Multinational treasury

MNE treasurers have an extremely broad remit, including investment planning, simulation, budgeting, management control, accounting, reporting, cash management, insurance and tax management. But probably the most important job they have is securing the capital that is the life blood of their company’s operations.

External funding

Where the capital that an MNE generates through its internal operations does not suffice, it will need external sources. There are two main categories.

Debt finance

Few banks offer a full spectrum of debt instruments; the big players will all offer the main international banking products but as non-resident institutions may not be allowed to transact certain instruments in tightly controlled regimes. For this reason, MNEs tend to work with shortlists of global banks plus a few locals offering specific national services and information.

Finance’s traditional “transformation” model sees savers deposit short-term funds with banks who then lend the funds back out to borrowers, usually for longer periods of time. In this model — which still functions, particularly for SMEs deemed too small to issue securities — providers and users of capital are mediated via banks, whose gross margins are comprised of the difference between the interest paid on deposits and the interest received on loans.

Back in the 1980s, however, solvency fears associated with this traditional model led to an international agreement that banks needed to reduce their risks. One way was to reduce their direct lending activities and start working as “lead managers” paid to support borrowers issuing securities directly to investors, who would then assume any default risk. This explains why today’s MNEs acquire a much greater percentage of their debt funding from non-bank sources and why international financial market volumes have exploded over the past 40 years.

Investors decide whether to purchase debt issued by a given MNE based on their assessment whether the interest it offers constitutes a true reflection of its solvency. Corporate borrowers must generally pay a “risk premium” above and beyond the interest charged to a zero-risk borrower (usually the government). The more investors worry about an MNE’s ability to repay debt, the greater the risk premium they require. As a result, a big part of a treasurer’s job involves monitoring factors like public perception of an MNE’s creditworthiness (often influenced by reports published by ratings agencies such as Standard & Poor’s or Moody’s) and the impact on investor psychology worldwide. Otherwise, under normal circumstances risk premiums tend to be higher the longer an MNE wants to borrow money — with the cost then depending on the difference between short- and long-term interest rates (called the “yield curve”).

To increase their chances of borrowing cheaply, MNEs can either try to borrow in the short-term money markets — at rates often indexed to the London Interbank Offered Rate, known as Libor — or issue longterm debt securities like bonds, often in offshore “Euro” markets operating outside of national authorities’jurisdictions. Euromarkets tend to offer tax advantages as well as lower transaction costs. Above all, they are one way to access foreign investors who may not be active in an MNE’s home market.

Even so, national financial markets remain very important to MNE funding, if only because many providers of capital, often “institutional” investors,are obliged by their statutes of incorporation to only purchase securities in the domestic capital market where they are familiar with the rules of disclosure. Hence most MNEs’ interest to list their securities (both bonds and shares) on numerous exchanges worldwide. In turn, this raises questions about which unit within an MNE’s configuration should be the entity signing a debt agreement. MNEs would prefer that one of their smaller units play this role and/or offer any requisite guarantee, if only to “ring-fence” potential default risk. Investors, on the other hand, prefer if their loans were backed by the assets of the MNE’s larger, better capitalised entities.

Equity finance

The second external source of MNE funding is equity capital. Here investors purchase shares in the hope that values will rise. Price changes not only reflect general economic conditions but also expectations of a company’s future profitability, which in itself is influenced by many factors.

One is the extent to which a company tries to increase its return on equity (ROE) by decreasing the proportion of its total funding that conies from equity rather than debt finance. If things go well, shareholders increase ROE using borrowed money. If things turn sour, the company must still reimburse its debt, increasing the risk of bankruptcy. “Leveraging” in this way is a high-risk/high-reward strategy. One interesting topic in MNE finance is the international variation in companies’ attitudes towards this kind of “gearing” dilemma.

A second focus in international equity finance is the distinction between “passive” and “active” investment. The former often involves institutional investors eschewing any direct role in a company’s management and simply seeking high returns (either over the long term or, if they are speculative “hedge funds”, very rapidly). This differs from active investors who engage in operational and strategic decision-making..

MNEs often organise global “road shows” to convince investors worldwide of their shares’ attractiveness. By so doing, they are trying to diversify their pool of potential funding sources. The question then becomes how any ensuing deals are to be organised. This will depend in turn on the kind of equity finance involved. Large MNEs seeking new equity often have few problems satisfying the procedural conditions required to get themselves listed on different national stock exchanges. SMEs seeking overseas equity finance face a challenge however. Because most major stock exchanges only list companies exceeding certain size and age thresholds, other equity finance mechanisms have had to be developed. One has been the rise of smaller stock exchanges (like Nasdaq in the United States or AIM in the UK) specifically geared towards smaller companies. Also worth noting is the rise of “private equity” arrangements where investors’ equity stakes do not materialise in any tradable securities but simply enact changes in the company’s ownership. One variant of this form of equity funding — “venture capital” — is interesting because of many countries’ attempts to imitate the success that California’s Silicon Valley had funding hi-tech start-ups in this way. Multinational finance can only be accurately understood in the context of the real international business strategies with which it is associated.

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