor, USA. Dr. Olavi J. Mattila Former Minister of Trade and Industry, and Minister of Foreign Affairs, Finland, Professor J.S. Metcalfe Dean, Faculty of Economics, University of Manchester, and Member of the Advisory Council on Science and Technology. UK. Sir Rupert Myers President, Australian Academy of ‘Technological Sciences and Engineering, Australia. Michael Naylor Genera Director of Corporate Strategic Planning, General Motors Corporation, USA. Professor John Parnaby Managing Director, Lucas Applied Technology, UK. Professor Edward B. Roberts ‘Chairman, Management of Technology Program, Massachusets Institute of Technology, USA. Professor Abdus Salam [Nobel Laureate. and President. Third World Academy of Science, lal. ‘Tadahiro Sekimoto Chairman, NEC, Japan, Mark Snowdon Boor. Allen & Hamilton Ine.. France. Dr. Klaus-Heinrich Standke President, OstWestWinschaftsAkademie. Berlin, Germany. Takuma Yamamoto CChaieman, Fujitsu Lid, Japan, Dr. Gerhard Zeidler (Chief Executive Officer, SEL-ALCATEL Group. Germany.Intemational cash management for a multinational corporation Mm 1.2. Methodology This paper discusses and analyzes methods, practices and activities relating to an efficient international cash management by 3 (spical multinational corporation. It draws on academic research as well as treasury management and banking practices of corporate treasurers and bankers. Issues of international cash and treasury management are becoming more important with the globalization of economic and financial activities in the 1990s. Synthesis of many aspects of international cash management in this paper provides a total perspective as the technology makes it possible to achieve greater efficiencies in global cash management Previous research on many aspects of international cash management and treasury ‘operations have included studies of (i) cash and foreign exchange management by Maier (1983), Soenen and Aggarwal (1986). Soenen (1986). and Williams (1986); (i) banking services by Minchin (1988); (ili) neting by Perkins (1986), Srinivasan and Yong (1986); (iv) pooling by Griffiths (1982), Anterian (1993); (s) financial investments and policy by Griffiths (1990), Allman-Ward (1992): (si) international operations by Robinson (1990), Griffiths (1991); and (vii) blocked funds by Welt (1986). 2 Cash management in foreign countries 2.1 Receipt and disbursement practices ‘The cash flow diagram in Figure 1 shows the major elements of any collection or disbursement system and the techniques or terms that can be employed or negotiated by _. any trade creditors and debtors to govern their cash flows: + Negotiation of credit terms with suppliers or customers, which can be as long as six ‘months in some areas ofthe world. + Selection of a mail or wire transfer mechanism, based on efficiency. + Selection of procedures that can expedite deposits, such as the use of a ockbox. Such services and their availability can vary ftom one country to another. + Negotiation of availability terms, with the banks, shich varies internationally for ‘both the payee and payor. For example, depositor availability can be up to five days in Latin America, compared with two days in the US. On the payor's side, debits to bank account ofthe customer can be made prior to the date on the cheque in many countries. The result isthe use of this free money by the bank as compensation for its collection and account services. This is different from the US where the customer or payor gets the benefit ofthe float instead of the bank. Banking services needed and their practices for collection, payments and management of cash are discussed next. 2.2. Banking practices In terms of banking considerations, such as bank balance availability, efficient US cash management systems can achieve zero excess cash balances. On receipt of cheques presented daily for collection, coverage of the cheque can be achieved with cash obtained112. S.K. Kaushik and LM. Krackov through shori-term borrowing, like commercial paper. In fact, given the remote clearing. float, negative bank balances can be used regularly. Even if an error is made, contractual overdraft facilities exist (o meet payment needs. Such early notice and the ability to borrow to cover cash needs are not available in many countries. This requires ‘maintenance of some foreign cash balances to insure smooth operations. Figure 1 Cash flow diagram Payor Payee Payee Good Mailed Releases Receives, Deposits Value by Payee Check Check Check of Funds} Credit Terms Mail Float Processing Availability ‘Negotiated Mail, Pickup, | Lockbox, Value Wire Hand Agreement Deposited ‘There may be several different operations in different subsidiaries and divisions scattered around the country. Irespective of their cash balances. they