Nascent adoption by financial institutions in Europe of virtual account management (VAM) technology reflects a fundamental transformation in the current model of global cash management. Whereas the traditional cash management model involves sophisticated cross-border multi-currency pooling structures and sweeping techniques to physically consolidate cash, the new model uses virtual account structures to segregate balances virtually and enable real-time global cash management under native cash pooling where possible.

Virtual Accounts Optimize the Cash Conversion Cycle

Today many recognize the working capital management (WCM) and operational efficiency gains achieved by applying virtual accounts to corporate receivables management. Virtual accounts are created for each receivable customer. The virtual account number, which complies with the financial messaging standards (e.g. local and IBAN formats) required for interbank clearing, uniquely identifies a remitting party. In the context of collections, this remitting party settles invoices by making payments using the virtual account number, which supersedes unreliable sender reference information alone.

Using virtual accounts in receivables management means the financial component (i.e. the invoice payment) of a business transaction (i.e. the sale or purchase) can be linked by the account number, which is always present in every payment. The virtual account number therefore becomes a 100% reliable data key that allows automated matching and end-to-end reconciliation of a payment with the payee and invoice. 

The working capital management benefits realized by accelerating the cash conversion cycle through automating collections matching represents a significant working capital optimization in financial supply chain processing that a financial institution can offer corporate clients using VAM technology.

Multi-Currency Hierarchy

The emerging model of virtual cash management provides Payments-on-Behalf-of (POBO) and Collections-on-Behalf-of (COBO) virtual account hierarchies with segregation of co-mingled related-party funds. In this In-house Bank (IHB) model the payments and collections of entire groups are managed from a single bank account. While foreign exchange may be applied to incoming or outgoing transactions transiting a POBO/COBO structure, all accounts within a hierarchy are typically of the same currency.

VAM removes this limitation. The multi-currency POBO/COBO structure in Figure 1 illustrates the cash management account model for multi-currency in the context of payables management. Such a structure would be attractive to enterprises whose sales are exclusively in one currency while sourcing and payables are often in local currency requirements, such as commodities producers.

Account Structure

A virtual multi-currency hierarchy is topped by a single currency header account in the base currency. This header account mirrors the bank ledger account. The top level account funds the underlying hierarchies from which multi-currency payments are initiated.

A second level of control accounts, similarly in base currency, segregate balances by logical unit or legal entity. Position management, balance control and payment accounting pertaining to the entire hierarchy is done at this level. Physical fund movements are ultimately executed and cleared against the bank ledger account.

A third level of multi-currency transaction accounts support payment initiation by currency. These accounts typically hold no balances; however may do so depending upon the FX exposure risk appetite of the servicing institution. A best-of-breed VAM system will dynamically create new local currency virtual transaction accounts upon entry of a payment for any local currency for which no virtual transaction account already exists.

Finally, a set of summary accounts provides aggregate reporting by currency per logical unit or legal entity. These are not transaction accounts and maintain no positions; they are used for historical analysis and for consolidating forecasting of future foreign currency payments and positions.

Foreign Exchange

Foreign exchange is managed under one of two models: Market FX rates may be applied in real-time at the transaction level or an end-of-day netting of local currency payments is made and settled by an FX trade per currency. Rates can be applied using market mid-rates, optionally with buy or sell margins to support IHB pricing, and using direct or cross rates with reference to a base currency depending upon the currency corridor pair. Regardless of the model, upon payment execution balance control is applied, FX conversion applied, accounting is performed against the relevant accounts, payments are batched (where netting is configured), and financial messaging is sent to a bank’s payment order system for processing with associated bank ledger posting and delivery to clearing systems.

Benefits

The multi-currency virtual account hierarchy offers a global business real-time group liquidity management with native cash concentration in its base currency. At the same time, where permitted by local regulations, it supports real-time multi-currency payment processing without costs of maintaining real foreign currency accounts. While not every enterprise is appropriate for this type of VAM proposition, for those global business operating sales in a base currency globally and payables in many currencies the single multi-currency virtual account offers myriad benefits.