Talk about losing streaks, consider Sony’s troubles this year. The Japanese consumer electronics giant announced lower-than-expected yearly results in April and projected a 57 percent drop in net income this year. Its mantle is being challenged everywhere, in Asia most notably by Samsung, the Korean giant, which has shown greater skill in cutting costs and rushing cleverly designed, trendy products to market — once thought to be Sony’s unique line of trade. Then as if proof that bad luck marches in battalions, Sony’s Vaio laptop computers started giving harmless but disconcerting electrical shocks to its owners. At press time, Sony is still mulling recalling 18,000 of the machines as its management finesses this latest blow to its image of digital-age elan.
Little wonder, then, that pressure is building on Hiro Kurihara, the managing director of Sony’s London-based Global Treasury Services (GTS) unit, the company’s bold attempt at globalizing working capital and risk management. Set up in 2001, the ambition for the center was to spread its services to Sony’s electronics, Playstation, music, entertainment, and movie divisions, pooling the group’s working capital, centralizing foreign currency hedging and cash management, and opening a global window on risk management.
“Cost savings,” Kurihara said to CFO Asia in August 2001, “are just one part of the reason why we’ve established a GTS. The more important thing is that we can have full control over the global liquidity of the group, so we can utilize the funds so that the size of the balance sheet can be reduced.” So how does progress look so far? “We are on schedule, but not fully rolled out,” Kurihara says on the day that Sony’s spin doctors are busy managing the Vaio dustup.
Sony’s electronics group is nearly fully plugged into the GTS services, while the Playstation unit is partially so. He adds: “Regarding the other companies, the problem is that [their] activities are quite different from electronics. We are discussing how to apply our services.” Translation: it’s still too early for him to say that the GTS can attain its original, revolutionary goals.
But while the benefits of the model are taking longer than expected to emerge, the GTS has already proven capable of offloading some of Sony’s interest-rate costs, gaining efficiencies in funding on a global scale, and providing strong hedging advantages, both via derivatives and so-called natural hedging. In the meantime, Kurihara has discovered that the global operations of even a forward- looking company like Sony have enough moving parts to confound the most sophisticated vision of a treasurer.
Making the RTC Sing
Despite rough times, most large multinationals have embraced some form of global treasury operations — and are looking to them to produce the savings, economies of scale, and risk management opportunities that will widen currently squeezed margins. Sony pioneered the structure in Japan when the government liberalized certain areas of the finance sector in 1998.
Nissan followed suit as part of its revival plan in 1999. Others in Asia are catching up, including Japanese electronics maker NEC and SARS-beleaguered carrier Cathay Pacific Airways of Hong Kong. Shell Oil and Exxon Mobil each now have a global treasury structure of their own, as does mobile-phone maker Nokia of Finland. Reuters has just rolled out the Asian portion of its global treasury operations.
In lean times marked by profit warnings, company strategists regard treasury operations as a focal point for the incremental gains that boost margins as well as cutting costs. The pressure on Sony’s GTS can be measured by the aggressive goals announced by Sony for its turnaround plan. Company CEO Nobuyuki Idei has said that Sony will more than double its profit margins to 10 percent by 2006. In a sign of market skepticism, Moody’s downgraded the company’s long-term unsecured debt to single-A1 from double-A3 on the assumption that Sony wouldn’t boost profitability soon. Idei is anxious to disprove naysayers and is looking to Sony’s innovative projects like its GTS as one of the vehicles that will do so.
These concerns have heightened the exposure on what was always, from the beginning, meant to be the gradual rollout and fine-tuning of Sony’s bold bet on the future of global treasury operations. (Sony has never disclosed the cost of setting up the GTS, which is designed as a self-funding unit. However, some of the cost of conversion in Sony’s operations will be absorbed by the group’s recent US$1.2 billion restructuring charge.)