create no problem of excess consolidated cash balances in the US. Major clearing banks can pool cash from different ‘operating bank accounts of a corporation around the country. The pooling allows the net bank balances to be zero or a positive balance. as needed, for each operation. While similar arrangements in the UK, Canada and Germany are routine, it is dificult to obtain such services in France and other countries. with banking systems not as developed and integrated, to meet the needs of the global customer. ‘Another practice that varies from country to country is the use of compensating bank balances to pay for bank services. This is much less practiced in the USA. There is a ‘move towards explicit pricing of each service by US banks, In Europe, Latin America and Asia there is still wider use of compensating balances. Use of compensating balances to pay for banking services is inefficient when a corporation minimizes holding of cash balances in the bank. Maintaining excess cash balances results in cost equal to the full ‘opportunity cost of overall capital (20 %). and not merely the interest income foregone or interest expense paid (8%) (1]- 2.3 Investment policy For many treasurers and theit local foreign financial staffs, perhaps the area of greatest interest in managing foreign cash is the selection of financial investments. It is important in this regard to set the policy guidelines in terms of currencies, risk levels. and maturities. Aggressive cash managers could choose to play worldwide stock markets, ‘with no specific constraints on maturities or ~rrencies. Alternatively, the treasuryInternational cash management for a multinational corporation 13 department could take a conservative stance with respect 10 cash earned and neither repatriated to the USA nor invested in subsidiaries or affiliated businesses abroad. For example, at CBS Inc., cash was allowed to be invested: (i) in local currency instruments in order to avoid any foreign currency transaction exposure forthe local subsidiary (2), (ii) in a paper backed by a sovereign such as an Al PI commercial paper or deposits maintained in a safe bank, (ii) in maturities of six months or less to preserve availability of cash for local capital expenditure or repatriation atthe parent. ‘A conservative cash management is based on the philosophy that foreign cash should remain safe and readily available 10 be invested in foreign businesses to earn normally high required returns ~ such as the waditional 20% pre-tax cost of capital used by many multinationals, Alternatively, the foreign cash should be returned home to be invested in the company's worldwide businesses. 10 retire debt or to repurchase stock ~ all of which have a similar 20% return (3). ‘There are many elements of risk-aversion in managing foreign cash in certain foreign countries. Fist, there is the question of a safe bank. In less-developed countries, there may be no large o relatively safe bank, So the choice then becomes one of selecting the least risky institution. Branches of home couniry and other global banks are usually good options if present in the host country. Second, while ‘paper of the sovereign’ is usvally the safest local investment, government debt does not always represent riskless paper. Many governments operate close to insolvency so there is the political risk of a potential for funds becoming blocked with could lead to a loss oftheir unavailability. In foreign countries, where significant longer-term investments are made, many times safety can be sought at a US or another major international bank. Ideally, the comfort from the bank isin writen form The comfort extends o payment in the USA, not merely locally, since all local (host country) funds may become blocked. 24° Arbitrage policy ‘Another point on local cash management relates to arbitrage. Local finance directors may seek out arbitrage situations where they can borrow from one portion of their market, such as a bank, and invest the money at a higher rate in another portion of the market. Usually, of course, the higher rate reflects higher risk, as inthe efficient US markets. This is not always feasible in foreign countries, as the US multinationals have learned. For example, several years ago, there was a more pervasive and surprising situation in Germany where US corporations could borrow money more cheaply than the rate paid on German government securities. Some US corporations, therefore, borrowed money and invested the funds in the higher yielding government securities. It appeared, initially, that the accountants would allow both the ‘riskless’ asset and the debt to be netied and reflected at zero on the balance sheet, This would have left the interest-rate spread as some without any additional