The questions surrounding the setup of your back-end system can be overwhelming and daunting – What are my options to make sure I adhere to PCI standards? Is my system compliant? What measures should be taken to prevent a data breach? Is it necessary to house the information or outsource the storage of payment data?

The responsibility to manage your card payment environment is delicate and any breaches in PCI compliance could lead to potential negative fallback from your customer’s perception of your company. This could lead to diminished sales, fraud losses, higher subsequent costs of compliance, as well as other very expensive costs of remediation such as credit monitoring to all impacted customers, damaged systems, cash paid out, and damage to your brand name.

As Eric Page, Senior Director of Compliance and Controls at Airgas says:

“[PCI Compliance] is a company wide effort. When we look at PCI, the cost is not necessarily just what we pay to vendors [or] how much the salaries are of the people managing PCI. It’s the intrinsic cost across the organization to make sure that everybody knows what PCI rules are, how PCI affects the organization, how critical it is to maintaining our internal control, and how critical it is to make sure our executive officers can sleep at night.”

Eric Page, Senior Director of Compliance and Controls at Airgas

What is PCI Compliance?

In 2004, the main players in the payment card industry established several security requirements called the PCI (Payment Card Industry) standards. They did so in order to address the ever growing increase in payment card fraud. The goal was to harmonize the security measures between different parties in the payment card realm. Each party is responsible for ensuring the rules are properly applied by its members.
PCI Security Standards have 3 different components, which include all parties involved in the payment card chain:

• PCI PTS: PIN Transaction Security applies to payment card terminal manufacturers
• PCI PA-DSS: Payment Application Data Security Standard applies to developers
• PCI DSS: Data Security Standard applies to merchants and processors

The standards continue to evolve and update in order to keep up with the ever changing landscape of technology and fraud. “You have to deal with the PCI Council and when they change the regulation and you have to mirror that with your requirements on top,” says Eric Page, “so it does become a challenge not only to keep up with the latest risks but also keep up with the latest regulation and latest technology—we try to keep pace with all of that.”

What are the requirements of PCI Compliance?

For the purposes of this conversation, only the Data Security Standards (DSS) requirements that apply to merchants and processors are highlighted below. There are 12 requirements broken down into six different goals.

These 12 requirements are only the minimum in order to be in compliance with the Payment Card Industry’s Data Security Standards. These requirements alone do not guarantee against data breaches, and depending on your business you should exceed what is expected and treat your customer’s data with the utmost safety. At Airgas, Eric Page and his team tighten things up far more than standards require. “Just because there are PCI standards out there, doesn’t mean that is our exact guidebook; we use those as minimum standards, and above and beyond those in certain areas we make sure that we reduce our risk and really address those concerns through additional controls, additional security measures, as well as configuration.”

What are my PCI Compliance obligations and what options do I have?

PCI compliance has a far reach in all avenues of payments and fortunately, the burden of data security does not have to fall solely on the merchant’s shoulders. There are two options for PCI compliance: outsource to a specialized vendor or accept the burden and internally house the payment card data securely.

One avenue for payment processing is to eliminate the need for the customer’s payment method from passing thru the merchant’s site, such as utilizing PayPal, Amazon, Square, or other providers to bear the burden of payment data security. By adding these providers as a form of collection of payment, the merchant reduces their risk and thereby reduces their PCI compliance obligations. This is exactly how Eric Page discussed Airgas’ approach to their compliance.

“As our business changes we have to keep up with vulnerabilities to our existing business. We bring in experts that tell us what the new vulnerabilities are. So that is key—we have partnerships outside of Airgas, and the folks inside of Airgas that have intense knowledge of how our networks are set up, where payment card data flows through. So for us we look at the different payment channels. We understand our global risks, we seek outside expertise to analyze those risks, and then internally we ask ourselves where our payment card data is flowing through our systems and try to remove it as much as possible. We try to tokenize it as soon as we get it and try to move it outside of our systems so that we don’t have any actual credit card data in our systems. There has been an evolution for a hands off approach to credit card data, and that is to let the experts handle it, because they know how to encrypt it and keep it safe, use the data only when necessary, and keep that data and information out of the hands of bad actors.”

Eric Page, Senior Director of Compliance and Controls at Airgas

However, some merchants prefer to have a DIY approach and house the card data internally. PCI compliance would need to be examined from the beginning of the payment transaction to the storage of the card data. A full blown assessment of the credit card data flow would need to be mapped out followed by the phases needed to secure the information. This would consist of testing the storage of the data on the merchant’s internal network, conducting random penetration tests, and sampling the data for any potential breaches. A partnership across internal departments from Treasury to IT would be needed along with input from your providers to ensure compatibility with your internal systems/networks.

Regardless of the approach, the degree and frequency to which your systems must be assessed depend on which tier or level your business falls into. These levels are largely based on the amount of payment card transactions your business processes annually.

As merchants move up the compliance tiers, their obligations and responsibilities increase. In order to better meet the requirements merchants should not store any customer data when it is not necessary to do so, segment networks and separate systems that store, process, and transmit cardholder data from those that do not, tokenize transactions, and/or equip a point-to-point encryption solution. Utilizing these recommendations, merchants can drastically decrease their PCI DSS scope.

An annual self-assessment questionnaire (SAQ) is one of the requirements that all merchants must complete, except for those that qualify as level 1. These merchants instead are subject to an annual compliance report completed by a qualified security assessor or internal auditor. The majority of merchants that qualify in the other 3 tiers will all have a questionnaire to be completed by a dedicated employee(s) of the merchant. These questionnaires are meant to validate and document the results of the merchant’s own PCI DSS self-assessment and detail their level of compliance. The specific questionnaire that each merchant completes will vary greatly depending on the merchant’s business.

What channel are my payments accepted and how does that affect my PCI compliance?

Whether your payment card transactions are taken in person, over the phone, or online, they are all subject to the same 6 goals and 12 requirements of PCI DSS. Although the requirements are always the same, the stakeholders and systems involved in the transaction flow will surely differ. Which is why the questionnaires meant to document merchant’s level of compliance differ based on your business. As the merchant, it is important to understand all of the employees, stakeholders, systems, and networks your payment card transactions flow through for all of your different payment channels. Airgas accepts payment card transactions over all three channels so Eric Page needs to ensure he has a complete understanding of the transaction life cycle from start to finish, and then ensure his understanding is passed on to other relevant parties.

“We have a telesales environment where account managers process telephone orders. Those account managers need to know how to safely handle credit card transactions just as much as the person at the store location that actually receives a credit card and swipes it. So all of those people have to receive information in different ways and we have to train them differently. You can’t train someone sitting at a desk with a headset on all day the same way as someone at a physical location. The stakeholder depends on how we have to approach it. Our role with PCI is to make sure we’re aware of who touches it, what’s our risk, making sure the controls are in place, then most importantly, testing it to make sure that what we say we are doing is what we are doing.”

Eric Page, Senior Director of Compliance and Controls at Airgas

Other merchants may not have been used to multi-channel payment acceptance, but this pandemic has forced many merchants to implement an additional payment channel like e-commerce or even develop an omnichannel solution. Additionally, especially with an omnichannel solution, creating customer profiles aimed at increasing customer loyalty with faster and improved checkout experiences is quickly becoming the standard. The only way to maintain customer specific profiles is by collecting and storing customer information.

Although collecting and storing this information increases risk, exposure, and your PCI DSS scope, there are still ways to do this safely. In addition to the 12 PCI DSS requirements, merchants can utilize multi-pay tokens that encrypt customer cardholder data at the time of the transaction. That token will stay with its respective cardholder for the life of the card and can be used across the merchant’s entire payments platform. Multi-pay tokens present a tremendous opportunity for merchants to meet customer’s checkout experience expectations, while at the same time keeping their sensitive data safe and secure.

In conclusion, PCI compliance is not a topic that any merchant can afford to ignore. Increased regulations and obligations inherently make doing business more difficult, but these security standards were born out of necessity and are meant to protect both the customer and the merchant. Obtaining compliance is not an easy task and it’s never completely achieved as technology and standards progress and change.

It’s important to identify employees within your company that can be champions of the compliance process, while also remembering that there are industry experts and other resources available. These resources can help make the process as easy as possible and reduce the burden placed upon the merchant. Utilizing these resources are key to maintain compliance with the data security standards and above that, ensure your customer’s data is properly safeguarded. Airgas has the employees and internal processes aimed at giving PCI compliance the attention it deserves, but what sets Airgas apart is their ability to utilize the resources within the industry. These items together make Airgas a pillar for success and an excellent merchant to model after.

Justin DiCioccio & Sara Moren

A special report on the cash management & payment trends that will transform your treasury department in 2022

The growth and vitality of the payments industry has fascinated all observers during the past two years of the pandemic. Now with recent geopolitical developments arising from the Russia-Ukraine conflict, it is being tested again.

Our new publication analyzes the most prevalent trends and innovations in the treasury world today.

