Long term or short term debt – your choices

|18-5-2017 | François de Witte |

You might visit this site, being a treasury professional with years of experience in the field. However you could also be a student or a businessman wanting to know more details on the subject, or a reader in general, eager to learn something new. The ‘Treasury for non-treasurers’ series is for readers who want to understand what treasury is all about. Today our expert François de Witte will explain de difference between long term and short term debt.

One of the main tasks of the treasurer is to ensure that the company has the required funds to operate. The treasurer will usually contact the banks for this funding. They can also extend long term loans (LT) or short term loans (ST).

Raising short term debt has several advantages, because it is more flexible, there is a lower cost due to the lower margin (smaller risk profile than long term debt) and usually lower interest, funds can be raised quickly and usually, you can repay your debt without penalty.

However, there are some drawbacks. The required repayment comes quicker than for LT loans, there can be potential difficulties in renewing short term loans, and it will be more difficult to combine ST debt with a fixed rate interest.

For this reason, many corporates take up long term loans. It helps them to improve the financial structure (better liquidity ratio). During the term of the credit facility, there is no renewal risk, and long term loans can be taken up with fixed or floating interest. Many banks will see long term loans as a prerequisite to finance fixed assets and investments.

In that case, the corporate will have to accept a higher price on these loans, a longer set up time and a possible prepayment penalty in case there is a fixed interest rate during the long-term loan.

Financing policy

The classic financing policy aims to match the maturity of the financing with the maturity of the assets. Under this policy, long term assets will be financed by long term loan, and short term assets by short term loans. An area of concern are the working capital needs. Are these to be considered as long term assets as short term assets? Usually the uncompressible part of the working capital need is considered as a long-term asset, whilst the fluctuating part (including the seasonal requirement) is considered as short term asset.

Some companies use a more aggressive financing policy and chosse short term financing to finance all the working capital needs, which can be risky. Others are more conservative and use long term loans to finance also the fluctuating part of the working capital needs.

Bank Financing versus bonds or Commercial Paper financing

Usually midcorporates and smaller corporates will use bank financing, also for the long-term financing, because it is easier to be set up. There is no need to have a complex prospectus or to ask for an external rating and there are less disclosure and reporting requirements. In addition, there is more flexibility in the repayment schedule, and it will be easier to negotiate a floating rate.

However larger corporates, those with an external rating or a large name recognition, will also consider bond or Commercial Paper financing. The bond financing will allow for longer term maturities, and the possibility to lock in the interest rate for longer periods. Bonds and commercial papers enable a diversification of funding sources, and can be traded in the market. In addition, there is no obligation provide side business to the lenders.

Bond financing

The world’s bond market can be divided into two broad groups:

  • The domestic bond market (issued in a country by resident issuers)
  • The international bond market (issued in a country or in the international markets by non-resident issuers). These also include the Eurobonds

Different bonds

The most common bonds are the straight bonds. In this case, the issuer issues securities for a fixed term with an annual or semi-annual interest payment at a fixed rate.

Example: Issuer A issues on 10/6/2017 EUR 100 Million debt at 6 % for 7 years.  In this case, the bondholders are entitled to receive an annual interest rate of 6 % (also called the coupon) on the 10th June of each year from 2018 until 2024, and the full reimbursement of the loan on 10/6/2024.

We also see quite frequently the issuance of Floating Rate Notes. This is a medium term or long term bond with a coupon based upon a floating rate based on a benchmark rate (e.g. Euribor or Libor) plus a “spread” based upon amongst others the credit quality of the issuer.

Zero-coupon bonds that do not foresee for periodic interest payments, but for the full reimbursement of the capital and interest at the final maturity of the bond.

Convertible bonds can be exchanged later or with another instrument, mostly shares.  The coupon is usually lower because of the option granted to the bondholder.

Public bonds are bonds issued by a bank syndicate through a public offering with prospectus. These bonds are focusing both on the retail and on the professional investors. They also must comply with the specific requirements for the prospectus, which sometimes needs to be submitted beforehand to the competent authorities for approval.

A private placement (or non-public offering) is a bond issue through a private offering, mostly to a small number of chosen investors. Private placements have less heavy constraints in term of prospectus.

Since 2000, the global bond markets size has nearly tripled in size. Today it is worth more than $100 trillion

(Source: Bloomberg, June 2016).

François de Witte – Founder & Senior Consultant at FDW Consult & Flex Treasurer

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More articles of this author:

Treasury for non-treasurers: Short term loans from a treasury perspective

Working capital management: Some practical advice on the optimization of the order to cash cycle

Management of bank mandates – EBAM – A lot of challenges

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Short term loans for financing your company

|11-5-2017 | François de Witte | treasuryXL

You might visit this site, being a treasury professional with years of experience in the field. However you could also be a student or a businessman wanting to know more details on the subject, or a reader in general, eager to learn something new. The ‘Treasury for non-treasurers’ series is for readers who want to understand what treasury is all about.
Our expert François de Witte tells us more about an important task of a treasurer: funding, namely short term loans.