capital investment. When this was tru, that was a good deal. Now, however, it appears the accountants will force any such increase in capital to be reflected on the balance sheet. However, the $0-basis-point interest-rate spread may be a poor marginal return on the incremental capital ~ such as an increase from 8% to only 8.5% ~ compared with the 20% return required by the parent corporation.14 S.K. Kaushik and LM. Krackov 3. Cross-border funds transfers 3.1 General issues Cross-border funds transfers must comply with the government regulations that are often restrictive. In addition, even payments to the parent iself are covered by such restrictive regulations of different entities which have been set up for tax, legal, or political reasons. This, in turn, burdens the transfer process with meeting the legal basis and paperwork documentation to support movement of funds between parts of the same business. 3.2 Foreign exchange conversion procedures International procedures may also be complicated when the funds transfers involve currency conversion. For many currencies itis possible to make the conversion through a major interbank market, such as New York or London, for all major foreign-exchange purchases. For small transactions, however, it is often more convenient to utilize subsidiary relationships with local banks. For countries with conversion restrictions, such as in Latin America, al bank involvement is required: and foreign-exchange purchases by the local subsidiary is probably the most efficient procedure [4]. Finally, in ‘cases where the foreiga-currency rate-fluctuation exposure is hedged with forward contracts, itis sometimes more efficient to take delivery ofthe currency than to purchase a separate spot contract. 3.3 Netting systems Greater overall efficiency for a regional group of subsidiaries can be obtained through a regional netting system. Instead of direct payments from one subsidiary to another and from each subsidiary to the parent company. all the payments of each entity to and from all the other entities are netted. As shown in Figure 2, in bilateral neuting, the $1000 payment to the French subsidiary is partially offset by the $500 payment to the Holland subsidiary, so only one payment of $500 need be made. In multilateral netting, even greater efficiency can be achieved. The five net payments in Figure 3, totalling $1900 among the four entities. are converted to three net payments, totalling only $800, made to the principal bank of the system. ‘Thus. not only are gross payable and receivable payments netted, but payments to different subsidiaries are further netted. The netting provides three benefits: (i) a significant reduction in the number of foreign exchange purchases and their associated transaction costs; (ii) an opportunity to obtain more competitive quotes on larger (combined) foreign exchange purchases; (ii) the ability to give all subsidiaries receipts and disbursements in their local currencies. If most eross-border payments can be designated at one point in a given month, then this can be utilized as the netting payment date. A small staff. therefore. can make most of the payments required for a multinational company with the fewest transactions possible and in the least amount of time. Companies also use such a netting system to lag large payments in different currencies as an exposure-management device. Similarly, leading and lagging can transfer liquidity by automatically financing one subsidiary through a buildup of itsInteriational cash management for @ multinational corporation us intercompany account with another strategy. The netting system itself makes payments mote efficiently once they have been designated by divisions and subsidiaries or by the international treasury operations depanment Figure 2 Bilateral gross Bilateral Netting FRENCH $00 HOLLAND SUB SUB Most large multinational companies, with major international operations in one or more regions of the world, use some form of netting system. Dupont and a few other major companies have recently established such systems in Asia. The systems may be run by the corporate headquarters staff, a major multinational bank, or a regional headquarters staff. 