What can virtual accounts offer?

Virtual Accounts have evolved through technological innovation, offering businesses the advantage of streamlining account structures and enabling true end-to-end solutions that are fluid, accessible, and integrated. Virtual Accounts provide broad functionality and facilitate interconnectivity between debt, receivables, and liquidity solutions through a better view and control of the activity. They also support localization strategies and global treasury operations. The primary benefit of virtual accounts is the concentration of all activity into a single physical account, while maintaining the ability to reconcile transactions at a more granular level (e.g. by entity or customer).

Advantages of virtual accounts

For many international businesses, global banking is time-consuming, frustrating, and costly. Without a resident bank account in Europe, international payments can take nearly a week to post. In addition, because of the sprawling systems and thousands of employees of traditional banks, the costs are high.

With virtual accounts, you do not need to be a resident to open an account. This is not the case with opening traditional bank accounts where you have to be a permanent resident. Virtual bank accounts are a solution for global entrepreneurs who do not have European residency, for example. This avoids the complexity and costs associated with traditional international cash pooling.

Virtual bank accounts can also facilitate the centralization of cash activities and daily cash management. They add agility in the structure of payments and receipts with the ability to open, close, or modify as many virtual accounts as needed and organize account hierarchies at your convenience without the need for heavy KYC documentation.

In addition, virtual accounts maintain the traditional bank reporting functionality with Swift, Camt, and other methods available. Undertaking digitization as part of the virtual accounts project allows for centralizing of the cash flow and achieving economies of scale. For professionals, it guarantees better visibility and control of transaction volumes.

Drawbacks of virtual accounts

Despite all of the benefits and years on the market, companies have been slow to adopt virtual accounts. There are a few reasons as to why this slow implementation into the market persists:

1. The first issue is that not all banks are at the same level of development due to different banks having different capabilities across geographical regions. Not all banks offer virtual accounts, at least not in the optimal capacity. In some cases, banks do not develop this offer as a priority due to lack of demand. For example, regional banking in countries where legal restrictions are important and where physical accounts are mandatory negate the benefits of virtual accounts. In other cases, it is a question of technical capacity. The issuance of virtual accounts adds a new layer of reconciliation complexity from the provider’s perspective.
2. The second issue is companies’ fear, uncertainty, and doubt surrounding significant changes in their treasury model. Indeed, banks need to address customers’ risk appetites in this new transition. For example, coding between physical and virtual accounts may not be the same, which can generate problems for companies if the bank has not made the link.
3. The third issue is the unwillingness or inability to accept significant change in the treasury structure required by implementing virtual accounts. Projects can be spread out over a few months to more than a year depending on the company and the internal resources available. Moreover, teams within a company require thorough training to be able to take full control and realize all of the benefits the virtual structure has.

In addition, certain tools are required, such as TMS, for maximum use of the solution. It is therefore understandable that the move to virtual accounts requires a great deal of effort on the part of companies in terms of time and cost associated with this change. Virtual accounts also suffer from their current lack of recognition as an innovative payment architecture. Plus, the interest of the banks is not necessarily to push the solution if the companies do not have many accounts in other banks.

Is there an ideal virtual account customer?

At first sight, virtual accounts are a product for all companies that want to be innovative.
The product can be implemented by a young start-up that can initiate a flexible and innovative architecture from its inception before making it more complex as it grows over the years.

They can also be used by large, mature firms to simplify the treasury structure, optimize cash management efficiency, and facilitate post-acquisition integrations. A large number of companies can be interested in this, from educational institutions, loan companies, electronic distributors and generally all companies acting in B2B, to retailers and others! Virtual accounts allow companies to customize the transfer and collection chain, so revisiting a traditional architecture will make sense.

Companies that are in the process of rationalizing the number of bank partners and accounts should be very interested in virtual accounts, as they offer a quality service and their implementation fits perfectly with this transition.

Virtual accounts are not an isolated solution. What makes VAM structures powerful is their connectivity with other capabilities related to cash, payments, collections, channels and currencies. A complete VAM solution has the power to transform a reporting layer service into an effective and powerful business tool. A company that is looking to revamp its payment chain would be well advised to take an interest in the subject.

When to transition into virtual accounts

Virtual Accounts have evolved with technological innovation and virtual reference numbers have paved the way for more holistic virtual account offerings that streamline account structures. These offerings enable true end-to-end solutions that are seamless, accessible and integrated. They offer broad functionality and facilitate interconnectivity between debt, receivables, and liquidity solutions. They support localization strategies as well as global treasury operations and
Virtual accounts are part of a futuristic vision of treasury and the digital transformation that is and will continue to be required to centralize flows while retaining visibility and control.

The rather “slow” implementation can be explained by the human factor and the magnitude of a project affecting the entire treasury function. The transition between the traditional to the virtual model requires technical skills and support in the implementation and thus human resources for IT integration. The ideal moment to make the transition ultimately depends on each company’s specific situation, but the benefits of virtual accounts await those who are willing to take the plunge.

Thomas Finkelsztejn & Chris Gibson

A special report on the cash management & payment trends that will transform your treasury department in 2022

The growth and vitality of the payments industry has fascinated all observers during the past two years of the pandemic. Now with recent geopolitical developments arising from the Russia-Ukraine conflict, it is being tested again.

Our new publication analyzes the most prevalent trends and innovations in the treasury world today.

For a company seeking liquidity, integrating the ESG dimension into its financial strategy has become key. Today, while numbers are still low in the US, more than 30% of syndicated loans in Europe and nearly 40% of bond private placements (notably EuroPP) include objectives based on criteria of this nature (source: Redbridge). In the euro public bond market, 26% of the amounts raised last year by all non-sovereign issuers were in the form of green, social, sustainable, or sustainability-linked bonds vs. 17% in 2020 (sources: Bloomberg, Natixis).

Sustainable finance will continue to grow until it becomes the new norm in the near future, in Europe as well as in the US. On the supply side, banks are repeating their intention to reallocate their balance sheet resources to clients committed to corporate social responsibility, while an ever-increasing proportion of fund managers’ inflows are directed towards SRI-labeled or equivalent funds.

On the demand side, the “greening” of liabilities has also become a priority for many finance departments. Last September, Redbridge surveyed European and American corporates on this topic: 61% of them had already issued ESG financing or were considering doing so in the next 18 months. Over a five-year horizon, 41% even anticipated that more than half of their financing resources would come from instruments that integrate a sustainable dimension.

Heterogeneous ESG structures

For the past four years or so, this trend towards sustainable finance has been focused on sustainability-linked financing, both in the banking sector (sustainability-linked loans) and in the bond sector (sustainability-linked bonds). These general corporate purpose finance products aim to encourage the borrower / issuer to expand its CSR approach by including a number of environmental, social, or governance objectives (usually two or three) in the financial documentation. Depending on whether or not these objectives are met, the borrower’s credit margin or the issuer’s coupon may fluctuate by a few basis points, either upwards (malus) or downwards (bonus).

In this respect, the deal structuring varies from one transaction to another. Our recent survey showed that two thirds of the sustainability-linked loans raised by the corporates surveyed incorporated a bonus/malus mechanism, and one third a malus mechanism only. For sustainability-linked bonds, the ratio was 75% to 25%. Regarding the size of the bonus/malus, it is generally +/- 5 bps for bank loans and RCF facilities, and between +/- 5 bps and +/- 10 bps or more for bonds.

A virtuous but perfectible approach

Designed to be virtuous, the bonus/malus mechanism deserves to be improved to achieve greater materiality.

First, the purpose of ESG financing is to encourage a company to grow in a more responsible and/or sustainable way. However, the bonus is far too low to be a real incentive, at an average of 5 bps in bank financing. In this respect, sustainable financing serves more to reinforce an existing CSR strategy than to give a boost in this area.

Secondly, banks like to present this bonus as a way to reward their clients for their efforts in favor of major issues, such as energy transition and social inclusion. However, as a reminder, the purpose of the credit spread is to compensate the lender for the default risk of the borrower not being able to make payments. Therefore, the ESG bonus tends to distort pricing and benchmarking. The mechanism further opacifies the banking market, insofar as lenders integrate this potential future bonus into their initial pricing. Since the transactions are different, it becomes difficult to distinguish the price of credit risk. The same goes for private placements.

Add to this the fact that we find it surprising to reward a company for keeping its commitments. Let’s bet today that in the short term, the bonus system will naturally disappear as ESG becomes the norm, leaving only a penalty.

Who benefits from the mechanism?

In a mechanism where the borrower who fails to meet its CSR objectives is penalized with an additional margin, the question of how the malus is allocated is central. Currently, the malus is allocated to the lenders in almost all transactions. The banks consider this situation to be legitimate and are even happy to claim it! For example, ING recently explained its position in these terms: ” As a credible sustainability strategy aligns increasingly with credit risk, discounts and premiums are part of a bank’s business model and we would be reluctant for them to go to charity”.

