Deciding to ruN netting in-house or outsource it to a provider.
In-house or Outsourced Netting? Deciding whether to run the netting system in-house, or to outsource it to a bank or other provider. November 4, 2020 | Author: Nigel Cripps
When it comes to setting up your netting system, one of the principal choices is whether to run the netting system in-house, or to outsource it to a bank or other provider. Each of these two alternatives can be a perfectly valid choice for different companies with different needs and resources. Here are some of the factors to consider:
Available Manpower Running a netting system in-house certainly means you must have a number of man-days available each month to manage the netting center functions, but exactly how many? The answer is it depends on the number of netting entities you will be administering, how their netting data will get into the netting database (file transfer or remote entry?), and what other specialized functions such as hedging you will be incorporating into your netting procedure.
Looking at EuroNetting’s broad group of clients, time spent each month can range from 30 minutes per month for a highly-automated and well-configured client, up to several man-days administering a more disparate set of users with multiple data sources and a more complex netting configuration that includes complex custom FX hedging analysis components.
But does this manpower requirement evaporate if you choose to outsource the netting center function, and what does the outsourcer actually do?
Who provides Outsourced Netting? There are two principal categories of netting outsourcing agents:
Independent companies whose primary purpose is to provide outsourcing services for treasury and other corporate functions. These entities were often found in locations such as the Netherlands, Belgium and Ireland in order to provide tax-advantaged corporate benefits, although now the tax advantages appear to be de-emphasized in favor of other benefits. In this category, EuroNetting has a preferred outsourcing partner to whom we can refer clients.
A few of the major banks have offered outsourced netting as a way to gain captive foreign exchange volume from their clients. Common in the 1990s and early 2000s, many of the participants in this arena either failed to expand and retain their client base through inadequate marketing and product knowledge, or struggled with the underlying obligation to provide a comprehensive back office function to support the netting, and then abandoned the business. In their place there are now some banks who offer a ‘free’ or low cost netting service in return for the captive FX business, but the actual management responsibility is not outsourced and remains with the client.
What to expect from an Outsourcer A good independent outsourcing agent will handle much of the administration of your netting system: they will implement a structured approach to managing the static data elements that drive the netting - the users, entities, and those entities’ banking instructions that are typically used to settle net position cashflows at the end of each netting cycle - and they will oversee the monthly netting procedure ensuring your users get their data into the netting on time, then most importantly they will run the end of cycle netting calculations and handle the cycle end settlement process.
But you will still have responsibility for initiating and approving changes in users, entities and banking instructions, and then you will have to review the preliminary and final netting results, and consider the impact of the netting results on other elements of your treasury cash management procedures unless, of course, the outsourcing agent is handling more than just the netting piece of your treasury. Regardless, you will very likely still be involved in the monthly netting process to a greater extent than you might expect.
Integrating Other Outsourced Treasury Functions Using an outsourcer really gets useful if they are handling more than just the netting: managing cash and liquidity management, treasury accounting and reporting, intercompany loan administration, and other corporate services all add to the value received from a professional outsourcing agent and can help reduce your in-house treasury headcount.
Cost It's not always easy to compare in-house and outsourced netting costs. Not only is the explicit fee charged by an outsourcer often higher than the annual license cost for a service such as EuroNetting, but a bank-outsourced service may also include another cost that isn’t so apparent: banks are tempted to build in additional spread profit on the captive netting FX trade volume to earn the majority of their income.
While this is an appropriate way for the bank to recover its costs, you may be able to execute your netting trades at better rates by keeping the netting function in-house. Netting FX trade volumes have generally contracted with the Euro having removed much of FX volume from intra-European trade, and with FX spreads generally diminishing due to improved rate visibility, some bank outsourcers have found it necessary to either drop unprofitable clients, or raise the explicit outsourcing fees to compensate for the lost FX revenue.
On the other hand, running the netting in-house will consume some additional manpower at various times during the month.
Complexity This can work both ways. Some of our most complex netting implementations are run very efficiently in-house by our clients, because they have taken the time to optimize their netting procedure and they make extensive use of automated data interfaces. These clients would gain nothing by handing over their carefully-tailored netting system to another party.
On the other hand a netting system involving hundreds of users and entities using less-optimized data sources can be tough to manage, simply because it requires tracking the data input from so many people - it may be better to give this job over to an outsourcer who has the dedicated resources to deal with so many entities without the distractions you would have from your other treasury management obligations.
However, beware that an outsourcer will likely have a fiscal duty to implement even more stringent controls over your netting process than you may feel necessary running your netting in-house.
A good example is dual approval over changes to users, entities and banking instructions: all outsourcers we have worked with insist on dual approval for all changes to these elements, and often also dual approval of the actual data imported into each netting cycle, whereas a clear majority of EuroNetting’s direct netting clients feel this is less important and don’t apply dual approval anywhere in their netting: they will say this is an internal company process using a closed set of participating company entities, and if there are any errors remaining after internal review of preliminary and final netting results prior to actual settlement, then it can be sorted out in the netting cycle.