The increase in use of equity funding, the complexity of transfer pricing discussions and using house banks for long term funding are some of the topics covered in this report which explores the different approaches that companies take to funding their subsidiaries and how their processes are evolving.
This call came out of a series of discussions with treasurers: we spend a lot of time worrying about intercompany loans, external funding locally, etc. But a lot of these issues arise as a result of a series of key decisions, which are strategic and often historical: how do we structure our subsidiaries?
This is a complex decision. A non-exhaustive list of considerations includes:
Company policy: the more equity in a foreign entity, the bigger the perceived risk
Flexibility: loans can be quickly repatriated (at least, in theory): equity cannot
Duration and refinancing risk
Involvement of the in-house bank
The need for internal loan agreements
Tax. This is very complex, and can become circular:
Local thin capitalisation and equity requirements
Arm’s length pricing for intercompany loans – the end of LIBOR complicates this
Profitability of the local business
Charging for credit risk – this is circular, as we control the credit quality
Business performance issues: equity does not result in a charge in the local books. This can disguise the true cost of funding working capital or capital expenditure
Difference between local accounting rules and those of the parent
Workload: the analysis is usually manual, which can be a problem if there are many subsidiaries
Most of these topics came up in the call. As always, there are a variety of approaches, with no one right (or wrong!) answer. But some shifts seem to be under way:
People seem to be considering equity more than in the past
Transfer pricing is becoming more of an issue, so Tax is having a bigger say
Specific problem with negative interest rates, especially for the euro
In-house banks initially just provided short term funding. Some are moving to do all funding
Bottom line: it can be worth taking some time to stand back to look at the overall structure, and ask “What would I do if I started from a clean piece of paper?” We never start from a clean piece of paper, but it is good to have a view of what the preferred structure would be, and work towards it.
CompleXCountries Treasury Peer Calls are expert-led confidential peer group calls in which a small group of expert treasurers compare their approaches to specialist treasury challenges, answer each others' questions and combine knowledge. If you would like to know more about what we do, or to receive our Global Treasury Intelligence reports, please get in touch.