The jury is still out on just how much centralization will produce the magic that global companies seek. In a typical regional treasury center structure, individual subsidiaries manage their own payables and receivables, and at the end of each business day would have either a surplus or deficit position in their local currency bank accounts. The regional treasury center (RTC) then brings in the local currency position as close to zero as is practical, by swapping the surplus to its preferred currency. The surplus is brought to a concentration account the RTC manages. The structure becomes global when surpluses in each RTC — in Asia, Europe, and the United States — are then concentrated into a master account and sent around the world.
Yet some of the basic assumptions of this model are often nettled by real-world problems. For one, true cross-currency netting and pooling is hobbled in Asia by different regulatory and tax regimes in the region’s many markets. “When you’re talking about cross-border cash pools, it’s still incredibly restricted,” says Jimmy Yap, head of cash management for Asia Pacific for Deutsche Bank. “It’s not an easy task,” he adds, “and we (bankers) are accused of not working hard enough in this area, but we’re highly restricted by the regulations that we’re bound by.”
Andy Griffiths, finance manager of the Reuters regional treasury center in Singapore, agrees. “For the best return on working capital, we tend to transfer excess funds from Asia back to London, where they’re working with a larger pool of funds and where they are able to obtain better rates.” He adds: “I’m not aware that you have cross-currency netting and pooling in Asia.”
Wonders of the Pool
Sony’s dream is to garner as much advantage as possible from its global cash flow by erecting another tier of control over its RTCs. Its treasury centers in Tokyo, Singapore, London, and New York have individual local currency accounts (Japanese yen, euro, and U.S. dollar). All these are then linked to a pool account that the GTS established in each center.
At this level Kurihara monitors the pooling from one RTC account to another. The amount pooled between Sony’s RTCs depends on their individual cash flow requirements and forecasts. Because pooling is done at the GTS layer, no intercompany lending actually occurs, avoiding tax dues. Sony’s first step in 2001 was to introduce netting and pooling between the euro and yen. It has now switched over to pooling in U.S. dollars as well, a giant step, but only for its Sony electronics and a part of its Playstation unit. Still to go are its entertainment, movies and music businesses.
One of the key requirements for this level of scrutiny and control of global cash flows is the partnership with banks of global reach. No surprise, then, that Sony’s two main financial institutions are JPMorgan, which handles the lion’s share of its dollar and euro business, and HSBC. In contrast, many companies, including Reuters, deploy different banks to service each of its RTC shared service centers. The advantage to Sony of working banks at a global level are cost savings. Since the GTS handles 95 percent of the company’s derivatives contracts, Kurihara says it is able to gain concessions on fees from its major global partners.
At the launch in 2001, Sony delivered a statement of its goals outlining “pillars of global treasury services.” Boiled down, the pillars address two categories: cash management and electronic payments and settlements in one corner, and liquidity, forex, and risk management in the other. The cash management portion of these goals have been instituted in only 60 percent of the electronics group and partly in the Playstation unit. This includes services such as automatic cashless settlements and automatic sweeping.
Kurihara says that Sony’s electronics business currently uses cashless settlement, automatically crediting or debiting an account held by the GTS for US$10 billion to US$15 billion of its annual turnover in its electronics unit. The aim will be to increase that amount to about 80 percent, or US$30 billion, of Sony’s annual electronics sales.
Kurihara says that the pillars applying to liquidity and forex services have become fully operational. However, one roadblock to liquidity management may come from that familiar spoiler, the U.S. taxman. In a way seemingly designed to make treasurers’ lives difficult, local tax regimes remain a wrench in the works of such technological and strategic wonders as Sony’s GTS.
The question in the United States is whether the Internal Revenue Service will consider Sony’s GTS a British company or a Japanese one. The sticking point is the standing of reciprocal tax treaties: the United States has one with Britain regarding loans from unit to unit, but has no similar treaty with Japan. “We’ve asked the U.S. tax authorities to give us an opinion. If it is not favorable, that means our U.S. subsidiaries would have to pay taxes on what we lend them through the GTS,” says Kurihara. If this is the case, “we’ll seek other options,” meaning that the units will rely on more traditional funding, such as bank loans.
