Global Cash Management with Crypto-assets and XRP
A new use case beyond payments
tl;dr: The world of financial DLT business and digital assets is focused on payments. But corporate cash management is not only payments. Multinational companies have been using a variety of treasury processes to optimize their global liquidity. Some of these processes are costly or impractical due to the current cross-border funds transfer model. Utilizing a crypto-asset, such as the XRP, in a regulated and resilient market, could result in significant benefits for the global cash management business by lowering treasuries’ costs, bringing operational efficiencies to corporate clients, and maintaining the market position of treasury services at investment banks.
Intro
In the previous post (Ripple and XRP for the Corporate Treasurer) we presented an analysis of Ripple’s solutions functionality from the corporate treasury’s point of view. We saw that, while discussions on distributed ledger technology (DLT) payments applications are mostly centred around financial institutions’ use cases, the widespread adoption of these solutions could bring tremendous benefits to corporate treasuries as well.
But payments processing is only one piece of the treasury’s cash management puzzle. Could there be anything else — beyond payments — for XRP and DLT-based liquidity solutions in general?
This paper introduces the possibility of utilizing crypto-assets for treasury services and corporate cash management.
Corporate Cash Management in a nutshell
The intended audience of this post is both crypto and treasury professionals, so it is appropriate to begin with some definitions. The article is not intending to be a treasury or a cash management guide. For the purpose of the presented case study we will use the following breakdown of corporate cash management processes:
- Flows management (payments and collections)
- Balances management (bank balances originating from flows)
In a nutshell, corporate treasurers use flows and balances management tools to ensure that (a) the company will have enough money to fund its operations, (b) the company’s excess cash will be utilized in the most efficient way and (c) the above tasks will be executed with the minimum possible credit, market and operational risk.
These tools can be either in-house strategies deployed with the use of technology (ERP and TMS), or processes provided as a service (treasury services) by major financial institutions, such as JP Morgan, HSBC, and Citi.
The tools range from simple cash pooling strategies and intercompany loans to highly sophisticated structures involving the set-up of one or more in-house banks. There is no “one-size-fits-all” tool because the availability of each one of them varies from country to country. And as each corporate faces a unique set of challenges, it is no surprise that most global treasuries choose to apply a combination of cash management tools in an overlay structure.
The Problem
In order to describe the problem and to identify the pain points where the suggested solution could find its application, a simple example of a hypothetical company operating in multiple jurisdictions will be used. It should be noted though, that global treasuries face far more complex situations than the one presented here and a single example is not enough to describe all the issues.
Let’s assume the scenario of a multinational real estate development company with headquarters in the UK (UK_HQ, group currency GBP), two subsidiaries in Dubai (DB_DEV and “DB_INV”, currency: UAE Dirham — AED) and two in Singapore (SG_INV and SG_DEV, currency Singapore Dollar — SGD). Due to the nature of real estate development business, companies’ finances run on cycles: As long as a project is being developed, funding needs are high and revenues are low. The opposite happens when projects complete: Sales and rental proceeds boost revenues and funding needs fall. For this example, *DEV refers to development subsidiaries while *INV refers to the investment subsidiaries which manage the completed projects.
The CFO and the Treasurer face the following situation:
- DB_DEV has a deficit of 1,000 AED and needs immediate funding to continue its operations
- DB_INV accounts have a positive balance of 1,200 AED
- SG_INV has a positive balance of 640 SGD
- SG_DEV runs on a deficit of 100 SGD
The Solution(s)
The most common strategy deployed by corporate treasuries in such cases is cash pooling. Cash pooling can be either physical (i.e. actual movement of cash) or notional. With physical pooling, the bank “sweeps” cash from sub-accounts (turned zero balance accounts — ZBA) to a master account. These sweeps can take place end-of-day and master accounts can be set up on multiple hierarchy levels (entity, country, bank, currency). Subsequently, the master account provides funding to the entities with a deficit and invests the excess cash. All movements of funds between accounts belonging to different entities trigger intercompany loans.