Our analysis of the subject is completely opposite. Given the philosophy of sustainable finance and the onerous costs of ESG compliance, failure to meet targets should not be exploited by lending institutions with no transparency for borrowers. The mechanism must redirect the malus to specific projects related to the energy transition or social impact managed by the company or institutions working to offset the non-completion of the sustainability targets.

Our advice to corporates

1. Be a driving force in the structuring of financing
   Despite the existence of guidelines (Principles) established by international organizations such as the International Capital Market Association or the Loan Market Association, practices related to the implementation of a sustainability-linked loan remain disparate from one lender to another. As banks seek to impose their own standards, it is essential to maintain control over the process of structuring the financing (nature of the KPIs used, trajectory of the targets, etc.) so that it takes into account the DNA, business model, and CSR strategy of the company. The best approach to achieve this is to surround yourself with one or two lenders who share your convictions, so that they can then convince the other participants in the syndicate.
2. Negotiate a loan at the right price
   If the borrower cannot avoid the inclusion of a bonus mechanism, he or she must ensure that the financial terms offered are not artificially inflated by banks anxious to cover the potential cost of disbursing the bonus later on.
3. Introduce a progressive malus grid
   Whether the issuer fails to meet its ESG targets by a small margin or by a large margin, the penalty will be the same, as the malus will be applied in a uniform manner. In order to make the issuer more accountable, and in order to stay in line with the “Principles”, we could consider introducing different malus thresholds.
4. Making the use of the malus conditional
   Last but not least, we recommend that corporates include a system for earmarking the funds corresponding to the possible excess margin or coupon in the financing documentation. Thus, this malus envelope could only be used to finance projects that contribute to compensating for all or part of the consequences of not achieving the objectives defined when the sustainability-linked loan or bond was set up.

*ING, Position paper – The credibility of the sustainability linked loans and bond markets, 2021

Working hand-in-hand with treasurers and CFOs to innovatively optimize their financing strategy, liquidity, payments and treasury efficiency, we observe four promising trends in supply chain optimization.

Inventory build

Due to the ongoing supply chain disruptions, cash-rich clients have decided to rebuild their inventories. It is the quickest way to invest cash and avoid the cost of cash balances. Although conceptually simple, it requires a strong understanding of the activity and detailed classification of different inventory categories.

Dynamic discounting

Supporting your suppliers through earlier payments in exchange for discounts brings many benefits for the buyers:

• Attractive risk-free returns. Buyers are effectively investing their own cash in order to capture discounts, which translate into risk-free returns.
• Immediate reduction of the cost of goods and services purchased, which can support procurement KPIs.
• Enhanced supply chain resilience and reduced likelihood of any disruptions.

Conversely, benefits for suppliers include:

• Reduction in days sales outstanding (DSO) and thereby cash conversion cycle improvement.
• Access to external funding, often at a lower cost than other options available, enabling better management of unexpected costs or investment in growth and innovation.
• Choices in financing a single invoice, several, or all of them.

On the implementation side, resorting to digital solutions/platforms can be extremely helpful to avoid the operational burden arising from the management of dynamic discounting programs.

Supplier short-term funding

Should you want to further strengthen your supply chain, another option is to provide your suppliers with direct financing. In such cases, we would highly recommend implementing a counterparty risk assessment framework to avoid adding any risks to your liquidity investment.

ESG reporting

Close to 80% of retail and consumer staples companies’ carbon footprints come from the supply chain. To tackle global warming, suppliers will have to be involved in the company’s CO2 reduction effort.

One way is to associate them with the reduced funding costs you can extract from your banks and investors. Our experience has shown that most ESG or sustainability-linked financing instruments today can help you reduce your funding costs by 5bps to 10bps.

We foresee the rise of supplier financing programs, where suppliers are no longer tiered according to their size or strategic importance, but instead based on their ESG rating or commitment. This is an efficient way to foster the alignment between your suppliers and your own ESG strategy.

Time for action

We assist our clients at various stages to ensure that their projects make a real impact. Together, we build a solid cash forecasting and working capital monitoring framework to identify the optimum available liquidity to invest.

Highlight: Forecasted returns that can be achieved through the above options range from 2% to 12% of the investment, via increased EBITDA and lower cost of funds, i.e., way higher than any secured liquidity investments.

We estimate the potential benefits of supply chain investment to build a business case and support the change management. We support the selection of the relevant digital/platform providers and, when required, we assess counterparty risk profiles, or review counterparty risk policy/process. Ultimately, we implement the above and transfer ownership/expertise to our clients.

– How is the finance-treasury function organized at Albéa?

– A three-person central treasury team in Paris leads the finance-treasury function, and it relies on local relays in India, China, Indonesia and the U.S. This setup provides centralization without a hierarchical relationship. Each financial director has autonomy and the ability to consult local banks. We’re keen to retain this entrepreneurial spirit and enable our local finance directors to evolve freely within a defined framework and shared processes. It’s an organization based on trust, mutual recognition and appreciation — and it works well.

The central treasury department plays a supporting role by providing knowledge and experience. We help everyone to carry out the reporting that is crucial for our executive management team to monitor activity. We also provide tools. Because we have deployed a treasury management system (TMS) for the group, treasury processes between countries and business lines are more secure and homogeneous.0

In terms of financing, the group’s medium- to long-term debt is centralized in our holdings in Luxembourg. Our priority is to fund the working capital needs of our subsidiaries. To that end, we have four cash-pooling schemes – in Europe, the U.S., China, and Indonesia – as well as factoring programs in Europe. Until recently, we also had an Asset-Based Lending (ABL) scheme in the U.S. In China, our factoring program is dormant because our subsidiary’s treasury has a surplus. Financing working capital needs enables us to eliminate the discrepancies between our receipts and disbursements — and ultimately to better manage inventory. This is essential in our businesses.

– What principles guide your banking relationships?

– We seek to establish stable, long-term relationships with banking partners capable of providing quality cash management services in line with local needs. We are still working with too many banks around the world — a total of about 30. Our bank account structure could be simplified so that we can spend less time reconciling, minimize operational and fraud risks, and free up teams’ time for projects with higher added value. The ideal target would be to have two local banks and one international bank in every major geographical area in which we operate.

The adoption of our treasury system has led us to streamline our banking environment with the aim of limiting the multiplication of contracts, licenses and implementations on the one hand and concentrating our side business on the other.

– What challenges did your recent cash management tender in the US involve?

– In the U.S., where we make a quarter of our turnover, we had a single bank. The relationship had existed for a decade or so. We were satisfied with the quality of the cash management services, but the relationship had become strained with respect to the functioning of our ABL program. This collateralized financing, worth some $60 million, had many constraints — do’s and don’ts — requiring the U.S. banking partner to agree to our development strategy. We felt like we had a bank whose team failed to understand our concerns and those of our board of directors.

Repaying the ABL removed all of our obligations to the U.S. banking partner and facilitated all of our M&A operations. As such, we repaid the debt, paid the break-up fees, and put inter-company financing in place. This, in turn, triggered an immediate termination letter from our bank. We had 120 days in which to leave the relationship with the bank. Our priority was to notify our clients and launch the process of selecting a new banking partner for the next 10 years.

– How have you replaced your ABL program?

– Having financing from your cash management bank is convenient, but it’s not indispensable. After the sale of several assets in the U.S. in June 2020, the introduction of new financing was no longer an urgent matter. Our U.S. subsidiaries have no debt, and the proceeds from sales remove short-term treasury requirements. The ABL provides an important financing base on invoices and inventory, which we no longer need as much.

Given the funding envelope required for the next three years in the U.S., we decided to break away from the legal, organizational, structuring and lien (guarantees, cross-guarantees, obligors) constraints of the ABL. This will enable us to avoid the hassles we had experienced when dealing with our former banking partner.

We have naturally switched to factoring, which is a lighter, simpler solution that is not too expensive. This new funding is confirmed for three years, like our European program. From the point of view of rating agencies, it is a stable resource. Finally, in the U.S., factoring is seen as true sales (no recourse) and, therefore, deconsolidating, which is an additional advantage.

– What criteria did you use to select your cash management partner

– We had a preference for a U.S. partner that was fully compatible with our banking communication tool and TMS. We were also looking for a bank recognized by our clients and suppliers. We wanted a partner that was well known and recognized in-house; able to deliver the same quality of service as our former cash management bank, including the capacity of setting up letters of credit, guarantees, leasings and financing beyond factoring; and provide the broadest possible portfolio of services.

The structuring of the tender, led by Redbridge, enabled us to prioritize the essential matters: lockboxes, letters of credit, treasury tool compatibility, forex, and generation of dematerialized checks. We built our specifications in project mode. With the call for tender, which was conducted quickly and efficiently, it was ultimately easy to separate from a banking partner we had worked with for 10 years. We were surprised by Redbridge’s ability to put us in contact with banks that we would never have dreamed of.0

The collaborative approach also facilitated the final decision. We got our U.S. subsidiaries on board before proposing the final choice to Albéa’s Chief Financial Officer, and there was no hesitation in our selection. Moreover, although the priority was to change banks, we achieved the savings that we had envisaged two years ago when we were looking into the matter.