3.4 Repatriation ‘The most important goal of international cash management is to bring home excess cash that is not needed for fixed and working capital investments in the business. For example, excess cash may earn only 6% US dollar equivalent return. Repatriated cash, on the other hand, can be invested in the business, in the USA or worldwide, at the 20% required return, of can be used to retire debt r stock with the same effect on return.116 S.K. Kaushik and LM. Krackov Figure 3 MULTILATERAL DIRECT HOLLAND SUB MULTILATERAL NETTING ~ 8 CENTRE $200 $2 BELGIUM. SUB Dividends and intercompany fees are the two major vehicles for repatriating foreign cash. ‘Yet excess cash can still build if the internal operations. management psychology, and/or 3International cash management for a multinational corporation nT legal restrictions impede the payment of significant fees or dividends. The legal restrictions on fees usually centre around arms-length market pricing and restrictions against transferring profits from one country to another. The legal restrictions on dividends usually centre around retained earnings and other declaration/remittance capacity calculations. The internal dividend philosophy, however, usually focuses on the percentage of current earnings to be paid out, and the capital structure of the foreign subsidiaries. Therefore, the neat section includes these capital structures as one of the financing srategies as they relate 10 and are a par of international cash management 4 Financing strategies 4.1 Foreign subsidiary capital structures ‘The capital structure of foreign subsidiaries is related to repatriation of funds through dividends because retained earnings not paid out in dividends is usually the biggest part of the equity portion of the capital structure. Therefore, before any cash management or financing sirategy is developed. the type of capital structure sought for each subsidiary should be determined. ‘There are three major approaches or philosophies for foreign subsidiary capital structures. First, subsidiaries can be treated as independent, self-sustaining businesses to be funded on their own, Second, the parent can invest the minimum amount of equity allowed so as to retain as much cash as possible in the USA, or repatriate as much cash as possible to the parent company. by paying off local or intracompany debt as cash is, {generated. Third, the company can use equity to finance a specific portion ofthe foreign assets that are beyond the local managers decision and control, such as non-current assets. Generally, these alternatives should be chosen on a case-by-case basis, both when investment and financing decisions are made and when the dividends budgets are set each year. In addition to the overall financial strategy of philosophy, local government and banking relations, management psychology and incentives, foreign exchange exposures, and expectations are all considered in the decision making. ‘The eriteria for the independent approach are similar tothe overall criteria applied 10 the consolidated corporate debt. The capitalization, cash-flow-coverage and current ratios could each be emphasized, dependent on local banking and government practices. The standards, however, will vary by couniry, as well as by industry. Higher debt levels ‘would be supported ifthe parent believes in higher leverage. This is the practice of most major US corporations. ‘The independent approach emphasizes operating incentives. It also encourages local ‘management to control their operations in the form of investment and pricing decisions vis-a-vis the local competition, to use industry and country standards in evaluating performance of a given local subsidiary, compared with another subsidiary, and the overall corporate targets. From a financial perspective, however, the minimum-equity approach is preferred, since the only real capital structure decision is that for the overall corporation. The local foreign capital structure, therefore, should be decided on the basis of the flexibility it Provides to reduce excess cash that is generated through remittance to the USA or through repayment of local debt. This approach will also help the overall foreign118 S.K. Kaushik and LA, Krackov ‘operations. Rather than having cash build ap in a subsidiary, as a result of inadequate dividend capacity or remittance restrictions. i is remitted to be available when needed for another subsidiary. ‘While minimum equity levels may yield extreme local leverage. te local government and banking requirements are met by the minimum standards. In addition, the parent may stand behind all its foreign operations, inthe form of comfort letters or guarantees to the banks, for the local debt they provide, and in the form of a commitment to send funds or ‘make foreign intracompany loans whenever a subsidiary is in financial difficulty ‘The last approach is o use interest-bearing debt funding (BOX #2 in Figure 4) for the working capital requirements not funded by interest-free trade payables (BOX #1 net amount of items, shown in the top half of Figure 4). In this approach we need fund only rnon-current assets (BOX #3:n Figure 4) with equity (BOX #4 in Figure 4). This approach addresses local management incentives in a different, more direct form. The portion of the balance sheet beyond