Background

One of the main tasks of the treasurer is to ensure that the company has the required funds to operate. The treasurer will usually contact the banks for this funding. The banks can extend secured or unsecured credit facilities. These can be long term or short term. In the current article, we will cover the unsecured short term loans.

Overdraft lines

The most flexible credit line is the overdraft loan: when providing an overdraft facility, the bank authorizes the company to go below zero on its account up to a certain amount. Overdrafts can be a good way to borrow  money for a short period of time. For example, if you don’t have enough money in your current account to cover your outgoings, and are uncertain about when your accounts receivables will be collected, you can negotiate with your bank an overdraft limit. If in that case, you have say 1 million Euro of expenses you can pay them, even if your account balance goes below zero. Once you will collect the accounts receivables, the overdraft position will be settled.

Usually the banks charge in case of use of the overdraft facility an interest rate based upon the internal rate of the bank plus a margin, and in some cases an overdraft fee charged on the total amount of the facility.

Having an overdraft can act as a useful buffer to cover your peak cash needs. It is the most flexible loan, because, in case you have cash inflows, they can be immediately used to reimburse the facility. However if the cash need is more structural,  overdrafts are not a very effective way of borrowing, because they may come with a higher rate of interest than some other loans such as the short term advances.

Short term advances

When you have a more structural cash need for a certain period of time, it can be useful to consider short term advances or straight loans. In this case, the bank will extend a short term advances (straight loans) facility.

When the client wishes to utilize this facility, he will ask for a drawdowns amount made available for an agreed upon period at an agreed upon rate. On the required date, the bank will make the amount available, e.g. 1 million Euro, on the account. At the maturity of the short term advance, the borrower needs to repay the advance and the interest. The interest is usually calculated on a benchmark, e.g. Euribor or Libor plus a margin.

The client determines the timing of the drawdowns. Advances are usually extended in the framework of a credit line, although in some cases, the client can just ask a punctual advance to cover a specific need.

Short term advances are less flexible then overdrafts. If you have a short term advance of say 1 million Euro for 1 month, and 15 days later you receive a large collection of say over 1 million, you cannot reimburse your short term advance, and will hence during the last 15 days pay interest on your short term advance, without any or almost any remuneration on your current account. For this reason, we recommend to use short term advance for long(er) term cash needs.

Conclusion

Overdraft facilities are the most flexible loans, but are quite expensive. If you have long(er) term cash needs, it might be useful to consider straight loans, as they are usually less expensive.

There exist many other solutions to finance the short term needs of your business, such as the financing of accounts receivables and factoring. This will be covered in a separate section.

 

François de Witte – Founder & Senior Consultant at FDW Consult & Flex Treasurer

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Flex Treasurer – Besparing na een treasury quick scan: Nog meer praktijkvoorbeelden

| 22-3-2017 | François de Witte | Patrick Kunz |

Als je ondernemer bent of als financiële professional werkt in een kleine of middelgrote organisatie die geen treasurer of cash manager in dienst heeft, vraag je je wellicht af of je alle treasury taken wel goed geregeld hebt. Iemand aannemen voor deze taken gaat misschien een stap te ver. Maar dat betekent niet dat je geen kosten zou willen besparen of dat er geen mogelijkheden zijn voor bijvoorbeeld funding. Wij hebben jullie al eerder kennis laten maken met onze Flex Treasurers en de Treasury Quick Scan die zij kunnen uitvoeren in een onderneming. In een eerder artikel hebben wij al praktijkvoorbeelden gepresenteerd. In dit artikel nog twee voorbeelden, waaruit blijkt dat een Treasury Quick Scan grote besparingen kan opleveren.

Onderneming C: Internationaal Handelshuis in voedselproducten

Omzet ca 1 miljard Euro

  • C is handelaar in voedselproducten in de B2B markt. Wereldleider in zijn segment en op alle continenten actief. Producten worden standaard in USD geprijsd. C heeft geen treasurer in dienst, de finance managers deden dit erbij.
  • Een treasury scan in 1 dag liet zien dat een besparingspotentieel op treasury processen mogelijk was van minstens EUR 200.000 per jaar (oplopende tot EUR 1.000.000 op jaarbasis)
  • Door optimalisatie van cash management processen en heronderhandeling van transactiekosten is binnen een maand EUR 300.000 jaarlijkse besparing gerealiseerd
  • Door optimalisatie van interne processen en toevoegen van extra banken en een online handelsplatform is op FX hedging een verdere besparing van EUR 100.000 gerealiseerd. Verder is het proces verbeterd waardoor er minder tijd wordt besteed aan de processen.
  • C heeft inmiddels een eigen treasurer, treasury afdeling en treasury management systeem. De flex treasurer is nog steeds betrokken bij projecten.

Onderneming D: vastgoedbedrijf

Omzet ca 125 miljoen Euro.