– Constance Veron, you have accompanied for Redbridge your client Albéa in this RFP. Can you briefly explain the choices that were made with Albéa to match the deadline?

– Because Albéa only had one banking partner in the U.S., we needed to find one or two new partners who could address all of their needs and constraints in terms of cash management and financing. We built our specifications in project mode and invited U.S. banks, international banks and lenders to the RFP. We designed the tender to include both cash management and financing while prioritizing essential matters such as lockboxes, letter of credits, treasury tool capability, forex and digital check solutions.

Redbridge already assisted Albéa in our TMS selection, so we were familiar with its treasury operation, and it made the difference in completing the project within the limited timeframe we discussed. We worked closely with the banks to find the best solution and services for Albéa, as well as competitive pricing. Less than three months from the beginning of the project, Albéa found a new U.S. banking partner for our cash management operations. After the review of all the financing offers received, none of the banks or lenders met during the RFP process offered us a factoring program. Instead, most banks were proposing either a new ABL program or a noncommitted or overly restrictive program for Albéa. So, we finally selected a factoring program with one of the group’s partners in Europe that met all of the requirements of the financial department.

– Oliver, how has the migration  to your new bank taken place?

– Once the accounts were live, we first circulated the information to our clients and then called each of them to let them know about the change of bank. Fortunately, we had a strong relationship with our U.S. clientele. We issued our first payments. Apart from electronic checks, which we are not yet fully prepared for, we have re-established the full range of banking services, enabling our U.S. entity to operate as normal. We are currently using our new bank’s in-house platform, and the connection to our treasury tool will take place at the end of the year.

– What about your financing partner?

– We selected Eurofactor for the U.S. factoring program. It already operates our pan-European program and provides a tool compatible with our TMS. True sales involve additional legal costs, but overall the cost of our financial resource in the U.S. has fallen considerably compared with the pre-existing ABL. A slight downside is that financing will only be credited D+1.

– What are Albéa’s treasury plans now?

– We always have a lot of projects on the go! We aim to finish optimizing our treasury architecture with our TMS, to continue aligning our internal signatory processes and operating methods, to train subsidiaries that fall within our TMS, and to activate the new modules on our treasury tool, such as netting, cash forecasting, cash pooling, debt management and exchange rates. We also intend to prepare as best as possible for M&A operations in the near future by starting to reflect on our debt structure and the positioning of our credit profile (credit insurers and rating agencies).

What is in-house banking?

An in-house banking structure aims to replicate the services offered by an external bank. Such services can include liquidity management, payments on behalf of (POBO), collections on behalf of (COBO) and even managing the foreign exchange risk of a group’s sub-entities.

Adopting in-house banking encourages the finance department to revise its practices and rethink its effectiveness and alignment within the organization.

The benefits

In-house banking can provide a company with a number of benefits.

1. Adopting in-house banking compels a company to define an organizational model to improve its flows and rationalize its banking structure, thereby optimizing the working capital requirement. It enables the company to work with a solid, sustainable cash management structure that can support the company’s growth.
2. In-house banking also enables groups to manage their currency risk better. That’s because currency risks are concentrated within the same entity. It provides a more direct overview of the financial risks and the treasury team can be more responsive when it comes to managing these risks. What’s more, transaction execution costs can be reduced due to the company’s greater bargaining power resulting from its foreign exchange operations being concentrated, and hence bigger in size.
3. In-house banking directly contributes to a reduction in the risk of fraud and improvements in cybersecurity. Group entities reduce their external interactions and delegate responsibilities to the company conducting the in-house banking. The operational risk associated with workflow management is concentrated and opportunities for fraud are minimized.
4. A related benefit of in-house banking is a reduction in bank charges: the complicated banking environment that was previously justified at a local level by a large number of transactions, currencies or even types of cash receipts can be streamlined, reducing the associated fees.

Some important considerations

There are a number of factors to think about before successfully implementing an in-house banking function.

1. 1. Don’t underestimate the scale of the change management process that will be necessary, both within the company and with respect to its customers and suppliers (especially if a POBO-or COBO-type payment center is being established). When implementing such a project, bank flows should be anticipated and the customer recovery service should be supported to avoid a slip in customer payment terms. Training for stakeholders is needed to demonstrate the medium-term benefits of the new structure. There needs to be buy-in among staff as they will be faced with a heavier workload during the implementation phase of the project.
   2. Deploy gradually. There will be substantial effort required from everyone involved, and detailed project management will be necessary. To avoid overstretching your teams, the project can be deployed in phases; for example, by country or region. This also enables the organization to learn and test its processes as it goes. In the projects we’ve been involved with, we have found that good preparation of the project upstream – with the drafting of a target operating model that is the result of collegial reflection between experts throughout the company – accounts for a third of the success of this kind of project.
   3. Ensure that the financial tools your company uses – especially those dedicated to cash management and accounting – are able to support such a structure. The need to manage the allocation of flows and update current accounts manually should be avoided. Work can be carried out upstream to streamline the number of financial applications used by the company. Our customers regularly take the opportunity presented by the implementation of in-house banking to optimize their application environment.
   4. Investigate the potential tax impacts and documentation requirements related to transfer pricing in the jurisdictions involved, both from the perspective of the participating entities and the parent entity. Strong intra-group relationships are vital if all the benefits of establishing an in-house bank are to be enjoyed to the full. The company’s tax scheme can only be optimized if the tax departments are involved in the project from the outset. We also recommend that the accounting treatment of intra-group flows are validated with the company’s auditors. Ongoing management of post-implementation tax audits and declarations is essential.

Prerequisites

We summarize some of the prerequisites for implementing an in-house bank below.

1. 1. • Confirm the maturity of the organization carrying out the project in view of organizational and practical changes. Not all organizations are eligible.
      • Be aware of the tax impacts applicable to the jurisdictions of the companies to be integrated, particularly in cases in which the in-house bank structure includes a POBO- or COBO-type payment center.
      • Assess the ability of the application environment to support an in-house banking structure. In the event of disparities in accounting tools, operating the in-house bank may be a complex affair.
      • Ensure that both the financial department and the IT department are aware that the project is a priority. This is vital if the project is to have the dedicated business (accounting, treasury, tax and legal) and technical resources that it needs at its disposal.

Challenges

In-house banking has been around for some time, but there are still some challenges it needs to overcome.

Harmonization of regulations

Depending on the country, the regulations in force may not necessarily be favorable for in-house banking. But this could change. It’s a good idea to monitor prospective regulatory developments to assess whether it may become beneficial to adopt in-house banking and, conversely, where it may become less favorable to do so.

The increasing importance of technical skills

The successful implementation of an in-house banking project is dependent on the people working on it having the right skills. Beyond the involvement of the CIO, the treasury resources need to be able to combine expertise in both operations and technology. External assistance will sometimes be required.

Conclusion

Despite the cross-functional requirements of this kind of project and the extra work needed to get it up and running, the creation of an in-house bank will bolster a company’s treasury practices and should provide an attractive financial return on investment.

Over the last five in-house banking projects we’ve worked on, the set-up costs have been made back after an average of around 1.5 years of operation. This has been possible due to the reduced bank charges and foreign exchange transaction costs and the return on investment of the additional cash that has been invested.

Taking into account the productivity gains and reduced risk of operational fraud these kinds of projects result in, they pay for themselves, on average, within one year.

Having attended both TXF and GTR conferences in Geneva over the last few weeks, I could not help a feeling of going back to normality, after over 18 months of virtual events only. What looked even better was to see everybody more concerned about how to secure liquidity and risk appetite for performing commodity-trading businesses rather than manage problem loans. Both commodity traders and their bankers need to cope with increases stemming from both volumes and prices.

In the past, as a banker the biggest business risk I saw was that of persistent low commodity prices, with credit lines utilized at 20-30% and revenue seemingly going nowhere. Couple that with low interest rate environment driving overall limited performance of the transaction banking sector and senior management quickly run their attention to cutting costs. Rather short- term thinking!

An even bigger trigger for banks retrenching was brought about by the pandemic with several commodity trading firms causing billions of losses for the main trade finance banks and some specialized direct lenders. A year ago, some banks were completely exiting the commodity trade finance sector, while others were trimming their portfolio as part of a “flight to quality” (probably one of the most misused sayings in modern finance and banking). Again, this was short-term thinking!

The business boom

Fast-forward 12 months and we are in a booming (musical) world. The commodity traders have learned to play the accordion feature of their syndicated facilities. With commodity prices 50–100% higher than a year ago, liquidity is king again – especially for those traders with the privilege of high margin calls, as driven by the rapid appreciation of various commodity prices. As rising prices go hand-in-hand with increased volumes, line utilization has also doubled – or more – over the past year. Profits are accumulating for trading companies, and they are for banks too, which means they are likely to have their best year in a decade.