the local manager's control ~ which is a long-term corporate management responsibility ~ can be funded with equity. since the interest charge is not needed as a local incentive. Then the portion of the balance sheet within local control can be funded with debt to incur an interest charge as an incentive to control the investment. This method is often used to give the managers an incentive to control their working capital. In other words, a buildup of inventory and receivables must at least yield incremental profit returns in excess of the interest costs. Yet, since interest rates are well below the overall required rate of return of any business. as in the weighted average cost of capital, this can be viewed as a generous funding approach for most subsidiaries. Figure 4 Financing concepts BOX #1 Cash BOX#? Inventory Short-term Debt ‘Receivables ___ x NET WORKING CAPITAL DEBT FUNDING, BOX #3 BOX 4 Fixed Assets ‘Common Stock ‘Other Non-Current Assets — NON-CURRENT ASSETS, EQUITY FUNDING, 4.2. Regional finance centres ‘Another financial strategy, related to cross-border funds transfers. isthe use of a regional centre to optimize financing and foreign-exchange exposure for the entire region. AS previously stated, a regional netting system could incorporate leads and lags in the cash payments to transfer liquidity and/or to modify foreign exchange exposures. An additional set of “bells and whistles" could similarly be’added by making the regional centre a re-invoicing operation and/or a captive finance company. A re-invoice centre allows re-denomination of all invoices, and their related payables and receivables, in the subsidiaries’ local currencies. The centre pays all non-local invoices, for supplies, fees, royalties, etc.. which are denominated in the currency of the payee. The centre rebills the foreign subsidiaries in their own currencies. All foreign ‘exchange exposure is concentrated in the centre where it can be identified and managedImerational cash management for a multinational corporation 119 more easily - through external financing and leading/lagging. as well as with forward, contracts. If liquidity exists within the overall region, then the centre's credit terms 10 subsidiaries can be used to finance the ones who need it when they need it. Financing for the ones who do not need it can similarly be reduced when they have adequate cash. This Iype of trade financing of subsidiaries can. therefore, easily transfer the liquidity from cash-rich to cash-poor operations whenever itis needed. For example, see how the finance centre in Figure 5 retains the £200 payables for 30 days owed by the French and German subsidiaries to a third party supplier in the UK. Yet. both subsidiaries’ payables are converted to French francs and deutsche marks, respectively. Also the French subsidiary’s liquidity needs are financed by an increase of 20 days in credit terms. This, in turn, is funded by the German subsidiary’s liquidity through a reduction of 20 days in credit terms. Figure S$ Resinvoice centre NomalTiade PaabesiaSunslisrin ik Modified Acsouns with Re-invoice cenize French Sub = French Sub Payables £100 ~ FR 900 ~30days = 50 Days = German Sub ~ German Sub Payables -£100 =DM 300 = 30days = 10 Days = Revinvoice centre = £200 Payabies ~ Average 30 days = FF 900 and DM 300 Receivable’ = $0 and 10 days If the overall region needs to borrow, that can be done through the use of the regional centre, as a captive finance company. Thus, both external financing for the group and allocation of financing for all the subsidiaries can be managed centrally. Another alternative for many of the same purposes isa factoring centre. Factoring of subsidiary receivables can also be used both for exposure management and the transfer of liquidity. ‘Since both foreign exchange and interest income and expense are obviously being somewhat shifted in,all forms for this type of finance centre, there may be some tax advantages available. For such reasons, low-tax countries are often selected as the domicile for a finance centre. Tax experts, therefore, should be contacted before any plans fora regional centre are finalized. 