  • D had een treasurer in dienst welke met pensioen ging op korte termijn. Een flex treasurer is aangenomen om kritsch te kijken naar de treasury processen welke intern en extern gedaan werden
  • Alle terugkerende treasury activiteiten zijn naar intern gehaald. Dit zorgde voor een besparing van ca EUR 50.000 per jaar.
  • Een treasury rapportage werd opgezet zodat (senior) management en lijn management beter geïnformeerd zijn over treasury activiteiten
  • Cash Management en cash flow forecasting is geoptimaliseerd welke het renteresultaat verbeterde. Besparing ca. EUR 10.000 per jaar.
  • Corporate finance activiteiten werden verbeterd waardoor er zeer scherp in de mark geleend kon worden.
  • Treasury kon uiteindelijk afgebouwd worden van 36 uur naar 8 uur per week. Besparing ca EUR 60.000 per jaar.

 

Herken je een of meer situaties uit je eigen organisatie? Heb je een vraag? Onze experts zijn gaarne bereid om met jou in gesprek te gaan. Zij werken als Flex Treasurer en helpen jou graag verder. Overigens ook als je bijvoorbeeld na een treasury quick scan behoefte hebt, om tijdelijk een (flex) treasurer in dienst te nemen.

 

François de Witte 
Senior Consultant at FDW Consult

 

 

 

 

Treasury & amp; Working Capital Quick Scan Methodologie – Voorbeelden uit de praktijk

| 7-3-2017 | François de Witte | Patrick Kunz | treasuryXL

 

Als je ondernemer bent of als financiële professional werkt in een kleine of middelgrote organisatie die geen treasurer of cash manager in dienst heeft, vraag je je wellicht soms af of je alle treasury taken wel goed geregeld hebt. Iemand aannemen voor deze taken gaat misschien een stap te ver. Maar dat betekent niet dat je geen kosten zou willen besparen of dat er geen mogelijkheden zijn voor bijvoorbeeld funding.

 

 

Heb je al eens gedacht aan de mogelijkheid van een treasury quick scan?

Wij bieden je aan om deze quick scan voor je uit te voeren.
Een ervaren hands-on treasurer maakt een scan van jouw organisatie om te kijken of het de moeite waard is om te investeren in treasury. En vaak blijkt dat je door deze quick scan flink geld kunt besparen, zoals de volgende praktijkvoorbeelden laten zien.

Onderneming A: Productie onderneming in de verpakkingssector

(omzetcijfer ca. 150 miljoen euro)

  • A gebruikte voor zijn financiering een combinatie van EUR 5 MM met straight loans aan 2,25 % en EUR 3,5 MM met factoring (totale factoring faciliteit : EUR 10 miljoen) aan een rente van 0,75 % + 0,15 % flat op het omzetcijfer (of 225.000 euro op jaarbasis).
  • Een treasury quick scan maakte snel duidelijk dat er een besparingspotentieel was indien de onderneming een deel van zijn bankfinanciering verschoof naar de factoring. Het beroep op de factoring werd verhoogd naar EUR 7,5 miljoen, wat toegelaten heeft een jaarlijkse besparing toe realiseren van EUR 60.000.
  • De facturen werden niet altijd tijdig opgesteld en werden per post opgestuurd. De quick scan maakte duidelijk dat er besparingspotentieel was. Dankzij een strikter facturatieproces en het overgaan op e-invoicing is de onderneming er in geslaagd 3 dagen te winnen in de Order to Cash Cyclus of een besparing van ca EUR 1,25 miljoen aan werkkapitaal en ca. 30.000 euro aan financiële lasten.

Onderneming B: Groep die een aantal autoconcessies bezit

(omzetcijfer ca. 175 miljoen euro)

  • B gebruikte voor zijn korte termijnfinanciering (ca. EUR 13 miljoen) korte termijn kredietlijnen bij banken (financieringskosten voor van 1,90 %) en bij de financieringsmaatschappij van de importeur (financieringskosten van 1,10 %).
  • Een treasury quick scan maakte duidelijk dat er een besparingspotentieel was indien men een deel van de bankfinanciering verschoof naar de importeur financierings-maatschappij. In casu besloot de onderneming EUR 7,5 miljoen meer op te nemen bij deze, wat een jaarlijkse besparing aan rentelasten heeft toegelaten.
  • B had regelmatig credit saldi op een aantal bankrekeningen, terwijl ze debetsaldi op andere bankrekeningen had. Een van de aanbevelingen van de quick scan was het invoeren van een dagelijkse opvolging van alle banksaldi. Hierdoor is onderneming B erin geslaagd het gemiddeld uitstaand bedrag aan bankleningen te doen dalen met EUR 1,6 miljoen, wat een rentebesparing oplevert van 30.000 Euro.
  • B ondervond regelmatig vertraging in de incassering van facturen op leasingmaatschappijen, omdat de dossiers niet in orde waren (ontbrekende documenten, etc.). De quick scan maakte duidelijk dat een striktere opvolging van de procedures en keurige dossiers (first time right) zou toelaten de gemiddelde incassoperiode te reduceren van 23 naar 18 dagen. De onderneming heeft uiteindelijk een besparing van werkkapitaal van 800.000 Euro en een jaarlijkse rentebesparing van meer dan 15.000 Euro gerealiseerd.