But it’s not been an easy journey. Banks have been allocating a lot of risk capital to other businesses, and cut head-count s while still struggling with KYC requirements. As I anticipated a year ago, the resilient banks are now reaping the benefits of the current volume and price boom and have successfully passed the stress tests they’ve been subject to.

The “exiters” have become spectators and are now re-thinking their approach. A leading European investment bank is even considering re-entering commodities trading after exiting the arena eight years ago due to the reputation risk it involved and concerns about return potential. But as a commodity structured finance leader stated, “we don’t like banks that come and go”. That perception has a cost too, it’s not just about switching the lights on again.

Is the current business boom sustainable?

Some analysts believe that despite the economic rebound, inflation is only likely to be transitory. But if the economic recovery and pent-up demand for commodities are sustained, there will be continued pressure on liquidity management for commodity traders. The well-known global trade finance gap, as measured by the Asian Development Bank increased from USD 1.5 trillion to USD 1.7 trillion according to figures released on 12 October. This is worrisome as it witnesses the incapacity of the providers of trade finance solutions to keep up the pace with growing needs. And into 2021 this gap is probably much higher in reality, also with risk appetite for emerging markets remaining scarce.

All this means that commodity traders will have to, both compete for bank liquidity and access new, generally more expensive, sources of capital, such as funds, capital markets, family offices and private equity. The latter represents healthy diversification and a reality check, driving up average cost of borrowing.

Meanwhile, competing for bank liquidity should not mean overpaying for bank financing, especially for established players. No more covid premium. It means understanding who their banks are, the right price for the risk bank are taking, and the way it translates into regulatory capital. Basel IV standards, which are expected in January 2023, are still being formulated, and have the potential to deal further surprises affecting the cost of trade financing (watch out for the credit conversion factors and Loss Given Default levels).

Any bank is the sum of its people and its business model

As I mentioned in an article a few years ago, the better commodity trading firms understands what drives their bankers’ perception of risk, the higher the chance of increasing their credit appetite and reducing the margin charged. As one of my former managers used to say, “perception is reality”. The risk perception of your relationship manager and especially that of his business and risk chain will be the reality when it comes to your liquidity and cost of borrowing.

Are you spending enough time improving that perception, or do you think it’s simply the relationship manager’s job to write all those memos, perform risk analysis and ensure you receive an optimal deal? What drives banks’ risk appetite remains an ever- green topic! (click here for a refresher) Will your banker help you become more profitable, on a risk weighted basis, for the bank and hence be able to provide more credit? Will the structure of your facility result in risk-weighted return improvements?

On a related note, linking loans for commodity traders to ESG KPIs is becoming the new norm, almost similar to compliance. There is still work to be done educating both sides, and especially in terms of how companies should be rewarded or punished via their cost of financing in a meaningful way. One thing is for sure: the malus premium should not be kept by banks. Embracing ESG criteria and related mechanisms may alleviate certain internal pressure within banks on the sector. That explains the need to press forward full- steam ahead, embrace the change and learn along the way. But don’t be afraid to challenge what’s relevant and needed in developing the commodity trade finance sector ESG guidelines.

Conclusion

As the pendulum seems to have swung all the way back in a rather short time frame, CFOs and treasurers of commodity traders need to stick to their long term diligence with the banks! Either way, whether prices keep on surging or demand falls in the new year, NOW is the best time to monetize the trust and increased comfort across relationships with those resilient banks while still investing in newer financing partners.

Ensure a successful migration from the MT format

The world of payments is in permanent evolution, but some changes are bigger than others. In today’s environment, commercial exchanges are globalized, and payment transactions are tremendously varied, numerous and complex. To address these challenges, the payment industry is preparing itself for the largest disruption so far in this century: the migration to ISO 20022.

Why is the MT standard being phased out?

Created in 1973, SWIFT (Society for Worldwide Interbank Financial Telecommunication) is a private company that developed the SWIFT network, which enables all businesses and financial institutions to connect and exchange financial messages.

In 1977, the first electronic message using the MT standards was sent. Since then, SWIFT has introduced many changes and innovations to the MT messaging system. Although the new MX standard was introduced in the early 2000s, the old MT standard remains predominant.

The industry, however, has decided to replace the old MT standards entirely with MX messages because they are compliant with ISO 20022 standards.

When will the MT format no longer be available?

The adoption of the MX format will be progressive and depends on countries or regions. In the European Union, cross-border / high value payments across the regions going into the SWIFT Network, Target2 and a few others in scope will be transitioned first in November 2022. The U.S. Federal Reserve will transition in November 2023. Both formats will coexist until 2025 (the deadline set by SWIFT), and most of MT messages will then no longer be permitted. The following figure shows the timeline planned for the interbank space.

Source: ISO 20022 Programme – Quality data, quality payments

What is the main difference between MT and MX messages?

Message type (MT) messages are structured according to the specifications of the ISO 15022 standard, using the FIN protocol. MX messages are structured according to the ISO 20022 standard and use the XML protocol.

Message structures

MT messages are followed by a three-digit number:

• The first digit indicates the message category
• The second digit indicates the message group
• The third digit specifies the message type

The MX message is composed of four parts:

• 4 alpha characters indicate the message type
• 3 alphanumeric characters identify the message number
• 3 numeric characters highlight the message variant
• 2 numeric characters indicate the version number

For example, a single customer credit transfer MT 103 will appear as pacs.008.001.0x in MX format.

MX messages will be composed of 940 separate fields and will incorporate more structured, robust and comprehensive data.

What are the advantages of the MX format?

The goal of this new standard is to use the same message structure, form and meaning to relay financial transaction information around the world.

Who does the ISO migration affect and how?

The migration will affect all SWIFT members: banks, brokers, corporates, non-bank financial institutions, service providers and others.

The impact on banks

Some banks already support ISO 20022 for corporate payment and account statements services. However, if they do not, process changes are required to transform the internal processes to be interoperable with future market infrastructure ISO requirements.

Most banks have legacy messaging platforms that have been in operation for years. The new ISO 20022 migration, along with the overall shift in the payment industry to “instant,” will place immense pressure on banks by making these platforms obsolete. Banks will have to choose between fully upgrading their platforms or building an external, integrable system. If they do not act, they risk making their existing products and services inoperable.

The impact on corporations

The migration will impact end clients in multiple ways while also offering new opportunities.

For example, some legacy payment messages allow address information to be inputted into a nonspecific field and in no particular order. ISO messages, however, require filling in building number, street, city, and other specific data fields. Breaking down the addresses, coupled with procuring any missing data fields, will likely prove a cumbersome task for end clients. If the migration of data fields is not mapped and prepared properly, a significant risk of data loss or data integrity arises.

Corporate treasurers should ask their ERP providers when they plan to migrate from the MT format and the formats they will able to receive. Treasurers should also ask their banking partners what formats they will be able to send and receive in the future.

The impact on treasury management systems

Regarding banking communication, some treasury management systems (TMS) are already integrated with a transcoder that converts data to any target format. As a result, Regarding banking communication, some treasury management systems (TMS) are already integrated with a transcoder that converts data to any target format. As a result, there is no impact in terms of development. This transcoder is available for all clients, enabling them to be autonomous.

However, this integrated solution required that, on the company side, the ERP must be able to provide the needed data to build the target file because MX messages contain more information than MT messages. In some cases, the transcoder permits the user to apply rules in case the ERP is unable to provide all of the information to build a viable file.

In terms of information processing, the capacity of the TMS to manage large volumes may be a concern. MX messages are very dense, which will test the robustness of the existing banking communication, posing potential speed and storage issues for vendors.

SWIFT is offering a Test Sparring Partner to enable members to test to confirm that their systems can send and receive the messages to validate functional integration testing. Most SWIFT users are aware of this offer, but some may be unaware. Detailed information on this migration is available on the myStandards web portal.

Achieving a successful migration

TMS providers remain highly dependent on the ability of banks and ERPs to provide the new formats. The new MX standard involves several parties and requires all of them to coordinate and communicate to ensure a successful migration.

Avoid costly oversights by double-checking 5 key provisions

Once the term sheet is done and everyone agrees on the deal, the rest can be left to the attorneys, right? Not so fast!

Redbridge has seen multiple examples of terms—even relatively important terms—changing from what was on the term sheet, and we’ve encountered even more examples where what was on the term sheet did not match with the borrower’s understanding of the terms.

A minor mistake in documentation may be fixable, but it can also be a warning sign for misunderstandings, sloppy drafting and even a purposeful change to the terms without prior agreement. Loan agreements are complex, and mistakes can be extremely costly in terms of wasted time, missed business opportunities and damaged relationships.