4.3. Intracompany loans ‘The primary goal of bringing cash home, excess liquidity that cannot be repatriated through dividends and fees, can be achieved via intracompany loans from the cash-rich subsidiaries o the parent company.120 SK. Kaushik and LM. Krackoy Financially, the loan payables and receivables are eliminated upon consolidation of the corporate books. See how the $100 of excess assets at the subsidiary can be reduced 10 $50 on a consolidated basis on Figure 6. For the parent company in the USA. this can bbe done on only a short-term basis of less than a year to avoid deeming a payment as a dividend for tax purposes. Yet if the loans are made to other subsidiaries in lieu of corporate funding or external borrowing. they can often be done on a long-term basis and achieve the same net effect, namely, an incremental reduction of both excess foreign cash-and consolidated debt. Figure 6 Intracompany loans to corpo BEFORE LOAN CORP. DEBT CONSOL. BAL. SHEET Cash $100 Com. $100 Cash $100] Com. $100 Paper Paper AFTER LOAN SUBASSET CORP. DEBTS CONSOL. BAL, SHEET Cash $50 Com. $50 Cash $ 50] Com $50 Paper Paper Loan to Loan from $50 Corp. $50 | | Sub If intracompany loans are used regularly on a monthly basis to remove excess cash from local balance sheets, the date for such loans should be the same as the date used for any regularly scheduled monthly netting system for foreign currency conversions. Such efficiencies can greatly reduce transactions costs. Ifexcess cash levels are either seasonal or temporary, intracompany loans may néed to be repaid or even reversed. Using flexible ‘evergreen’ loan documents, analogous 10 a revolving line of credit. can allow for the ebd and flow of cash as needed in net conversions and greatly reduce the legal/accounting costs of documentation for each loan In countries where the multinational corporation has a bank pool, or cash concentration system, covering more than one subsidiary. the same effect can automatically be achieved, as long as the overall pool has more cash than overdrafts and 1 long as there is some local funding needed. This can be seen in Figure 7, where $200 of excess cash in the subsidiary can be cut in half by funding the corporate nets with 3 thank overdraft that nets against the cash balances,Imernational cask management for a multinational corporation 121 Figure 7 Bank pool CORPORATE ACCOUNT. ‘Overdraft $100 CONSOL. ACCOL? Net Cash $100, DIVISION ACCOUNT, Cash $200 There are also some benefits of either a bank pool or an intracompany loan in avoiding paying an outside creditor, such as a bank or bond-holder. A higher rate on borrowed funds than the rate earned by the corporation on its excess cash, namely the 20% requited return versus the 6% return on bank deposit is avoided through this mechanism. ‘Now going one step further, it is possible 10 reach the ultimate in international cash management through regional of worldwide bank pools. Cash in one country could offset overdrafts in another country, on a forcign-exchange-adjusted basis, using forward market rates, This would include overdrafts in the USA being used to completely offset cxeess foreign cash. In discussions with banks, the following problems have been raised with respect to global pools: requirements with respect to individual country la secounting for one pooled bank account in more than one country: and the limitation in ‘electing foreign banks that must be affiliates of one worldwide bank. ‘The closest thing to a multinational pooling system in practice is the one used by Monsanto at Citibank for each of its major regions of the world [5]. In Europe, for ‘example, most of Monsanto's operations establish deposit accounts in their own local currencies at Citibank branch in Brussels; and all excess cash in these currencies is deposited on a daily basis by Monsanto's Brustels-based European treasury department In addition to more efficient international banking systems, such improvements have been made possible by the relaxation of regulations in many countries with respect to off-shore bank deposits. For any cash needs in each currency, money can be drawn from the positive balance in this pool for use by the local subsidiary, which then shows a deficit in fis own account. Only if there is no balance in that currency. must the pool be funded, such as with an overdraft. Ti may be possible to go one step further, with automatic conversions of the net balance to one currency. This would then allow a corporation’s total debt funding to be reduced on a daily basis with the conversion of all net pool balances to dollars and the use of the dollars to reduce issuance of commercial paper. Only with such a cross-currency pooling and the ability to use net balances to remove excess cash from the balance sheet122 S.K. Kaushik and LM. Krackov does it become a true cash pooling with the same effect as automatic inttacompany loans. Another point on financial strategies relates use of money market arbitrage across countries to obtain the benefit of the interest-rate spread. This is analogous of the local German arbitrage example discussed previously. Again. risk differentials may explain most of the difference in interest rates. Usually, the remainder is attributable to differences in exchange-rate expectations: covering the exchange exposure in the forward market offsets the interest rate spread. In the rare situations where a significant spread remains, this form of arbitrage should be rejected globally, as it was in the German example. Even $0 basis points is a small return, when it merely increases the true return to 6.5% from 6%, and the required return isthe standard 20%. 