Herken je een of meer situaties uit je eigen organisatie? Heb je een vraag? Onze experts zijn gaarne bereid om met jou in gesprek te gaan. Zij werken als Flex Treasurer en helpen jou graag verder. Overigens ook als je bijvoorbeeld na een treasury quick scan behoefte hebt, om tijdelijk een (flex) treasurer in dienst te nemen.

 

Patrick Kunz

Treasury, Finance & Risk Consultant/ Owner Pecunia Treasury & Finance BV

 

 

 

MEER INFORMATIE

Wil je gebruik maken van een treasury quick scan of een Flex Treasurer of heb je een andere vraag?
Of wil je je aansluiten als Flex Treasurer?
Pieter de Kiewit helpt je graag verder.

[email protected]
+ 31 (06) 1111 9783

 

Working capital management : Some practical advice on the optimization of the Order to Cash Cycle

| 27-2-2017 | François de Witte |

 

As mentioned in my article “Treasury : proposed “to do” list for 2017”, working capital management will remain a hot topic throughout the year. The first priority is to reduce the working capital needs and financial expenses by optimizing the Order to Cash cycle. In this article, we will develop a plan of approach and propose some concrete actions enabling to generate tangible savings.


Background

The purpose of the Order to Cash optimization is to improve the whole cycle from the moment of the ordering of the goods or services, until the final payment, with the aim to:

  • reduce operational inefficiencies and risks such as delays between goods or service delivery and invoicing, credit management issues, unapproved discounts and deductions, data quality issues, etc.).
  • improve a number of processes such as the invoicing, the dispute management, the credit management and credit control
  • assess the current the tools, build business case for the improvement thereof, and implement them.

Plan of Approach

When starting such a project, I recommend to have at first a quick scan of the overall Order to Cash process so as to identify the critical areas and to assess the business case. Based hereupon, one can then subdivide the project in a number of streams.

In such a project, typically the following processes should be covered:

Ordering processes:
It is important to have a client acceptance process (for me a must in the B2B) and a clear policy on the way orders are accepted. I recommend to only accept written orders. For nonstandard goods, we also need to examine if a prepayment is required before an order is accepted, so mitigate the risk in case that the client does not execute this obligations. It is also useful to check beforehand if the exposure on the client will not exceed the existing credit limits.

Current invoicing processes:
Ideally the sending of the invoice should coincides with the delivery of the goods or services. Furthermore it is important to have the invoices sent timely. These actions enable to reduce the “hidden DSO”. Quite a lot of companies lose several days of easy working capital by neglecting this.
A good customer database is key, and in combination with the ERP, this  enables an automation of the invoicing process.  I recommend to use as much as possible e-invoicing, so as to reduce the costs and the postal delays.

Current credit management processes:
A formalized credit policy is a prerequisite. A number of solution providers offer solutions for the scorings of your clients, so as enable you  to define the credit limits in function hereof. In some sectors this information can be enriched by market information. Of course, one need to ensure that sales staff comply with this and check beforehand that the  credit terms have been duly approved. The credit manager needs to work hand in hand with the sales staff.

Current dispute management processes:
Prevention is important. For this reason, when ordering nonstandard goods, it is recommended to check beforehand the availability of the goods and the timing of the delivery, so as to manage the expectations of your clients. Throughout the process (from the order acceptance to the delivery and the invoicing) one should apply thee “first time right” so as to avoid disputes and litigation afterwards. Check also if some services and repairs are to be done under a maintenance contract or warranty, in which case they should be invoiced to other parties.

Current collection and credit control processes
It is important to have a well-organized credit control process enabling to send reminders quite soon after the due date (if possible the first reminder after 15 days). It can help to send to send to your clients some days before a gentle reminder of the forthcoming due invoices. Once the 2nd reminder has been sent, and provided that there is no dispute, it can be useful to block the delivery of goods and services to your client, so as to have an additional leverage, and to have  the credit collectors should calling the clients to see why they do not pay, and agree with them on an action plan.
When the classic reminder and call actions do not succeed, involve also the sales department and consider first a final call  by another person, before sending your clients to the debt recovery service or to the debt collection agency.
It is important to also ensure an automation of the processes, in particular if one has to address high volumes. If you cannot do it with your current systems, there exist good solutions in the market.

Reconciliation and allocation of incoming payments:
This is a big challenge for many companies. Make sure that your clients use the right payment instruments and payment messages, so as to facilitate the reconciliation process. Within the accounting department, incoming payments are not always allocated promptly, distorting the real accounts receivable outstanding. As a result, reminders can be sent unduly, leading to client dissatisfaction.