Common sources of problems

Although transactional attorneys managing relationships usually have years of experience, it should be understood that often a relatively junior attorney may be executing the first draft of the document for the bank, and a junior associate for the borrower’s counsel may be handling the first review. Newer attorneys lack the hard-won experience to spot potential trouble signs and to understand the issues that may turn into hot buttons for the borrower.

Attorneys rarely start from a clean piece of paper when drafting loan documentation; they usually adapt documentation from the bank’s standard form or a previous transaction. Each borrower has different priorities and business drivers, so what works for one client rarely works for another. The bank’s standard agreement is usually more conservative than the terms and restrictions offered to a particular borrower. Many items are glossed over in the term sheet. Each of these items can potentially limit the borrower’s flexibility and lead to inadvertent defaults as many borrowers do not read and fully understand their documentation.

Key provisions to scrutinize

While each agreement is unique, it’s wise to pay attention to these five elements:

1. Defined terms: A list of defined terms appears near the beginning of the document. They drive the understanding and interpretation of the rest of the agreement. If a defined term has a different meaning than the plain English that a borrower assumed, it could be a serious fight to win a court battle. Trace all capitalized terms in the credit agreement to all of the defined terms, sometimes three layers or more. Often one defined term contains a reference to a second defined term and so on.
2. Financial covenants: These covenants should be tailored to the business plan and expected results. For example, if your company plans to use existing cash on the balance sheet to invest in the business or pay shareholders, make sure that expenditures made from excess cash do not flow through Fixed Charge Coverage Ratios. Even when companies are clear about requirements, the documentation can default to the cookie-cutter situation.
3. Nonfinancial covenants: Similar to financial covenants, these provisions should align with plans and expectations. Pay close attention to the process to waive or amend the covenants. Consider allowing the agent bank to have some discretion, within certain limits, to avoid the delay caused by the agent getting approval first and then going to the banks, which will all move at different speeds.
4. New trends: When banks struggled with energy loans in the mid-2010s, they began inserting “cash hoarding” language into credit agreements. If more than a certain amount of cash is on the balance sheet for more than a defined number of business days, the borrower must repay the line of credit. This has expanded beyond the energy space, and Redbridge has seen this in some agreements for COVID-impacted industries. Although agreements currently have representations and warranties to state that the company does not believe there is a potential default, cash hoarding language limits the availability of the revolver in a much more structured and severe manner.
5. Rate structure: Consider the grid pricing levels, leverage vs. ratings-based pricing, and the timing and frequency of permitted borrowings. Borrowing procedures can force companies to borrow at the alternate base rate due to required minimum notice or a limited number of permitted LIBOR/SOFR borrowings outstanding. The alternate base rate can be 1.5% or more above the LIBOR/SOFR rate! Paying attention to the mechanics of the borrowing process is important.

How to protect yourself

These five elements are by no means an exhaustive list of potential problems and concerns when negotiating loan documentation. Redbridge’s process involves drafting a detailed term sheet, which includes defined terms, detailed baskets, covenants and borrowing mechanics for the financing. This process eliminates last-minute surprises during closing, allows the borrower to dictate terms to the banks and eliminates documentation time by up to 50%.

Schedule time with us today to learn more about market trends and how Redbridge can help!

Financial implications

Corporate credit ratings have a wide range of financial implications, such as the amount of trade credit received, terms of bank financing, and coupon paid on public debt.

Financial implications include:

1. The interest rate paid on debt is highly correlated to the credit rating. Most banks and many investors use a “risk adjusted return on capital,” or RAROC, to evaluate profitability and guide lending and investment decisions. A 3% interest rate to a company with somewhat shaky prospects is intuitively different from a 3% loan to Walmart. Which loan would you want to make?
2. Similarly, credit ratings influence the other terms of debt, such as required collateral and covenants. An investment-grade borrower (BBB- rating and above) can generally borrow without collateral, while some riskier companies may only be able to borrow if the lender has all assets of the company as collateral and even controls the company’s bank accounts and lockboxes!
3. Vendors may use a credit rating to determine the need for prepayment or extension of payment terms, which influences the amount of working capital and need for borrowing.
4. Given that your banks are using the risk rating to determine their RAROC, a higher credit rating can enable your banks to earn more money without you paying more and limit complaints about side business from your banks. Bank ratings can vary by two or even three notches from bank to bank.

Strategic implications

Credit ratings also have strategic implications for the business profile for customers, suppliers, employees and investors.

Strategic implications include:

1. A company’s credit rating represents its credit profile and riskiness to investors, employees, customers, vendors, and lenders. Customers and vendors will be hesitant to transact with a company if they fear it will default and declare bankruptcy.
2. A higher credit rating allows banks to approve larger requests for credit more quickly. This can be an important consideration for mergers and acquisitions.
3. Higher rated companies have access to additional sources of liquidity, such as commercial paper, and can put supply chain finance programs into place for vendors, potentially improving pricing.
4. Managing the story rating agencies tell is a way to influence the public discourse about a company’s risk profile and future prospects. If the rating analyst does not understand the business and publishes less favorable opinions, lenders and investors may believe the analyst. This will likely affect the yield required on institutional and bank debt, as well as the stock price.

Boosting your ratings

How can you actually improve your ratings? Ratings can be improved when companies evaluate and change qualitative elements, quantitative factors and structural elements, and when they have a dedicated focus and communication strategy for credit rating analysts.

Quantitative factors may consist of issues beyond your control in the short term, such as scale of the business, EBITDA margins, leverage ratio, and cash flow metrics. Qualitative factors used in most ratings models include an analysis of the business profile, such as demand, brand value, competitive profile, prospects for growth, financial policies such as acquisition or shareholder-distribution policies, and other factors. Structural elements include an analysis of the debt capital structure, collateral package and relative recovery prospects for debtholders in a downside case.

Although some of these factors are difficult to improve in the short to medium term, changes to debt structure and improved understanding of the business profile can move the needle. For example:

1. Financial policy: communicating an increasing share of cash flow used to repay debt, reducing perceived risk.
2. Debt structure: the mix of secured and unsecured debt can improve ratings by influencing the potential recovery on debt in a default scenario. Recovery analysis is quite technical and requires a good amount of expertise and dialogue with the ratings counterparty.
3. Business profile: providing the right story and data to a ratings analyst can erase misperceptions. Many times the analyst simply does not want to do the hard work evaluating the business or does not want to ask questions.

Building a long-term strategy to improve your corporate credit rating

The proper communication strategy and capital structure can help to optimize and improve your rating, but this approach requires a tailor-made solution for your unique business and situation.

Redbridge has the expertise, deep knowledge of bank and rating agency processes and senior-level resources to help you improve your ratings for current needs and future strategic priorities. Ratings require a dedicated, long-term strategy, and the sooner the process starts, the sooner the ratings improve.

Acquirers and card processors are pulling the trigger on reserve requirements for merchants. Here’s what you need to know.

The role of payment card purchases and the associated unsecured indebtedness in the American economy is often understated. Credit card purchases are the most common borrowing tool for American consumers and businesses. It is estimated that there are 180 million cardholders, more than 500 million credit accounts, and $995 billion in outstanding card balances as of May 2020. In 2018, credit card transactions totaled almost $3.98 trillion, an increase of $930 billion from 2015, according to the U.S. Federal Reserve System.

CFOs often do not fully understand, nor do they challenge, the acceptance fees that organizations incur with payment card payments. The fees merchants pay can vary depending on many factors, such as the industry, the size of the merchant, the acceptance environment, and the technology.

Fees can range from 1% to 4% of every card transaction. However, almost all merchants are more than happy to accept payment cards for three reasons: 1) cards are a universal form of payment, 2) cards make it easy for customers to make payments, and 3) cards have a positive impact on cash flow.

Increased risk to acquirers

The deteriorating economy has impacted the cash flow and balance sheets of merchants in almost every industry. As a result, acquiring banks are concerned that some businesses may not be able to cover their obligations to provide the goods or services for which funds were received. Acquirers and card processors (also called merchant acquirers) are pulling the trigger on reserve requirements for merchants and holding back funds due to merchants until the reserve requirements are satisfied.

In addition, card issuers are setting large loan loss reserves. American Express recently announced a $1.6 billion reserve for credit losses. The country’s largest banks – JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., and Wells Fargo & Co. – increased their allowance for credit losses by more than $28 billion in the first six months of 2020. To reduce their financial risks, acquiring banks across America are reviewing their underwriting policies, fee structure, and reserve requirements. It is important to note that many of the largest issuers are also acquirers.

Merchants experiencing the following events are likely to be hit with new or increased reserve requirements:

• Rising levels of chargebacks
• Excessive customer refunds
• Deteriorating financial conditions
• Extended times between purchase and delivery of goods or services

Many banks have reevaluated their underwriting standards or have decided not to take on new merchants from certain sectors at this time.

Account reserve requirements

A typical Merchant Services Agreement is complex, with a multitude of clauses to protect acquirers, not merchants. To the surprise of many CFOs, card processors typically have the right to implement or raise reserve requirements on short notice. Banks and merchant acquirers apply reserves to reduce their risk and shift it to the merchant.

