What does FX in-house bank mean for treasurers?

An FX in-house bank (foreign exchange in-house bank) is a centralized framework within a corporation that manages foreign exchange (FX) transactions and currency exposures for its subsidiaries. For corporate treasurers, an FX in-house bank serves as a mechanism to optimize FX operations, enhance efficiency, and reduce costs. But in practice, what does it mean for treasurers and CFOs? How can they deliver value through automation and centralization? Time is a precious and key features in foreign currency management. The faster central IHB is informed, the faster it can automatically hedge the underlying exposure. However, to master FX hedging, to be 100% efficient and fast, to mitigate risks, to ensure accounting and tax (TP) documentation, CFO’s must rely on leading edge and modern FX IHB solutions.

Centralization & Automation, best answer to the last crises

An FX in-house bank (foreign exchange in-house bank) is a centralized framework within a corporation that manages foreign exchange (FX) transactions and currency exposures for its subsidiaries. For corporate treasurers, an FX in-house bank serves as a mechanism to optimize FX operations, enhance efficiency, and reduce costs. But in practice, what does it mean for treasurers and CFOs? How can they deliver value through automation and centralization? Time is a precious and key features in foreign currency management. The faster central IHB is informed, the faster it can automatically hedge the underlying exposure.

The key question is therefore to determine how to optimize this FX risk management for treasury.

We have tried to list what it means for treasurers:

Key Functions of an FX In-House Bank

1.    Centralized FX Management:

The in-house bank (IHB) acts as an internal counterparty for subsidiaries, allowing them to transact FX directly with the parent company instead of external banks. This centralization streamlines operations and consolidates FX risk, potentially with off-set of opposite positions and natural hedging. Centralization means efficiency in processing hedging and monitoring them, it means comprehensive overview of FX risks across the group, multilateral netting if needed and enhanced reporting, especially for accounting and TP purposes.

2.    Netting of FX Transactions:

By aggregating and netting FX positions across the organization, the in-house bank minimizes the volume of external transactions, leading to reduced transaction fees and improved pricing from banks. The aim is to off-set what can be offset and to optimize the FX management by reducing the net balance of exposure to be hedged. Multilateral netting can also be (at imposed frequency) a solution to regularly reduce FX exposures, solve potential disputes between affiliates and reduce flows of transfers to one (inbound or outbound, depending on net amount calculated by netting).

3.    Internal Hedging:

The in-house bank facilitates internal hedging between subsidiaries, which can offset risks without requiring external instruments. The central IHB will immediately hedge the affiliate at a predefined margin/spread. However, the hedging transaction with the external world (i.e. the banks) can be done later, but with an inherent risk. Intercompany transactions are creating obviously transfer pricing (TP) issue and requires ad hoc master agreement (documentation in place), reporting on transactions in case of TP control, confirmations of deals, calculation of interest if amounts bought are not financed (yet). Usually, treasurers mirror the external deals with banks with their subsidiaries, with a potential TP spread or mark-up at arm’s length. It can be linked to funding of the affiliate and requires interest calculation.

4.    Improved Pricing and Liquidity Management:

Treasurers can leverage the corporation’s total FX requirements to negotiate better pricing and liquidity terms with external banks. Nevertheless, it remains an ancillary business for banks. Their profitability comes from several sources including that one. Diversification of partners and high volumes could drive to better and more competitive pricing. Fair sharing of the wallet (of transactions with banks) is also an important characteristic to maintain a good relationship with banking suppliers. Centralization remains virtuous in may ways.

5.    Risk Reduction:

By managing FX exposures centrally, treasurers gain better oversight of currency risks across the organization. This approach enables more consistent and effective hedging strategies, by avoiding risk of fragmentation in applying strategies and policies, by avoiding time delays, errors from non-expert treasurers and time lost in day-offs and banking holidays. Eventually the consolidation of FX risks enable to have a better grip on total risks and to simulate/stress-test (when needed and requested) and to prevent bad surprises.

But what are the benefits for Treasurers of an automated centralization?

Cost Efficiency:

Corporations can achieve reduced transaction costs through netting and centralization. These cost benefits can even be calculated and fairly estimated by the IT vendor in order to define a solid case and ROI. In an increasing hedging costs environment, cost control is always welcome. The treasury can also achieve interesting economies of scale when negotiating FX spreads and fees with external banks. The central treasury uses FX dealing platforms, connected to other IT tools (for STP).

Operational Efficiency:

A centralized approach enables consolidated workflows and reduces administrative overhead for subsidiaries, which can concentrate on business operations rather than on treasury matters. Hyper-automation remains the quintessence of treasury management and best recipe to optimize treasury management (in general). Simplified FX accounting and reporting processes.

Strategic Risk Management:

A fully consolidated overview of FX exposures enables treasurers to design a cohesive and comprehensive hedging strategy and potentially to adapt and adjust it if and when needed. This strategy or strategies (depending on different businesses) may be applied consistently and efficiently by machine when fully automated from A to Z, including the pre-trade phase. Treasury can obtain enhanced forecasting and liquidity planning due to better data visibility, which remains key these days. The FX element of cash-flow forecasting is essential in highly volatile periods as today. A machine, conversely, to human, may apply strategies consistently and without any risk of error. FX hedging is important but may become boring after a while as highly repetitive. Machines are never bored.

Control and Transparency:

Treasurers maintain centralized control over FX policies and compliance, by using IHB solutions like KANTOX (these types of tools are the so-called Currency Management Automation tool or CMA solutions). Transparency is also available for the C-level which can control through ad hoc reports the position art any moment in time and sleep better given resilience and reliability of the machine. Eventually, the CFO can have real-time insights into group-wide FX positions and easily verify and check correct application of group policies.

Challenges to Consider

·       System Implementation and Integration:

Setting up an FX in-house bank may require investment in treasury management systems (TMS) and integration with existing ERP systems. Nevertheless, weaknesses and absence of automation of the pre-trade phase and automation of hedging 24/7, the TMS must be often complemented by a CMA solution.

Regulatory and Tax Compliance:

Transactions between subsidiaries and the in-house bank may have tax and transfer pricing implications that require careful management. The hedging intragroup often includes a spread (at arm’s length) that must be determined, disclosed in a master agreement and documented, in case of controls by in-land revenue.

Operational Complexity:

Treasury must centrally guarantee skilled resources to manage processes, policies, and relationships with both internal stakeholders and external banks. We know of treasury talent quest is difficult and how additional FTEs are tough to “sell” to CFOs. Therefore, the best answer lies in hyper-automation.

The strategic real-time approach, panacea for a perfect FX hedging management

For treasurers, an FX in-house bank is a strategic tool that centralizes and optimizes FX management. It enables cost savings, improved risk control, and streamlined operations. However, setting up and managing an FX in-house bank requires careful planning, investment in technology, and adherence to regulatory requirements. When implemented effectively, it becomes a cornerstone of a robust treasury function. Never forget to check and ensure there are no even a single manual or semi-manual process around FX management and that time efficiency and real-time hedging is applied consistently. That’s the recipe for success.

François Masquelier, CEO of Simply Treasury – Luxembourg November 2024

Disclaimer: This article was prepared by François Masquelier in his personal capacity. The opinion expressed in this article are the author’s own and do not necessarily reflect the view of the European Association of Corporate Treasurers (i.e., EACT).