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Week 7
MNE Treasury and funding

Why do MNEs need funds?

  • Long-term investment needs (acquisitions, expansion)

  • Short term operational needs (working capital, etc.)

Industrial MNEs mainly concerned about access to

funds if crisis  skewed interest in low interest rates

As in foreign exchange,

MNE units can be ‘long’ or ‘short’ cash

External sources of funding

  • Debt vs. equity debate: basic in MNE finance

- debt: leverage but need to reimburse creates vulnerability

- equity: no need to reimburse but ownership is diluted

  • Varies globally – firms in some countries tend to prefer one or other form (culture, maturity of markets, etc.)

  • Also variations in national legal protections afforded shareholders vs. creditors

Debt funding

Relational aspect of (local?/global?) bank funding

Wide range of bank instruments

Trade finance: Documentary letters of credit, Bills of exchange

Lines of credit: Overdrafts, Commercial paper

Supplier’s credits: Factoring, Bankers acceptances

Term loans: Standby/revolving credit, Project finance

Risk derivatives: Swaps, Forward rate agreements, Caps/floors

Payments: Clearing systems, Cash settlement

Debt funding (cont.)

  • Traditional ‘transformation’ model = banks take deposits / make loans in own name to firms

  • Solvency problems in 1980s  efforts to lighten bank balance sheets (‘Cooke ratio’) and reduce loans

  • ‘Securitization’: putting investors (savers) directly in contact with borrowers via issuance of stocks/bonds

  • Brief history of Euro-markets (‘Belgian dentists’, etc.)

Securitization processes

  • Origination: bank advises borrowers on what kind of securities investors currently seeking (structure / currency / duration, etc.)

  • Security issued through lead manager. Transfers funds to borrowers / receives fees and syndicates (allocates) to pool

  • ‘Yield curve’: different interest rates in short-term ‘money markets’ and long-term ‘capital markets’: LIBOR

Other factors in debt securities

  • Price of security in ‘secondary market’ depends on general economy / perceived creditworthiness of specific borrower

  • Importance of ratings agencies’ assessments ‘credit spread’ for specific or general class of security

  • Question of guarantees: in name of group or small subsidiary? ‘Ring-fencing’ of risk

  • Bank loans still exist but now one source among many

Equity funding

  • ‘Economic patriotism’ – restrictions on foreign ownership vary from one country to another

  • Distinction between ‘passive’ and ‘active’ foreign investors – rise of global ‘institutional investors’

  • Focus on share price vs. other aims varies globally

- need to attract different investors (road shows)

- but excessive leverage = risk

Other sources of equity funding

  • ‘Sovereign wealth funds’ /‘State-owned enterprises’ –questions re: strategic, non-market aims

  • For SMEs:

- adapted stock exchanges like NASDAQ (US) / AIM (UK)

- venture capital (funded IT in 1980s – green revolution now?)

  • ‘Private equity’ funds – but asset stripping activities by foreign investor are politically very sensitive

Cross-listing securities

  • Open financial markets exist to facilitate access to funding abroad – but home bias remains

  • MNEs often issue globally to tap different investor bases: ‘Euro’-market = offshore

  • Different markets – different levels of regulation, requirements re: corporate governance, disclosure of information, taxation etc.

Internal sources of finance

NETTING

  • Each MNE unit has own long/short cash position

  • Instead of trading separately with outside banks, units can trade with one another via central clearing, creating receivable/payable position within group

  • Clearing manager will transfer net obligations
  • Advantages of netting: - accelerates internal payments - reduces external transactions (lowers frictional costs)

Example of netting (“normal” interest rate levels)

  • Berlin sub is long €5mio, wants to lend 1 mo.
  • Paris sub is short €10mio, needs to borrow 1 mo.
  • Bank bid/offer rate i.e., 3.00% - 3.125%

  • Separately….
  • - Berlin would lend @ 3.00%, receives €12,500
  • - Paris would borrow @ 3.125%, pay ca. €27,083
  • Overall, group would pay net €14,583

  • But if Berlin lends €5mio to Paris, external borrowings reduced to net €5mio, @ 3.125% = payment of €13,020

Transfer pricing and MNE taxation

  • Estimated 60% of world trade = intra-firm

  • MNE units send one another:

- physical goods (components/finished products)

- capital (loans / dividend payments / equity investments)

  • Some flexibility in determining prices at which these transfers occur:

a. performance assessment (end-of-year bonus distribution) – MNE colleagues spend much time negotiating transfer prices

b. local and global tax bills

Transfer pricing and MNE taxation (cont.)

  • Global variations in taxation:

- corporation tax

- treatment of dividends, intra-firm loans, etc.

(many US MNEs have their European treasury centre in Brussels)

  • MNEs might declare profits in low-tax locations, losses in high-tax locations – lower overall bill

  • Tax avoidance vs. tax evasion – semantics?

Various bases for transfer pricing

- ‘Cost pricing’: good is transferred without any mark-up

- ‘Cost plus pricing’: defined margin is added to return price of the good, often a finished product

- ‘Profit split’ methods: ultimate operating profit realized on good after it is sold is split by the manufacturing and sales subsidiaries, after objective measurement of contribution that each has made.

Tax havens

  • Countries with lax tax rate and regulations

  • MNEs can try to maximize shareholder returns

  • Yet if states receive insufficient tax revenues:

- much-needed services go unfunded, and/or

- other actors (households?) will have to pay more

Tax: another example of why IB is so political

What is the role of an Int Tsy?

  • Financialisation (c.f. Karel Williams)

  • To guarantee funding

  • To move funds: but structural factors

Moving funds

How does the MNE configure its Tsy function?

  • There is a single Global Treasury
  • There is one Domestic and one International Treasury
  • There are Regional Treasuries (ie. Co-ordination centres)
  • Each country has its own treasury (multidomestic)

b. How much power does each Tsy unit have?

  • What is its scope: Global, Regional or National?
  • Does the Tsy have a risk minimisation mission or is it aprofit centre?
  • Is it autonomous or integrated into the rest of Group?
  • Global Treasury (domestic & intl.) - at HQ? Heineken
  • - elsewhere - Rhone Poulenc

  • One Domestic and one International Treasury - Mobil, Renault

  • Regional Treasuries (co-ordination centres) - GM

  • Each country has its own treasury - ABB

Moving funds (cont.)

  • Tax regimes (tax rate on internal payments like fees, interest, dividends, royalties, sale of goods)

  • Communications (time zones, “passing the book”, consolidated international reporting system)

  • Personnel (skills base)

The local entity has to determine its own needs -

post cyclical operations

post financial decisions

Then question arises as to best mechanism for transferring surplus or subsidising shortfall -

dealings with external sources of funds

use of internal sources of funds

ie dividends? - issue of government regulations on dividend payments, ie link between size of dividend and size of local ops

easier to transfer money out of Brazil through debt repayment than should equity stake and dividend payment. Hence original investment structured as loan, not equity stake.

Other MNE treasury missions

  • Budgeting/management control
  • Cash management
  • Reporting (disclosure)

- internally (management accounting)

- to authorities

- auditing/accounting/financial statements

  • Risk calculations (stress-testing)
  • Assessment of local political risk / insurance