KPI’s and Dashboards:
It is important to foresee KPI’s for all the involved stakeholders, as well as incentives to ensure that everybody play the game. Dashboards should enable to remain in control and to monitor regularly a number of key indicators. An area of attention are the overdue receivables. A too high percentage of overdue receivables/total portfolio might be an indicator of possible uncollectable receivables and the need for write-offs.

Attention points

An Order to Cash optimization program is complex and we need to address a number of issues such as :

  • The resistance to change: people will come up with several reasons to keep on with the current processes. Overwork or client dissatisfaction will be used as excuse for deviations with the processes. Hence involve all the stakeholders, take time to listen to them and to make sure that they buy in the change. If the change is well explained, people will tend to accept the changed processes. The support of the senior management is key to address this resistance.
  • The limitation of the systems such as e.g. the ERP or the accounting package: Quite a lot of companies miss opportunities because they do not understand the capacities of their ERP. Involve from the start system experts and examine with them possible workarounds.
  • The standardization of processes throughout the organization : This can be an issue, in particular when working on multiple locations. Processes should be well documented. Once this is done, one can look for the automation.
  • The information and training of the stakeholders: Make sure that process documentation is easily accessible, and consider organizing training sessions for the involved staff.
  • The time and effort needed to implement external solutions: This requires a good business case, including all the aspects. Do not underestimate the cost, the effort and time to implement the tool.
  • The determination of the KPI’s and incentives: this should not only involve finance, but also other Sales, sales administration, the production department and the other involved stakeholders. Build in incentives to ensure that everybody play the game. Make sure that the KPI’s are monitored regularly so as to be able to take corrective action in case of divergences

Conclusion

By managing better the order to Cash Cycle, you can generate a lot of savings. This requires a global approach involving all the stakeholders. To be successful, an optimization requires a number of concrete process improvements, but also the buy-in of all parties involved. A good change management should ensure that the improvements are embedded in the organization, and smart dashboards will enable to monitor that one remains on track.
Technology can help to automate the processes, but do build first a business case and to not underestimate the effort.

It can be a long journey, but in the end, it is worth the effort.

 

 

François de Witte

Senior Consultant at FDW Consult

 

 

More articles of the author:

PSD 2: A lot of opportunities but also big challenges (Part I)

PSD 2: The implementation of PSD 2: A lot of opportunities but also big challenges (Part II)

Treasury: Proposed “to do” list for 2017

Working capital management – not just a finance issue

 

PSD 2 : The implementation of PSD 2: a lot of opportunities but also big challenges – Part II

| 1-2-2017 |  François de Witte |

After having examined the detailed measures of the PSD2 in my first article, in the 2nd part we will examine the impact of PSD 2 on the market. In order to help you read the text we will once more start with a list of abbreviations.

 

LIST OF ABBREVIATIONS USED IN THIS ARTICLE

2FA    :   Two-factor authentication
AISP  :    Account Information Service Provider
API :       Application Programming Interface
ASPSP : Account Servicing Payment Service Provider
EBA :     European Banking Authority
PISP :    Payment Initiation Service Provider
PSD1:    Payment Services Directive 2007/64/EC
PSD2  :  Revised Payment Services Directive (EU) 2015/2366
PSP :     Payment Service Provider
PSU:      Payment Service User
RTS :     Regulatory Technical Standards (to be issued by the EBA)
SCA :     Strong Customer Authentication
TPP :     Third Party Provider

Impact on the market

A major implementation journey:

The ASPSP (mostly banks) will have to make large investments in order to comply with the PSD2, in the following fields:

  • Implementing  the infrastructure enabling the application of the PSD2 scheme to the currency transaction in the EU/EEA area, and to the one leg transactions.
  • Ensuring that they can respond to requests for payment initiation and account information from authorized and registered TPPs (third party providers), who have received the explicit consent of their customer for to this. They will have to develop interfaces that enable third party developers to build applications and services around a bank. Internal banking IT systems might need to be able to cope with huge volumes of requests for information and transactions, more than they were originally designed for.
  • Ensuring their security meets the requirements of the SCA (strong customer authentication). This will be a big challenge both for the banks and for the other payment service providers).

PSD2 will make significant demands on the IT infrastructures of banks. On the one hand the IT infrastructure has to be able to be interact with applications developed by the TPPs (PISP and AISP). On the other hand, banks have to develop their systems in such a way that they don’t have to do this from scratch every time a TPP approaches them. This will require a very flexible IT architecture. The banks have to have a middleware that can be used by their internal systems, but also by the applications of the PSP’s.

Although PSD2 does not specifically mention the API (Application Programming Interfaces),  most technology and finance professionals assume that APIs will be the technological standard used to allow banks to comply with the regulation.