Despite the obstacles, the GTS’s effect on cost has been substantial. Kurihara says that management of working capital via the GTS will cut bank interest-rate costs by US$30 million to US$40 million per year. Under this system, Sony can pool money from its healthier Sony Electronics division and distribute it to more troubled ones like Sony Playstation, easing the interest burden that would normally fall on the struggling unit.
“They’re becoming self-funders, sharing it amongst their family,” says Thomas Etzel, senior manager, Japan, of treasury services at JPMorgan, and one of the architects of Sony’s GTS cash management structure. “That’s assuming that they could have been a net borrower at any location. If they’re not a net borrower at [a given] location, the GTS has the capability of providing a larger base of working capital, an improved investment return, and a more stable base of cash.”
On the foreign currency side of its business, the GTS has been lucky in its timing to some degree. The unit has been poised to take advantage of a windfall: the depreciation of the yen against the euro, which makes its Japanese-made products more affordable to European consumers (but gives no help to Sony’s European manufacturing units, which must pay their costs in the stronger currency).
Kurihara estimates that that every yen depreciation against the euro has a positive impact on sales of 10 billion yen and a net gain of 5.5 billion yen. This allows greater flexibility in pricing over European competitors. The GTS is already integrating its financing and hedging services in London, handling almost 40 currencies and US$20 billion to US$25 billion of foreign exchange.
Kurihara says that the “natural hedging capabilities of Sony’s GTS have been quite positive.” (See “Natural Acts,” at the end of this article). He adds: “This is particularly true regarding our Japanese manufacturing units. We’re able to eliminate between 20 to 30 percent of the Japanese [yen] exposure for our factories buying material parts from outside Japan, mainly in U.S. dollars.” But Kurihara adds that “Natural hedging is not big in euros, because of the relative lack of manufacturing in Europe.” He says: “But over all, natural hedging has been a great benefit of the centralized treasury.”
“Sony is running a dollar system and a euro system,” says Etzel of JPMorgan, and then it can aggregate other currencies for the participants as well.” He adds: “Just by collecting the flows some natural hedging would accumulate, as well as greater benefits from scale economies.” Adds Kurihara: “[Before GTS] all such hedging was distributed through the world. Now we have clear visibility and more control.”
Despite the slowness of the rollout, no other company has harnessed the potential that Kurihara has at his fingertips. Although at midstream, Sony’s GTS is contributing significantly, particularly in risk management. Moreover, the savings that Sony has already garnered from eliminating the need for some bank loans in the electronics and Playstation divisions point to real advantages in working capital management in the future.
Kurihara seems to be making Sony’s fiery trial by global competition a little easier to bear.
Arthur Clennam is a contributing editor to CFO Asia.
Companies are forsaking natural derivatives for natural hedges — matching revenues and costs for the same currency or offsetting losses in one currency with gains in another. There are two main reasons for this shift.
One, most multinationals have centralized their treasury operations, at least on a regional basis. With access to data and third-party transactions within the various countries in which the multinational operates, treasurers and risk managers can better understand how transactions in one currency offset those in another, and thus erect natural hedges.
The second reason, closely allied with the first, is the cost of derivatives, which can become prohibitive if they are used to excess. “Some companies hedge themselves into oblivion,” observes Christos Pantzalis, an associate professor of finance at the University of South Florida. “You don’t want to run that risk,” says Gail Sullivan, treasurer of U.S.-based Gillette Co., noting that hedging everything can lead to costs greater than those of unhedged exposures. For U.S. companies, or those listed on an exchange, there’s another compelling reason. Reduction in derivatives also reduces the stringent reporting backlog required for FAS 133, the Financial Accounting Standards Board’s three-year-old standard for accounting for derivatives.
It’s not clear whether companies are in fact cutting down on derivative use as a result of FAS 133, but recent studies by the Association for Financial Professionals in the United States suggests they may be doing so.