10
Jul 2015

Regulatory Issues in Netting: Where can you net?

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When treasurers start talking about multilateral netting, one of the first things you hear is “we can’t net because it’s not allowed in [key office]”. In every office you’ve got someone who will mention that netting is simply impossible due to national regulations. Although, sometimes there are strong rules and reporting requirements regulating netting, the fact is, netting is allowed in most nations, and if you are willing to invest the effort you can net nearly every one of your offices, or at the very least involve them in the reconciliation process.

Why is there so much regulation?

Well, if you think about it from a state perspective, it makes sense to have some control over the process. Netting allows you to transfer money without actually transferring money, which is the point of netting. You don’t have to shift huge quantities of money about, you just net balances against each other and let everyone keep whatever cash they have, while trading goods and services.  This opens up potential to cheat national rules, which countries need regulation to prevent.

China for instance, doesn’t like to allow money to be transferred out of the country. With netting one could, in theory, cheat the system to allow this. To prevent this from happening, the Chinese central bank scrutinizes these trades.

Netting also opens up potential for trade based money laundering, as products shipped can be offset against trades from different countries. Increasingly the west’s solution to this has been a move towards more detailed auditing. This is actually a very good policy, as netting holds all records for audits – making them easy to perform and inconsistencies easy to catch.

The final, and probably most common issue that causes countries to put heavy regulation on netting is tax avoidance. This is the most scrutinized part of netting - for obvious reasons.

Needless to say, we don’t recommend trying any of these. The regulation that exists does a pretty good job.

What countries have strict netting rules?

Because of this potential for abuse, many nations have put strong controls on it. The specifics of what is allowed depend on the country, and we don’t claim to be experts in local laws. However, we have talked to a lot of our clients and in doing so gathered a lot of data on what is and what is not allowed. For example:

  • Brazil, Malaysia, South Korea and Chile, and India allow netting but only in the local currency.
  • South Africa allows payables or receivables to be netted but not both. Companies wishing to net their South African subsidiaries need to be careful to make sure that their netting rules are set up for this. 
  • China’s desire to keep money within its borders makes netting there a difficult process; one which the central banks keep an eye on. As such, you better be ready to open your books to the central bank.
  • Same with most of Eastern Europe and the Baltic States, Brazil (once again), Greece, and Japan, which all require that you open your books to the central bank.
  • Many countries – including Belgium, Canada, Poland, Portugal, Lithuania, Slovenia, and Slovakia require reporting of netting.
  • In Russia and Ukraine netting can only be done on a gross in/gross out basis

Of course, just because it’s allowed, doesn’t mean it’s easy - or even worthwhile for all companies - but it’s always doable for a dedicated treasurer. For example, several clients have offices across Russia and Ukraine which have implemented netting. For example, China is often seen as a lost cause for netting. However, I had a treasurer quite proudly tell me that he had worked his way through the red tape, (this is often done by using a detour via Hong Kong) and their Chinese office was now fully integrated. In fact, as of last year we’ve had nearly ¼ of our clients with Chinese offices manage to implement netting.

What if I can't net?

In some rare cases netting isn’t allowed at all (Venezuela being the only one I can think of off the top of my head), which may tempt you to give up entirely, but while regulation may prevent your subsidiaries from being able to engage in the netting process, there are rarely – if ever – rules against involving them in the reconciliation process.   Remember that the value of netting isn’t just in the cost savings from reduced transactions, but in the value that the reconciliation process brings to intercompany dealings. Reconciliation engages all parties, keeps records, and assures that deals are properly disputed. This allows you to recognize things like which parties are creating problems, and which are having shortfalls, allowing you to more accurately manage and predict liquidity needs. So even if you don’t have netting, you want people included in the process. This is why you use virtual netting. It includes all members - even those not netting - in the reconciliation process.

Many companies try to claim that they can’t net because of offices in places where netting isn’t allowed, but the truth is that netting is allowed almost everywhere with some limitations – and even in those where you can’t there is at least virtual netting. A smart treasurer will take advantage of each of these possibilities to assure that they are making the most out of their IC payables and receivables process.

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