The diagram below shows how a cash pooling structure could be applied:
When sweeps are completed, the balances are set as pictured below:
Sub accounts have now zero balance (ZBA) and the remaining cash in the master accounts is available for investment. By covering the funding needs of the *DEV companies internally (in the form of intercompany loans), the group has managed to lower its borrowing costs.
What happens next? The management would normally want to repatriate the available funds in the UK. This is desirable for a number of reasons: First, having a larger pool of cash, the company will be offered preferential investment terms by their main banking partner in the UK. Secondly, by concentrating the cash in the parent company, group treasury will have much more control over it, being able to provide funding to other subsidiaries if conditions change. Third, trapped liquidity in various currencies and jurisdictions incurs significant FX, credit and operational risk.
The company could apply the same sweeping strategy described above but on a group level this time. After local sweeps are completed, a second pooling process starts and local balances are transferred into the UK and converted to GBP.
However, where permitted, cross-border cash pooling is often a costly and inefficient process. It is costly because it involves currency conversions and SWIFT cross-border transfers (besides any withholding tax levied on intercompany loans interest). And it is often inefficient because it usually involves multiple banks and foreign currency cut-off times.
A solution to some of these inefficiencies is notional pooling. The group’s main banking partner would agree to notionally aggregate (net) the regional currency balances into a group currency pool and to apply the same terms. However, the commercial future of multi-entity notional pooling is not looking bright under Basel III regulations as banks will probably be required to hold more capital for their ratios. Alternative structures, such as virtual account management (VAM) and in-house banking (IHB) can also provide solutions to these problems but they will not be examined in this post.
A new use case for crypto-assets?
First, why XRP?
The case study in this article will be using XRP. Theoretically, any cryptocurrency with bridge asset properties could be used. For example, the Utility Settlement Coin, initiated by UBS and supported by several global banks is a very promising project. However, looking at the market, we find XRP as the only digital asset designed for transferring value across borders which is backed by a commercially ready software suite. Ripple’s solutions and XRP seem to be far ahead of the competition in the DLT-based liquidity business.
Cross-border cash pooling with XRP
The idea is to take advantage of the high speed and low-cost transfers of XRP and apply these properties to corporate cash management processes, and more specifically to cross-border cash pooling.
The simplest cross-border cash pooling structure using XRP would be the following:
- Dubai and Singapore subsidiaries’ balances are swept into local master accounts and local currency financing is provided where needed (as shown in the previous section)
- Excess cash in local master accounts is swept through XRP Ledger and converted into group currency (GBP)
It should be noted that the conversion from local currency to group currency using XRP (or xRapid, to be more precise), would be viewed by the middle and back office as a one-step process.
There can be multiple ways to structure the above process. An alternative (and bold) process architecture would leave regional funds invested in XRP without converting them into group currency. Currently, this sounds absurd, given the state of the crypto market and the volatility of digital assets. But in a regulated market with multiple participants offering a broad range of financial instruments (derivatives, money market, etc.), this option would not be an unreasonable treasury strategy.
Benefits
Why would anyone apply this process which seems to add complexity? What could be the benefits compared to cross-border cash pooling using fiat currency?
- Reduced transfer costs: XRP is used as a bridge asset to source group currency (GBP) liquidity. XRP transactions like this one, worth millions of USD are settled with sub-penny (or “sub-cent”) fees. It is expected that, in a mature market, the end fees charged to convert fiat currency through XRP will be higher than the fees of plain XRP transfers, as market participants will price in their risks and operational costs. However, given the ultra-low base cost of XRP transfers, the total end fees should remain competitive.
- Operational Efficiency: Cross-border cash sweeps involving multiple banks and different time zones, require a carefully designed process executed in steps and taking into consideration various factors such as currencies cut-off times. Using a crypto-asset with instant settlement such as the XRP, treasuries and banks are offered unlimited flexibility in timing the sweeps. This allows treasuries to optimize their liquidity and enable just-in-time (JIT) financing for their subsidiaries.
