Treasury - It is all about fundamentals



A martial art teacher said one day that “fundamentals are fundamental”. For The one who had not the chance to practice martial art but who probably played the “Jenga tower”, know that when pulling out building blocks at the bottom of the tower, the whole tower becomes flaky.


Back to treasury and considering conferences themes, articles and publications around the evolving role of treasury, Fintech, strategic treasury and so on, we feel a need to return to the more fundamental topic of the role of treasury within organisations and the level of sophistication of the function. 

We all know that the essence of treasury management is all about the being the custodian of cash flows and (financial risks). But what does that mean for day to day practice? What treasury operating model best fits business needs and how to manage the treasury within a multinational environment?

Understanding these fundamental issues will allow the organization to set-up and implement robust and versatile treasury policies as well as processes, resulting in efficient revenue allocation between jurisdictions involved and optimal taxation on treasury operations.



Treasury Target Operating Model (“T-TOM” or “TOM”)


Figure 1 illustrates the relationships amongst all aspects of Treasury. Irrespective of the complexity and sophistication of an organisation, Management has to decide treasury’s role within the elements included, which entails considerations on the internal operations and structure of the treasury functions (e.g. service provider vs. entrepreneur vs. hybrid model), and related transfer pricing and tax consequences. The decision may be that an element is not applicable or has no priority (yet). The Treasury Operating Model (TOM) tailored to an organisation for today and the (near) future) hints at the maturity or sophistication of its treasury. It defines the overall objective (mission) and scope of treasury which in turn will be the main driver of its underlying cost and corollary budget. 



Treasury Maturity Model


While the objective and scope set the tone of the contribution of treasury to the organisation, the budget defines the cost to incur in order to materialize these benefits. In order to facilitate a discussion around the costs/benefits and choice of optimal TOM, PwC has developed the maturity model as per figure. The aim of the game is to find the appropriate point on the benefit curve and make sure TOM includes all applicable elements at the right level of sophistication. 


TOM corresponding to a “Safeguarding assets” strategy typically revolve around setting up processes from scratch and with the objective avoiding losses, regulatory mistakes, penalties and fines. Typical projects at this stage include documenting processes, configuring key treasury applications, such as basic cash exposure and reporting, with limited or no tax/transfer pricing considerations providing an easy port of entry for Tax administrations to challenge pricing on intercompany transactions. Furthermore, more often than not processes are spreadsheet based and highly manual.


TOM focused on “Cost Minimization” involve a higher degree of standardization, centralization of core treasury processes and pruning bank infrastructures with the objective to become more effective. At this stage treasury typically selects treasury technology for the first time, explores basic forms of in-house banking and central finance structures. It is then all the more critical, that at this stage the understanding of margins and transaction flows, as well as the alignment of expenses and revenue from a transfer pricing perspective be considered and explicitly embedded in the Treasury policy. 


Treasury centers evolving along the third stage of the maturity model will develop TOMs striving for leading edge holistic solutions covering technology and tax/transfer pricing to extract the maximum benefits out of treasury centers. At this stage, companies will often engage in the re-engineering of treasury processes (e.g. integration of cash pooling, external and intercompany cash flows) within an in-house bank type of model to optimize operations and related tax burden. In-house bank operations for treasuries at this maturity level are often still run by corporate treasury.


Those first three stage treasuries in this model are therefore best characterized by a focus on perfecting the execution of treasury transactions. They tend to focus on “how and what to do?” type of business questions which often implies further centralization.


At the fourth and strategic stage treasury operates as a true custodian of cash flows and financial risk. It coordinates enterprise wide processes and is no longer manager of a corporate department. The treasurer has become the trusted advisor and subject matter expert to the business operations and executive management regarding the cash flows and financial risk of the business. At this stage Treasury is involved in structuring business initiatives caring for cash flows, financial risk aspects and fairly recently, in discussions with tax departments centered around tax planning activities. The combination of changing market conditions (i.e., low interest rates and thinner spreads) along with the recent OECD Transfer Pricing developments challenge the appropriateness of existing TOMs and fundamentally alter the interactions between treasury and tax departments. Indeed, not so long ago, from a tax perspective, substance was meant to be understood as capital management which is clearly a treasury center prerogative. In this post Base Erosion Profit Shifting (“BEPS”) environment, substance not only covers capital but also topics ranging from the strategic support functions needed to ensure the sustainability of TOMs, the alignment of personnel with the location of funding vehicles and the proper management of financing risks. Adding to this list the Master File financing documentation requirements under Action 13 of BEPS, it is clear that a treasury policy framework to be sustainable needs to be the brainchild of treasury and tax departments. More than ever, close communications between these two stakeholders will determine the fate of the survival of selected TOMs.


In a mature setting, Treasury’s involvement upfront allows for pro-active detection and resolution of cash flows, financial and tax risk issues and the implementation of best practice process engineering. Transaction processing is highly standardized and automated and may already have been outsourced to a shared services organization that generates the reporting to manage (future) liquidity and exposures adequately. In summary the focus of a Strategic Treasury is on interacting with stakeholders discussing why entering into treasury transactions.


The evolution into a Strategic Treasury is more radical and transformational. A strategic treasury’s role is beyond the management of delineated responsibilities. It assumes a pro-active and collaborative engagement with senior management, business and tax functions aimed at advancing the strategic value of the organization. 


Whilst it is undoubtedly true that certain of the profession have reached a strategic position within their organization, the evidence for a wholesale shift is perhaps more patchy and to a certain extent aspirational. It begs for the question whether treasury should inevitably move into the far right upper box in figure 2. Having said that, each level of sophistication feeds off the prior stage in the maturity model. The prior level acts as foundation for the next. If the requirements linked to the prior stage are not satisfied solidly, treasury may not be able to deliver on its promises effectively. 


Depending on where Treasury is, its environment and allowed budget, it may want either to reinforce its current stage or add the next level but in any case, Organisations should keep in mind that “fundamentals are … fundamental”