The huge impact of multilateral netting on the credit risk and working capital management

Credit risk exposure and working capital financing are two of the main areas that concern businesses today. Currently these problems are being partially addressed by Financial Institutions but unfortunately they are not solving them efficiently. Banks offer, on the one hand, accounts receivable and business credit insurance to mitigate the credit risk exposure of businesses but these products are expensive and tight sales margins do not permit contracting them extensively. On the other hand, they offer short-term financing solutions to cover temporary deficiencies in funds so that companies can meet their accounts payable and other obligations, but credit is tighter and more expensive now than at any time in recent history and static discounts don’t reflect suppliers’ dynamic cash needs.

Peer-to-peer finance

Current solutions do not offer a suitable answer to the problems that businesses face. This has led, during the last few years, to the emergence of new entrants providing non-banking methods of financing to try to solve the problems commented above with a clear aim of banking disintermediation. This trend can broadly be described as “financial intermediation involving entities and activities outside the regular banking system”. Some examples of peer-to-peer finance (P2P Finance) business models that are trying to address the credit risk exposure and working capital financing problems are:

  • Peer-to-peer lending (P2P Lending) or crowdfunding platforms where individual or professional investors provide funds directly to businesses or projects allowing entrepreneurs to access funding in an easier and much cheaper manner.
  • Invoice discounting solutions that allow suppliers to obtain short term funding from their clients.

Obviously, these new channels are not substituting the traditional banking channel but they do complement it, giving businesses an alternative access to liquidity.

Additionally, not all disruptive and innovative solutions for the non-banking segment are emerging in the funding channel space. Following the same trend of banking disintermediation, new payment methods and platforms are also appearing. The new online payment platforms that are being developed are primarily focused on the individuals (P2P) or merchants (P2B) segments. When it comes to business-to-business (B2B) payments, there are some new entrants emerging that allow real time payments and provide businesses a greater visibility into the payment process, but they miss completely a much higher value-add capability such as debt multilateral netting, with which the need for money movements can be dramatically reduced, improving the system efficiency as a whole.

Although this multilateral netting process may sound extremely disruptive in the B2B payments area, it is in fact already being used in several areas of the financial sector, including interbank transactions, brokerage companies and intergroup subsidiaries.

  • Within the interbank payments, the clearest example is the Clearing House for International Payment System (CHIPS) in the United States which is in charge of processing fund transactions, particularly interbank settlements. Before effectively settling the funds, CHIPS executes a multilateral netting process of the different positions each bank has, so as to avoid mutual or cyclic payments, and reduce costs.
  • Brokerage companies and Clearing Houses perform the multilateral netting processes at the end of the day as part of their standard daily operations.
  • Multilateral netting processes between intergroup subsidiaries are also extremely common. In this segment, many multinational companies with subsidiaries in different countries and currencies utilize this methodology to save a significant amount of money.

 Multilateral netting benefits

Netting processes can help solving significant problems as described earlier. The multiple benefits that netting provides have been largely proven in other segments of the financial sector, but multilateral netting can also help businesses and governments both with their commercial debts and other financial obligations.

Multilateral netting capabilities allow businesses to only finance what is really necessary, thereby generating a significant costs reduction, at the same time that the facility to gain access to funding increases (compensating debts, companies´ financial ratios improve). Among other things, multilateral netting promotes early-payments, reducing credit risk exposure given that once the invoice is paid, the credit risk disappears.

Separately, as Lisa Pollack explains on the Financial Times´ Alphaville Operation sovereign debt net (http://ftalphaville.ft.com/2011/09/19/680436/operation-sovereign-debt-net/), multilateral netting would allow sovereign debt cancelation among countries: The EU countries in the study can reduce their total debt by 64% through cross cancellation of interlinked debt, taking total debt from 40.47% of GDP to 14.58% […] France can virtually eliminate its debt – reducing it to just 0.06% of GDP.”

The European debt crisis is the shorthand term for Europe’s struggle to pay the debts that have built up in recent decades. Five of the region’s countries – Greece, Portugal, Ireland, Italy, and Spain – have, to varying degrees, failed to generate enough economic growth to make their ability to pay back bondholders the guarantee it was intended to be. A powerful and efficient mathematical algorithm such as the one LICUOS has developed would allow the cross cancellation of interlinked debt. Even then, it would be necessary to solve a series of additional problems that are highlighted by Lisa Pollack:

  • Fungibility: “[…] sovereign debt varies along many parameters — currency, maturity, law under which it is issued, coupons, covenants…The list goes on and on, which leads to…”
  • Agreeability: “[…]  the only way to get there is to agree parameters for valuing certain attributes […] it can take years to agree on valuations”
  • Desirability: “[…] one may be holding certain assets and liabilities for a reason, whether one is a central bank, an individual, a pension fund, or an actual bank.”

These problems aside, the fact that the countries are maintaining so much interlinked debt (we can see the amount of debt in the “Eurozone debt web” developed by BBC http://www.bbc.co.uk/news/business-15748696) indicates that there is huge opportunity to solve, at least partially, one of the biggest problems Europe has.

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LICUOS, making it possible

With the problems of credit risk and working capital financing remaining unresolved by the financial institutions, a non-banking system of funding and payments has been created.

Peer-to-peer based platforms do try to provide an answer to these problems, and do so following the current trend of disintermediation of financial services, however they are not able to address the huge value-add that can be obtained through services such as debt multilateral netting. In this environment, and overcoming the shortfalls of existing solutions, we are proud to introduce LICUOS: www.licuos.com.

LICUOS is the global B2B platform that provides multilateral netting, payment and funding services to other companies that do not necessarily belong to the same group, in an easy, intuitive and automated manner.

LICUOS has developed a unique proprietary and patent-pending technology that automatically identifies and generates the most convenient and efficient multilateral netting, with completely automated payment and funding proposals that also manages all of the associated transactions that allow businesses to significantly reduce or eliminate their commercial debts.

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