Reserves can take several different styles and structures:

• Rolling Reserve Allowance: the merchant acquirer withholds a predetermined percentage of each transaction for six to 12 months (i.e., when the dispute rights of the cardholder have elapsed).
• Accrual Reserve Balance (sometimes referred to as an “upfront balance”): the merchant acquirer requires a fixed dollar amount, typically equal to a percentage of monthly processing volume, to be deposited or captured from payments as they are processed until the reserve is fully funded.
• Capped Reserve Balance: like a rolling reserve allowance, the acquirer withholds a predetermined percentage of each transaction until meeting the defined reserve. The withheld funds are held by the acquirer indefinitely unless contractual changes are accepted.

Recently, Square Inc. – a merchant acquirer and processor – sent shockwaves through the small business community after merchants complained that it was instituting a hold of 20%-40% of processed credit card transaction funds.

Even though withheld funds (the reserve) remain an asset on merchants’ books, merchants do not have access to the cash and working capital the reserve provides. While reserves protect acquirers from potential losses, the implementation of a 30% reserve effectively and temporarily increases merchants’ real costs for accepting card payments by more than 40% ($4,000/$100,000 = 4%; $4,000/$70,000 = 5.7%). The impact on cash flow is even more onerous.

Proactive steps to avoid or minimize payment card reserve requirements

The negative impact of increased reserve requirements is not limited to small and medium-sized companies. Even large corporates are experiencing many of the same challenges. Fortunately, with the aid of an experienced partner who is active in the payments industry, there are steps you can take today to minimize the impact of increased reserve requirements. Unlike interchange fees and card assessments, reserve terms and conditions can be restructured, modified, mitigated and negotiated.

• Level of reserve amount. The amount of a reserve required varies according to the nature of the merchant’s business; their financial strength; the type of credit transactions (large ticket, small ticket); chargeback experience; diversity, amount, and profitability of related business between merchant and bank; and competitive industry conditions.
• Length of withholding period. The requirements of a reserve, especially the term of the withholding period, can range from 75 days up to a year. From the merchant’s perspective, the shorter the time, the better.

Before negotiating with your processor or acquirer over a reserve requirement, make sure you have:

• Thorough knowledge of your payment card acceptance environment and the roles of the principal players
• A realistic perspective of the acquiring bank and their desired relationship with the merchant
• An awareness of terms and conditions detailed in the Merchant Processing Agreement
• A recognition of what is practically possible and what is not

The bottom line

To succeed in negotiations about reserve requirements, the merchant’s representatives need to understand what is a good deal or what is feasible.

Your organization must also have the team, process, technology, and tools in place to ensure you are proactive in managing your environment and costs. If you do not have the necessary team or resources, let Redbridge’s payment card experts manage this for you. We do all the work for you.

Visa announces interim rate changes, effective July 2020

The latest: Visa has changed the implementation date for its rate changes for a third time. The changes – originally slated for April 2020 – were initially postponed until July 2020, then further delayed until April 2021. Some of its changes will now take effect in July 2020. Furthermore, Visa has announced that it will be implementing an “interim” fee modification to its new non-qualified rate, effective July 17, 2020. This interim fee modification will remain in place until the previously published rates take effect in April 2021.

[MORE: The Definitive Guide to the 2020-2021 Card Brand Changes]

What can merchants expect in 2020?

In short, we will be faced with the most sweeping and transformative changes in more than a decade. While these changes have been touted by the brands to alleviate the cost of acceptance in certain sectors, most organizations can expect to see increases in cost along with a myriad of modifications.

The sole intent appears to be to further obfuscate what is already a complex web of interchange rates, network fees and qualification criteria. The increased cost and opaque nature of these changes could not come at a worse time, as most organizations are already struggling just to keep afloat in a tide of COVID-19 related disruption and devastation.

As merchants struggle with simply maintaining their business, they will also need to begin thinking about the card brand changes and the impact these changes will have on their payment acceptance environments.

This year, all of the brands will introduce changes, but the most significant impact appears to be delivered by Visa. These changes are not limited to the rates themselves but also the structure as a whole.

Here are some of the more the significant changes we expect to see from Visa, Mastercard and Discover.

Visa

• Elimination of Electronic Interchange Reimbursement Fee (EIRF) rates
• Elimination of several Standard rate categories
• Introduction of non-qualified categories to replace EIRF and Standard rate categories; new rates are as much as 85 basis points (bps) higher than historical rates
• Elimination of the interchange benefits associated with many of its B2B merchant category code (MCC) designations
• Visa is doing away with its legacy custom payment service (CPS) categories and replacing them with Product 1 and Product 2 designations
• Modification and expansion of Visa’s supermarket interchange tiers

Mastercard

• Introduction of a Transaction Integrity Classification (TIC) which will become an interchange qualification requirement
• Introduction of a new day care consumer credit interchange category
• Introduction of a cap for real estate Merit I interchange
• Consumer credit purchase refund rate modifications

Discover, Mastercard and Visa

• Discover, Mastercard, and Visa will require an authorization approval code for processing purchase return (refund) transactions
• Discover, Mastercard and Visa are all updating their stored credential transaction requirements
• Discover is also introducing small ticket pricing for transactions less than $5

What should merchants do to prepare and mitigate avoidable cost increases?

To stave off cost increases, organizations will have to be vigilant in understanding the new complexities of the April 2020 interchange and card brand fee structures.

A successful outcome will require, at a minimum, that the following key components be addressed thoroughly:

• Data: Accessibility is key. Data must be normalized across channels and providers in order to draw meaningful and timely conclusions about the current acceptance environment and associated fees.
• Infrastructure: It’s crucial that the organization has the necessary processes and systems in place, whether it be homegrown applications or third-party solutions, to effectively review and track their payments data.
  • Establishing key performance indicators (KPIs) and managing those KPIs is critical
  • Understanding where the organization is in relation to its current interchange qualification efficiency ratios
  • Establishing target ratios
  • Ensuring there is a system and process reconcile fees to ensure accuracy
• Execution: Organizations must have a well-defined plan including the right resources, tools and technology to transition from its current state to its desired future state.
  • Technology must be able to support the current business needs, while satisfying new card brand requirements
  • Vendors must be assessed to ensure they are able to provide the necessary level of technology and support
  • Account hierarchy and architecture must be closely reviewed to ensure it is yielding the most optimal outcome
  • Fraud and risk exposure and acceptable tolerance thresholds must be constantly evaluated

Conclusion

In short, what the card brands are doing is simple. They are seeking to take what is already a complex and convoluted web of fees and further obscure the structure to make it more difficult for organizations to proactively manage their costs.

It is up to the organization to fight back by taking control, closely managing its payments strategy and continuing to evolve said strategy to stay current with best practices.

An effective strategy is one that is robust, holistic and multi-faceted. This includes:

• Evaluating and aligning payment methods across payment channels
• Reviewing merchant account structures and leveraging merchant category classifications
• Staying ahead of the data and timeliness requirements
• Ensuring that the organization adheres to best practices in its payment collection and return processes

Effectively managed, an organization can expect to contain its costs and prevent superfluous increases. The right tools, processes, systems and knowledge base is key in winning this fight.

For more information or questions on how to take action, please contact your Redbridge advisor.

Pressure from the sales, marketing, as well as digitization, teams to adopt innovative payment solutions and access multiple card networks must make sense from a financial as well as security standpoint. An interview with our experts Mélina Le Sauze and Anthony Schulhof.– What challenges do merchants face with acquiring and processing American Express (AMEX) card transactions?

The cost of managing cash for large retailers generally runs into the millions of euros and, on average, 70% of these relate to card acquiring and processing. Historically, banks in France were key players in merchant card processing. However, in the last 10 years, their hegemony has been challenged by the emergence of non-bank providers in charge of terminal maintenance, the provision of acceptance platforms, not to mention FinTechs and Payment Service Providers (PSP), who have invested heavily in the world of electronic banking. The list is not exhaustive, but companies such as Adyen, Ingenico, Hipay, Stripe or Worldline are driving changes in the merchant card acquiring market today.

Furthermore, AMEX Cards, who are one of the leaders in consumer card issuance, are of interest to merchants wishing to attract new customers or retain segments whose purchasing power is generally higher than average. The payments industry has recently developed solutions to facilitate the acceptance of AMEX cards on terminals to meet a wider demand from the large retailers and niche players.

In Germany, Switzerland, as well as the United Kingdom, AMEX and PSPs are key players in the card acquiring chain. In France, they represent an increasing share of the total overall cost of merchant payments.

Whereas in times of crisis, the natural instinct of companies is to preserve the relationship with their banks who commit their balance sheet by providing financing, this does not apply to either AMEX or PSPs. Challenging these providers, therefore, represents a tantalizing route to generate savings.

– What is the added-value of these non-bank providers?

