Leveraging regulatory arbitrage and financial arbitrage to your benefit
While the digital age has ushered in a richer knowledge-based economy, the challenge of bridging the knowing-doing gap has actually increased. Despite technology widely being accepted as a business enabler, it is how countries and corporations respond to rapid global change that will make material operational differences; both in the rate of execution/adoption and in how knowledge is applied. It is these variations that create new degrees of complexity not previously encountered by global treasurers.
Today’s treasurer is therefore not only asked to deliver benefits based on financial arbitrage, but increasingly needs to find ways to solve and extract value from the differences in global regulatory, jurisdictional, and labour regimes – all of which is exacerbated by ever-increasing volumes of information and reducing windows of opportunity in which to deal with this information.
In this sense, if the return on cash seeks to achieve a balance between risk and reward, the return of cash is a conversation about understanding how time and differences can be used to gain competitive advantage.
Supply/finance chain convergence
What this means can be explained through understanding the historical convergence of the supply and finance chains.
For both these chains, the single largest driver of cost is time: time to undertake due diligence and execute effective risk strategies; time to deliver the physical goods; time to move documentation; time to process orders and payments for approval – the list goes on.
In parallel, many treasurers are under great internal pressure to shorten their days sales outstanding (DSO) and days inventory outstanding (DIO), while at the same time lengthen their days payable outstanding (DPO). Advances in technology are compressing transaction timelines in an ever more complex and interconnected global marketplace.
Differences in regulatory, jurisdictional and cost base have become increasingly important, not only in terms of how they affect financial outcomes, but also their impact on the extended physical supply chain, something a responsible treasurer must always be acutely mindful of.
In an effort to project manage this, a treasury department should take stock of its business operations, corporate strategy (e.g. expansion plans), and treasury priorities to support the business. By formulating a plan, a treasurer can map out where business planning and due diligence needs to be focused. For example, if a goal is to set up a shared service centre in the Philippines, understanding labour contract law could be of more strategic importance than learning the depth of the country’s banking market.
Here are a few examples of how to make this approach work for you and ensure that your business leverages these sources of competitive advantage.
Know your banker
Just like bankers need to know their customers (KYC), treasurers need to know and leverage their relationship with their banks in each region or market in which they trade or intend to trade. As regulated entities, banks are tuned into their home market regulators and have extensive knowledge of global regulatory impacts.
But banks are also subject to the laws that govern those markets. Banks are entrenched in the risk and liquidity management of both the physical and financial supply chains; as providers of services, data and technology that facilitates physical commercial activity as well as being providers of funding and investment management. How banks price these services to global clients is significantly affected by differences in markets.
If building up bank relationships in a new market is a top priority, then knowing how regulators are adopting regulatory principles is critical.
While the Basel capital accords provide the guiding principles for how regulatory capital requirements are to be measured and applied, adoption and application varies across markets. For example, the UK regulator has a different approach to the application of credit conversion factors for trade finance, as compared to the Australian regulator. Understanding how your bank is dealing with this is equally important.
Understanding differences such as foreign borrowing caps (China) that affect borrowing tenors and currencies and legislation such at the Resource Utilisation Support Fund (RUSF – Turkey) that imposes penalties on Turkish borrowers accessing short term foreign funding, are also important considerations when deciding to enter a market or obtaining funding in that market.
If the efficient allocation of cash is critical to funding new operations or simply improving working capital, then understanding how the deployment of cash in certain markets will be treated is valuable.
A European (home) treasury using a European registered in-house bank to place deposits into a foreign market (host), needs not only to consider its foreign exchange and sovereign risks relative to yield in that market. Questions to ask yourself would include:
- How does the host country’s adoption of the Basel liquidity rules compare to others in their region? For example, under Basel III, the timeline for 100% adoption by banks of the liquidity coverage ratio is 2019. Australian banks achieved 100% with effect from January 2015, with the US targeting 100% by 2017
- How will earnings be treated for tax in both the host and home countries?
Differences in generally accepted accounting practices are often overlooked in the crafting of efficient global expansion strategies – it is not just about tax. Simple practices, such as the treatment and ranking of security charges or the recognition of assets and liabilities being on or off balance sheet, can impair or enhance funding solutions such as receivables, payables or even inventory finance.
Ratings management has taken on a new focus and with it has come the awareness of how to leverage differential ratings of suppliers and buyers in the supply chain. This ratings arbitrage allows treasurers to develop strategies that not only help to manage the risk associated with their own rating, but opens the door to leverage the gap between buyer and supplier risk grades. Increasingly, suppliers are looking to gain advantage by leveraging more highly rated buyer’s risk grades through receivables finance structures; and buyers seek to use their ratings to achieve term and other relief from less well-rated suppliers, through supplier finance programmes.
Whether contracting for services or for the purchase or sale of goods, the cost of both executing and prosecuting such contracts can differ significantly. Where the legal systems between home and host countries are aligned, this cost and the related risks are generally lower than between jurisdictions with widely divergent legal frameworks. Not only does the lack of homogeneity in legal systems increase the risk-weighted cost of doing business, there is a direct impact on the time to transact, which can be measured in both real and opportunity costs.
While many of the above factors will drive cost, perhaps the most published consequence of globalisation is the importance of managing differences in labour costs. This is not just about understanding where you can get the lowest hourly rate of pay for a particular service, it is also about knowing how countries respond to these differences. Countries often manage these domestic challenges through a bundle of initiatives that can range from EPZ frameworks, to FTAs, all of which need to be taken into account when determining the true cost of labour in a given market. This bundle effect gives rise to labour markets being highly fluid, and it is not unusual to see selected onshoring of product occurring in the US at the same time as a market like Australia is moving production offshore.
By way of example, a marginally rated firm, based in a highly regulated, high labour cost market (left-hand diagram) that adopts appropriate strategies can significantly alter its cost base (green overlay right hand side) by executing strategies that exploit the difference in markets and enable it to ride the rising tide of globalisation.
Executive Director, Global
Westpac Institutional Bank
+44 0 207 621 7079