An API is a set of commands, routines, protocols and tools which can be used to develop interfacing programs. APIs define how different applications communicate with each other, making available certain data from a particular program in a way that enables other applications to use that data. Through an API, a third party application can make a request with standardized input towards another application and get that second application to perform an operation and deliver a standardized output back to the first application. For example, approved third parties can access your payment account information if mandated by the user and initiate payment transfer directly.

In this framework, the real challenge is to create standards for the APIs specifying the  nomenclature, access protocols and authentication, etc.”. Banks will have to think about how their new API layers interact with their core banking systems and the data models that are implemented alongside this. The EBA (European Banking Authority) will develop RTS (Regulatory Technical Standard) with more detailed requirements regarding the interface between ASPSPs and TPPs. While these are expected to be published early 2017, based on the EBA’s recent draft RTS, the question is whether they will define the interface’s technical specifications.

Emergence of new players and business models

By integrating the role of new third party payment service providers (TPPs) such as the PISP and the AISP, the PSD2 creates a level playing field in the market. Several market experts expect that this will foster innovation and creating new services. For this reason PSD2 should increase competition.

This might lead to a unique open race between traditional players, such as the banks and newcomers for new services and a possible disintermediation of banking services, as illustrated in the figure down below:

Source: Catalyst or threat? The strategic implications of PSD2 for Europe’s banks, by Jörg Sandrock, Alexandra Firnges – http://www.strategyand.pwc.com/reports/catalyst-or-threat

PSD2 is likely to give a boost to the ongoing innovation boom and bring customers more user-friendly services through digital integration. One can expect that the automation, efficiency and competition will also keep the service pricing reasonable. PSD2 will foster improved service offerings to all customer types, especially those operating in the e-commerce area for payment collection. It will enable a simpler management of accounts and transactions. New offerings may also provide deeper integration of ERP functions with financial services, including of their multibank account details under a single portal, and smart dashboards.

PSD2 also enables a simplified processing chain in which the card network can be  disintermediated. The payment can be initiated by the PISP directly from the customer’s bank account through an interface with the ASPSP. In  this scheme, all interchange fees and acquirer fees as well as all the fees received by the processor and card network could be avoided. The market expects that new PISPs will be able to replace partly the transactions of the classic card schemes. A large internet retailer could for example ask permission to the consumers permitting direct account access for payment. They could propose incentive to encourage customers do so. Once permission is granted then the third-parties could bypass existing card schemes and push payments directly to their own accounts.

On the reporting side, the AISP can aggregate consumer financial data and provide consumers with direct money management services. They can be used as multi-bank online electronic banking channel. One can easily imagine that these services will be able to disintermediate existing financial services providers to identify consumer requirements and directly offer them additional products, such as loans and mortgages.

The PSD2 is for banks a compliance subject, but also an opportunity to develop their next generation digital strategy. New TPPs can provide their innovative service offerings and agility to adopt new technologies, enabling to create winning payments propositions for the customer. In turn, traditional players like banks can bring their large customer bases, their reach and credibility. Banks have also broad and deep proven data handling and holding capabilities. This can create winning payments propositions for the customer, the bank and the TPP.

Banks will have to decide whether to merely stick to a compliance approach, or to leverage on the PSD2 to develop these new services. The second approach will require to leave behind the rigid legacy structures and to change their mindset to ensure  quicker adaption to the dynamic customer and market conditions. A first mover strategy can prove to be beneficial.  Consumers and businesses will be confronted with the increased complexity linked to the multitude of disparate offerings. There also, the incumbent banks who will develop new services  can bring added value as trusted partners

Essentially, PSD2 drives down the barriers to entry for new competitors in the banking industry and gives new service providers the potential to attack the banks and disintermediate in one of their primary customer contact points. New players backed by strong investors are ready to give incumbents a serious run for their business. This is an important battle that the incumbent banks are not willing to lose.

The biggest potential benefits will be for the customers, who can access new value propositions, services and solutions that result from banks and new entrants combining their individual strengths or from banks becoming more innovative in the face of increased competition. Market experts also foresee an increased use of online shopping and e-procurement.

Several challenges to overcome

The PSD2 will be transposed in the national legal system of all the member countries. The involved market participants will have to examine the local legislation of their country of incorporation, as there might be some country-based deviations.

The authentication procedure is also an important hot topic. PISPs and AISPs can rely on the authentication procedures provided by the ASPSP (e.g. the banks)  to the customer but there are customer protection rules in place. Hence, they must ensure that the personalized security credentials are not shared with other parties. They also may not store sensitive payment data, and they are obliged to identify themselves to the ASPSP each time a payment is initiated or data is exchanged.

ASPSPs are required according to PS2 to treat payment orders and data requests transmitted via a PISP or AISP “without any discrimination other than for objective reasons”. A practical consequence for credit institutions will be that they must carry out risk assessments prior to granting payment institutions access – taking into account settlement risk, operational risk and business risk. One of  the main issue is the handling of the customer’s bank credentials by third party payment service providers. The bank needs to be able to perform strong authentication to ensure that the authorized account user is behind the initiation message

There are concerns about security aspects related to PSD2. An example hereof is the secure authentication. All the PSPs will have to ensure that they can demonstrate compliance with the new security requirements. How it will be achieved and monitored ? How will TPPs  interact with banks, since there is no need for a contract to be signed?