– The new payment service providers, led by Adyen and Stripe, have developed propositions that meet more than just the needs of the finance team. These providers offer agile solutions combining innovative customer journeys, speed of execution and a wider range of accepted payment methods. In addition, they meet the needs of major retailers seeking unique payment solutions on an international scale.

Banks largely cater to the domestic acquiring needs of their customers and do not offer much by way of international solutions. Even banks represented across Europe cannot provide a single unique solution as each local affiliate has its own technical capability and discretion.

Furthermore, in a world where consumer payment habits are evolving fast, banks are struggling to drive the digitalization of payments, preferring, instead, to invest in young start-ups, such as PayPlug and Dalenys, who were acquired by BPCE Group in France between 2016 and 2018.

In companies today, digitalization or marketing teams lead the decisions of innovative payment methods and solutions, with input from the finance team to ensure the profitability of the project, as well as compliance with payment security standards and regulations.

The finance team is, therefore, not the only decision maker in the choice of payment service provider. Nevertheless, for those thinking of selecting a non-bank service provider, there are areas that need to be considered;

From a financial point of view, they can be between 30% and 50% more expensive than those of banks.

The solutions from non-bank providers are frequently integrated from the cash register system right through to the credit on your account. It is therefore very complicated to “back out” and change providers after the implementation of such solutions.

– What is the added-value of Amex?

– Accepting AMEX cards does not have the same importance depending on the sector of the company’s activities. Indispensable in the hotel industry, air transport and the luxury goods sector, its’ wider acceptance is driven more by a desire not to stand in the way of a purchase or to attract new customers for large retailers or specialized outlets.

The pricing schedule of AMEX incorporates many subtleties (inbound fees, wholesale vs retail rates, etc.) which are not always easy for the merchant to comprehend. The central element of this grid is a commission rate, which is unique in that it is never the same from one country to another (AMEX speaks of the market), not from one sector to another. The different commission rates according to economic sectors and countries is justified by the fact that the AMEX network brings a different added-value depending on the type and location of the merchant.

This pricing model makes it possible to apply high rates to merchants in the luxury and hotel sectors. Conversely, when AMEX wants to set up in a sector where its added-value is less compelling, it does not hesitate in offering competitive prices, similar to the grid prevailing in the mass retailers. Depending on the industry, the AMEX commission rate varies from simple to three times, or even more.

– How to optimize the non-bank service providers along the processing chain?

– Competition between non-bank service providers is increasing every year, with the appearance of new entrants offering services across the value chain. To optimize your relationship, it is essential to identify the services required so as not to have an inferior offer or have to asses a wide panel of providers. Often, PSPs propose an all-encompassing offer, where any service gives rise to a transaction fee or subscription; acquisition, processing, fraud prevention … This grid is negotiable for those who compete.

– And what about Amex?

With no real equivalent, AMEX is a provider relatively closed to negotiation. Their reluctance is based on the pricing integrity rule, according to which the network guarantees to apply a single commission rate within the same sector.

This “a sector equals a price” rule is more a matter of commercial policy than reality. Experience has shown that within the same sector, there are price differences in the range of 33% to 50% depending on merchants.

The fact is that, in today’s world, AMEX needs to gain market share amongst new merchants and at the same time acquire a maximum of “physical” customers using their consumer cards to legitimize their potential to merchants. This situation leads AMEX to rebalance its relationship with merchants and makes it possible to open an effective negotiation, which can yield significant savings, when accompanied by precise and formal analysis.

Achieving the conditions of a most favored client is not easy and requires:

– Solid arguments

– An extensive knowledge of the internal organization of AMEX and its decision-making process

– A precise and exhaustive analysis of the situation (volumes currently processed, evolution of volumes over the last years versus evolutions of total turnover and acquiring turnover, type of end customers, breakdown of goods purchased from the merchant by AMEX card holders, average transaction amount, …)

– An extensive experience to conduct a quick and efficient negotiation.

The COVID-19 pandemic has forced corporate treasuries to manage liquidity and ensure the continuity of service while employees work from home. To get a sense of how treasury management system (TMS) providers are helping their customers address this unprecedented situation, Redbridge spoke to 15 European and U.S. treasury software providers between April 3 and April 10. We asked them how they are adapting their services and offerings to address current challenges and about what they anticipate the short- and medium-term consequences of this crisis would be on treasury operations.

Our survey highlighted the resilience of hosted TMS solutions, even though providers have had to quickly adapt and strengthen their service levels to help clients manage their liquidity and risk. Providers revealed that they have adopted a range of measures to support companies in a variety of ways since the start of the confinement. New practices include offering access to TMS versions with reduced functionality free of charge, discounts on implementation fees, and billing deferrals.

Activating business continuity plans

When the pandemic struck, companies activated their business continuity plans (BCPs). The sudden upheaval had a major impact on cash flow, the essential lifeblood of a company’s operations. “Fortunately, today’s technologies and solutions allow most treasurers to continue their activities, even when they are confined to their homes,” said Jérémy Cocqueel, director of channel sales Europe at FIS. Guillaume Douarre, senior account executive at Serrala, added, “companies that were best prepared are those that have embarked on projects to optimize and digitize their processes. This has allowed them to maintain a constant rate of activity despite the absence of certain staff.”

For Jérôme Brun, VP of strategic advisory at Kyriba, the difficulties encountered have been concentrated on companies “less well connected, who may have experienced a slowdown, or even halt, in systems availability due to insufficient bandwidth.” This is particularly the case for companies hosting their treasury systems on-site and, as Thierry Miskaoui, VP of strategy and operations at TreasuryXpress, observed “whose technical architecture does not allow remote access due to the absence of VPN, servers that may have been overloaded, slower connectivity, etc.”

Jérôme Brun also noted that cloud and SaaS cash management solutions seem to have passed the test of remote working because “clients with cloud solutions have been able to function normally.” For David Freulon, sales director at 3V Finance, TMS solutions “allow for remote access and are therefore conducive to the teleworking imposed by the crisis.” Alexandre Bromberg, sales director at Diapason, added that TMS services are “already based on secure and remote infrastructures, accessible outside corporate networks.” However, the suitability of their solutions did not prevent some providers from “reinforcing certain SaaS infrastructure to meet the demand,” as José Teixeira, senior market manager at Sage, noted. Sage had to “speed up its processes and show flexibility to enable its clients to migrate quickly to the cloud environment.”

An employee at 3V Finance reported, “Some of our clients have taken advantage of the crisis to use the web versions of our SaaS offering or accelerate the migration from their on-premises infrastructure to our private cloud.”

TMS providers are definitely well prepared to respond to this type of situation

Like the majority of companies in Europe and the U.S., TMS providers have had to adapt to the difficult situation to maintain the availability of their systems, customer support, and associated services at satisfactory levels. “We also had to activate our BCP to cope with the measures introduced by the government to combat the spread of COVID-19,” said Olivier Bastin, sales director at ACA. He added that his company’s “level of service is identical to that before they triggered the BCP.”

Jérôme Brun indicated that work-from-home mandates have had a limited impact because “teleworking is a common practice at Kyriba, whatever the function.” For Benjamin Knierim, sales director EMEA at Bellin, “the crisis has demonstrated that many services can be provided remotely.” This is particularly true for consulting services and the implementation of treasury systems, which have been carried out almost entirely remotely in recent weeks.

Managing liquidity

Managing liquidity is the highest priority for treasurers. As a result, Olivier Rathouis, executive sales manager at Finance Active, has seen an increased level of treasury systems use since mid-March, “particularly in terms of accessing market data, but also in the use of the numerous simulation tools such as, for example, on drawdowns of confirmed credit lines, stress tests, and the impact of banks activating covenants.” Alexandre Bromberg, chief product officer at Act Trader Technologies, emphasized that some clients, “aware of the strategic challenges associated with managing liquidity, are currently requesting us to implement the medium- and long-term cash forecasting modules.”

Some providers have had to adapt their solutions to meet new requests from their clients. Regarding the extension of debt maturities that banks have proposed to companies, Rathouis shared that Finance Active was “canvassed widely on the technicalities of putting this in place and of integrating the capabilities into our debt management modules” and has “initiated the necessary developments” to meet the need.

At the service of companies

The vast majority of the providers we spoke with indicated they have reinforced their support measures since the start of the crisis by extending opening hours, expanding and enhancing third-party maintenance contracts, broadening consulting services, expanding helplines, and making similar adjustments.

These measures often complement such commercial gestures as selling certain services at cost. Some providers even made their platforms available free of charge for a limited period – often for three to six months. These offers are mainly related to basic systems, where only certain functionalities are accessible (cash management, cash forecasting, financial instruments, etc.). They are also more prevalent among cloud solution providers, whose business model is more conducive to this type of commercial approach.

Lastly, some system providers are offering more flexibility on contractual commitments, such as delaying invoicing, providing financing options, or reducing contract lengths to one year or a few months (compared to the typical three years for cloud-based applications).