Implications (known unknowns)
Cross-border cash pooling is already a heavily regulated process. In some jurisdictions, it is restricted or even not allowed at all, due to cash management and currency rules. China, for example, does not allow direct intercompany lending. The good news is that some of these countries (most notably China), have recently started to relax these rules.
In any case, a treasury management solution using digital assets would have to overcome not only the regulatory obstacles that currently affect fiat transfers but it would also have to address some crypto-specific challenges, described below:
- Crypto-specific regulations: Digital assets still have a long way to reach universal regulatory approval and the outcome seems far from certain. The solution suggested in this article assumes the participation of established actors currently operating in the global liquidity business. As these actors cannot be other than systemically important institutions, it is expected that regulators will examine specific rules for this market. A few weeks ago (Jul 2018), the Financial Stability Board (FSB) issued a report towards this direction.
- Market Structure: XRP is sourced through xRapid liquidity providers. The current structure (through crypto exchanges) cannot withstand the volumes required for a widely adopted corporate cash management solution. It is also unknown and even questionable, how these providers will act in times of stress. The future market will require large, respected and regulated participants.
- Tax Implications: International regulations require interest on intercompany loans to be set at arm’s length principle and, in many cases, withholding tax is imposed on the interest. Cryptocurrency lending is now an uncharted territory, being a highly illiquid OTC market. However, should digital assets be used for intercompany loans, authorities are expected to closely monitor this area and prevent practices which could be seen as violations of transfer pricing rules.
- Competition: Treasury innovation has brought a wide array of choices to the cash manager’s table. A crypto-based treasury management solution would face strong competition from new and existing fiat tools which already take advantage of the less regulated international landscape. For example, JP Morgan Treasury Services is releasing Virtual Account Management (VAM), a tool which dramatically minimises the need for intercompany cash transfers via SWIFT. But, as there is no single solution applicable to all markets and no single solution capable to solve all treasury management problems, there will always be room for new products. Most multinational companies will continue to use a combination of available tools and structures.
Why use a digital asset and not just a distributed ledger?
This is another reasonable argument against the use case presented in this article. R3, Hyperledger along with Big 4 consultancies and global banks have been engaging with central banks in payments and RTGS projects. Project Jasper (Bank of Canada) and Project Ubin (Monetary Authority of Singapore) have drawn useful lessons for future applications. The answer is yes, the solution could run on a distributed ledger without the use of a native asset. The use of DLT would still bring significant efficiency gains but without a bridge asset, the whole solution would suffer from the need to use pre-funded nostro accounts. This issue would be mostly felt by those multinational companies holding subsidiaries in developing markets, as their funds would still have to make multiple stops through the corresponding banking system.
How this product can be offered
Cash pooling is provided as a service by financial institutions to their corporate clients. A crypto-based solution could be seen — by these institutions — as a threat to their profitability. However, when permitted and regulated, treasury services at investment banks could take the opportunity and consider broadening their product offering, including crypto as a bridge asset for cash management processes. It is often better to stay relevant even if that means cannibalising your own profit margins.
Should such solutions gain traction and regulatory approval, investment banks could play multiple roles by offering custody services, issuing crypto-denominated money market instruments as well as providing liquidity. (more on that in a next post)
Conclusion
Global cash management structures set up require not only sound financial advice but also legal and tax expertise. Adding cryptocurrencies to the already complex picture sounds like a far-fetched idea. It could, however, gather steam if regulators decide to back digital assets for these uses and if the market matures, attracting bigger and more reliable actors. In that scenario, global treasuries could reduce their cash management costs and experience significant efficiency gains while treasury services at investment banks could maintain and expand their market position.
Epilogue
Expressing certainties over what the future will look like — especially regarding the role of technology in life and in business — seems a very naive thing to do. Blockchain and crypto have attracted heated debates, tribalism and high profile skeptics. However, innovation history is full of surprises and examples that contradicted all kinds of predictions. I respect — and often share — any legitimate concerns. But I prefer to be on the optimistic side.
Thank you for reading 😊
Get in touch to discuss and exchange ideas: www.linkedin.com/in/ikarosmatsoukas
(…or let’s start a flame war on twitter)