If something does not work correctly, there will also be discussions on the liability side. The PSD2 states that the TPP has to reimburse customers quickly enough that they are not bearing undue risk, but one will have to determine which TPP had the problem and work with them to resolve it. This will require further clarifications from the regulators.

In addition the PISP and the AISP vulnerable for to potential frauds. Web and mobile applications could become easy target for cybercriminals for various reasons, including the inherent vulnerabilities in the APIs that transfer data and communicate with back-end systems. The openness of the web could allow hackers to view source code and data and learn how to attack it. APIs have been compromised in several high-profile attacks that have caused significant losses and embarrassment for well-known players and their customers. The PSD2’s ‘access to account’  increases not only the number of APIs, but adds layers of complexity to the online banking/payments environment, adding to the risk of fraudulent attacks.

The market is waiting for the RTS (Regulatory Technical Standards) to give guidance on how some remaining security issues will be solved. These include:

  • Treatment of PSU’s (payment service user)security credentials
  • Requirements for secure communication between the PSP and banks
  • Full details and definition of strong authentication
  • Safety of the PSU funds and personal data
  • Availability of license registry for real-time identification of the PSP (PISP or AISP)

It is important that the required clarifications are published soon, in order to avoid a time lag between the implementation of PSD 2 in the national legislations and the real move in the market.

Conclusion

The PSD2 creates challenges, such as the huge investments to be made by the banks, compliance issues and protection against fraud and cybercrime. However several topics need to be clarified such as the RTS and the market players need also to agree on common standards for the interfaces. The clock is ticking in the PSD race.

Traditional players such as the banks appear to have a competitive disadvantage vis-à-vis the new emerging third party payment service providers. However, the Directive opens up new forms of a collaborative approach that can overcome this. New players can provide their innovation and resilience, whilst banks can add value thanks to their large customer base, credibility, reach and ability to cope with high volumes.

The biggest potential benefits might be for customers, who will benefit from new value propositions, services and solutions from new entrants, from banks and new entrants combining their individual strengths, or from banks becoming more innovative in the face of increased and agile competition.

François de Witte – Senior Consultant at FDW Consult

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PSD 2: a lot of opportunities but also big challenges (Part I)

| 26-1-2017 | François de Witte |

The Directive 2015/2366 on payment services in the internal market (hereinafter PSD2) was adopted by the European Parliament on October 8, 2015, and by the European Union (EU) Council of Ministers on November 16, 2015. The PSD2 updates the first EU Payment Services Directive published in 2007 (PSD1), which laid the legal foundation for the creation of an EU-wide single market for payments. PSD2 came into force on January 13, 2016, and is applicable from January 13, 2018 onwards.

By that date the member states must have adopted and published the measures necessary to implement it into their national law.

PSD 2

PSD2 will cause important changes in the market and requires a thorough preparation. In this article, we are summarizing the measures and highlighting the impact on the market participants. In today’s Part I we will focus on abbreviations and main measurers introduced by PSD2.

List of abbreviations used in this article

2FA    : Two-factor authentication

AISP  :  Account Information Service Provider

API : Application Programming Interface

ASPSP : Account Servicing Payment Service Provider

EBA :  European Banking Authority

EBF :  European Banking Federation

EEA :  European Economic Area

PISP :  Payment Initiation Service Provider

PSD1:  Payment Services Directive 2007/64/EC

PSD2  :  Revised Payment Services Directive (EU) 2015/2366

PSP : Payment Service Provider

PSU:   Payment Service User

RTS : Regulatory Technical Standards (to be issued by the EBA)

SCA : Strong Customer Authentication

TPP :  Third Party Provider

Main Measures introduced by PSD2:

The  PSD2 expands the reach of PSD1, to the following payments:

  • Payments in all currencies (beyond EU/EEA), provided that the two PSP (Payment Service Provider) are located in the EU /EEA (two legs)
  • Payments where at least one PSP (and not both anymore)  is located within EU borders for the part of the payment transaction carried out in the EU/EEA (one leg transactions)

A second important measure is the creation of the Third Party Providers (TPP). One of the main aims of the PSD2 is to encourage new players to enter the payment market and to provide their services to the PSU (Payment Service Users). To this end, it creates the obligation for the ASPSP (Account Servicing Payment Service Provider – mainly the banks) to “open up the bank account” to external parties, the so-called, third-party account access. These TPP (Third Party Providers) are divided in two types:

·        AISP (Account Information Service Provider) : In order to be authorized, an AISP is required to hold professional indemnity insurance and be registered by their member state and by the EBA. There is no requirement for any initial capital or own funds. The EBA (European Banking Authority) will publish guidelines on conditions to be included in the indemnity insurance (e.g. the minimum sum to be insured), although it is as yet unknown what further conditions insurers will impose.