5 Blocked/restricted funds 5.1 General issues As discussed previously, cross-border funds transfers require compliance with local legal * restrictions. Often, remittance of dividends, intracompany payments, and even payments to third parties are severely limited. Furthermore. the funds built up in a country may have limited allowable usage. These funds could be classified in three categories: (i) blocked funds, which cannot be used at all by the parent or affiliate companies: (ii) severely restricted funds, which can be used only locally; (ii) restricted funds, which can be used to purchase foreign currency for remittance ata discount or through open-market ‘transactions such as sale of certificates of deposits (CDs) in foreign countries. Once funds are classified as blocked or restricted, five types of strategies could be: (i) delayed collection of receivables from third partes until remittance or local usage can be obtained, such as the remittance of royalties from licensees: (ii) maximum local usage, such as use by travelling executives supervising operations in foreign countries; (iii) counter-trade and barter to remit proceeds from blocked receivables in the form of other goods: (iv) sale of CDs, etc, and similar cash equivalents ata discount, with payment in hard currency in some non-blocked country - such as dollars in the USA: (v) restructuring of the legal entities. which can make dividends or intracompany payments/loans allowable in some cases. 5.2 Parallel loans For blocked funds, the use ofa parallel loan with another company can. in theory. be used to simulate the effects of an intracompany loan in bringing home the cash. For example, three separate banks and one multinational corporation proposed this as a vehicle to solve a large blocked funds problem of drachma in Greece. While there is no direct cross border transaction in the blocked country. another corporation can lend dollars in the USA in exchange for a loan of Hlocked currency from local subsidiary to its local subsidiary such as in Greece. ‘The problem, however. is that. unlike intracompany loans, the parallel loans are not eliminated upon consolidation. unless the two transactions were combined with a right of set-off. The set-off ~ where “I need not pay you if you do not pay me” ~ would create a true swap instead of a parallel loan, Unfortunately. this swap structure violates theInternational cash management for a multinational corporation 123 exchange restrictions in many countries where funds are blocked so as to be illegal, such as in the case of Greece. Therefore, the problem with parallel loans as a solution to blocked funds is similar to some general misconceptions about repatriation of foreign funds. 6 Conclusion Foreign funds are not really “brought home” until they are either removed from the balance sheet, such as through the retirement of deb. or they ate invested in ihe business at home of worldwide without any increase in total assets. I they are not “brought home” and they are not needed forthe foreign operations. they become ‘excess’. This isthe real problem in international cash Management, with the cost of the problem being the ‘opportunity cost whichis the difference between a 6% return for the bank versus the 20% required return for the company: Notes 1 The 209% is merely the pre-tax equivalent of the approximately 10-12% post-tax hurdle-rate range used by most companies. This is ciscussed more generally below with respect to cash 2. There are more specific exceptions for hedging in countries with hyper- inflationary conditions but without the benefit of forward markets. 3 This 20% required return, or cost of capital, is merely the pre-tax equivalent of the approximate 10-12% hurdle rate used by most corporations, directly or indirectly, for capital investment decisions: the 10-12% hurdle rate is composed not only of an 8% pre-tax interest rate, but a much higher 15% post-1ax required retur, or cost of equity. The components are, of course, then combined on a weighted average basis to reach the approximate 10-12% required ‘return oF cost of capital; andthe 20% isthe pre-tax equivalent. 4 This may or may not require the services ofthe local legal counsel. S _Anterian,S. (1993). Treasury and Risk Management, Volume 3, Issue 4, Winter: pp.26-32. Bibliography Abdullah, F. A. (1987) Financial Management fr the Multinational Firm. Englewood Cliffs NJ, Prentice Hall. Allman-Ward, M. 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