·        PISP (Payment Initiation Service Providers): PISPs are players that can initiate payment transactions. This is an important change, as currently there are not many payment options that can take money from one’s account and send them elsewhere. The minimum requirements for authorization as a PISP are significantly higher. In addition to being registered, a PISP must also be licensed by the competent authority, and it must have an initial and on-going minimum capital of EUR 50,000.

Banks will have to implement interfaces, so they can interact with the AISPs and PISPs. However, payment initiation service providers will only be able to receive information from the payer’s bank on the availability of the funds on the account which results in a simple yes or no answer before initiating the payment, with the explicit consent of the payer. Account information service providers will only receive the information explicitly consented by the payer and only to the extent the information is necessary for the service provided to the payer. This compliance with PSD2 is mandatory and all banks will have to make changes to their infrastructure deployments.

Source: PA Perspectives on Nordic Financial Services
http://www.paconsulting.com/our-thinking/perspectives-on-nordic-financial-services.

A third important change is the obligation for the Payment Service Providers to place the SCA (Strong Customer Authentication) for electronic payment transactions based in at least 2 different sources (2FA: Two-factor authentication) :

  • Something which only the client knows (e.g. password)
  • A device (e.g. card reader, authentication code generating device, token)
  • Inherence (e.g. fingerprint or voice recognition)

 

The EBA (European Banking Authority will provide further guidance on this notion in a later stage. It remains to be seen whether the current bank card with pin code is sufficient to qualify as “strong customer authentication”. This “strong customer authentication” needs to take place with every payment transaction. EBA will also be able to provide exemptions based on the risk/amount/recurrence/payment channel involved in the payment service (e.g. for paying the toll on the motorway or the parking).

PSD2 also introduces some other measures:

  • Retailers will be authorized to ask to the consumers for permission to use their contact details, so as to receive the payment directly from the bank without intermediaries
  • There will be a ban on surcharges on card payments
  • There will be new limitations on the customer liability for unauthorized payment transactions

In a second article soon to be published on treasuryXL, François de Witte will focus on the impact PSD2 has on market participants. 

François de Witte – Senior Consultant at FDW Consult

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Working Capital Management – not just a finance issue

|14-12-2016 | François de Witte |

money-iii

 

When looking at the sales, conversion and procurement cycle, we should not only focus on the stated DSO, but also at the hidden DSO. In order to identify this, we must go much further to a complete analysis of the order to cash cycle, as illustrated by the following  6 examples:

 

 

  • Several companies do not manage their inventory efficiently
  • Quite a lot of companies still have a time lag between the moment that the goods and the services are delivered, and the moment that the invoice is issued
  • Several  companies still issue paper based invoices. The postal delay will also increase the collection time. For this reason, I recommend to my clients to move to e-invoicing
  • When I worked with a car dealer, I realised that between the moment that the cars were delivered by the importer, and the moment that they were sold, there was a huge time lag
  • A marketing company struggled with the process of offers, leading to purchase orders, because the various participating units did not provide their time sheet and cost estimation in time.
  • On the inventory side, purchase of spare parts were done, even without having a duly executed purchase order of the client, and clients were not reminded in time to take delivery of the goods, resulting in higher stocks

Hence, when starting an assignment on the working capital management optimisation, one should not only look at the processes within finance, but at the overall processes.in the company. By analysing the detailed processes on the floor, you can better understand the drivers of the cash conversion cycle, and take some actions, such as:

  • Ensuring that procurement only purchase spare parts when they have a duly executed purchase order, with then required the advance payment
  • Making staff aware of the need to ensure a quick invoicing process
  • Understanding the possible resistance to new concepts such as e-invoicing and automated incoming document scanning
  • Identifying the triggers, which will make that the staff cooperates to reduce the order to cash cycle
  • Having a better alignment between the finance staff and the sales department on e.g. the credit risk and the payment terms
  • Make procurement more sensitive to treasury aspects. I have seen several cash risk companies who left aside the possibility of supply chain financing of discounting schemes, because the KPIs of both procurement and treasury were not aligned;

But overall, if you wish to succeed in optimising the cash conversion cycle, you need to ensure that the changes are embedded in the organisation by:

  • Explaining to all the participants the importance of working capital management and their contribution to it
  • Providing to the various participants KPIs in this area, which are monitored on a regular basis. In my recent assignment, we have put joint KPIs for the Sales Administration in prompt invoicing and in DSO terms
  • Ensuring also that there is an internal control on the procedures
  • Ensure that you have the correct tooling (e.g. e-invoicing, credit management, credit collection, etc.)
  • Having a regular review of the processes

We can conclude that an efficient working capital management is a matter for the whole company. Beside hard skills, you also need soft skills and KPIs to ensure that the processes are really embedded in the organisation.

francois-de-witte

 

François de Witte

Senior Consultant at FDW Consult