Embedded Finance to Embedded Treasury: Are Corporates Ready for the Transition?
This article is written by Kyriba Embedded finance is the practice of integrating financial services within non-financial platforms and services with the objective of delivering the financial service at the “point of need.” In the not-so-distant past, accessing financial services such as payments, lending, and investments required either a visit to the bank or a redirection to a financial services provider’s portal or call center. Software platforms, software enablers, and banks are driving digital transformation, seamlessly integrating financial services, or ’embedding’ them, into non-financial services contexts. This revolutionizes how financial services are delivered and consumed. Payments are the most prominent of all embedded financial use cases for customers. Are you an experienced treasurer or someone looking to enhance their knowledge of financial management? We extend a warm welcome to TreasuryMastermind.com. Join our vibrant community and become a valued member of a network that prioritizes collaboration, expertise, and the pursuit of excellence in corporate treasury. Let’s initiate discussions and together elevate the art and science of treasury management! The Rise of Embedded Finance in B2B Context Embedded finance and, by extension, embedded payments are commonly talked about in the context of consumers. However, they are increasingly gaining prominence within the B2B context. According to 2021 estimates from Bain, B2B payment volumes amount to $27.5 trillion, with Accounts Payable and Accounts Receivable representing 90% of the value. This volume is expected to reach $33.3 trillion by 2026. Embedded payments account for a low single-digit share of B2B payment volumes. B2B embedded payments are expected to quadruple from $0.7 trillion (2.5% share) in 2021 to $2.6 trillion in volume (7.8% share) in 2026. ACH accounts for the majority of embedded payment volumes, with a small fraction coming from cards. This transition is becoming increasingly possible with the rise of open banking and APIs that enable the seamless embedding of financial services in business systems and processes. Before APIs, embedding financial services directly within existing business processes was complex. For instance, embedding payments from one bank into a business’s ERP could take anywhere from 6–8 months or longer. This long time-to-market was a result of many complexities (e.g., multiple ERPs, customizations, need for specialized resources or lack thereof). The onboarding time and investment required to embed financial services often outweighed the benefits. This was even more complicated for mid-market and enterprise businesses with multi-bank relationships. ALSO READ The Role of Software Enablers in Enabling Embedded Experiences The rise of software enablers utilizing the Software-as-a-Service (SaaS) model has been critical to delivering embedded experiences. These embedded finance solutions began by enabling payments and other financial services into business processes using host-to-host connections, diminishing the role of traditional bank portals. To enable truly embedded experiences, APIs are increasingly becoming available from banks and software enablers. Banks in the US and other geographies have made significant investments in APIs. In Europe, regulations such as PSD2 have aided this transition, while in the US, it has been market-driven. Banks’ motivations include reducing complexity, improving agility, enabling partners, ensuring regulatory compliance, and driving innovation. Over 75% of these APIs are for internal use, with the remainder intended for distribution purposes via partners or developers. Partners act as enablers, saving corporations time and effort in dealing with disparate API integrations across banks. Corporations empower themselves to automate downstream treasury or other non-treasury business processes. This is in alignment with the organization’s operational goals by seamlessly accessing multiple bank APIs via partners. Banks’ Investments in APIs Consider a scenario where a treasurer and a Treasury payment analyst discuss an urgent payment to a counterparty. They use their organization’s internal messaging platform (e.g., Microsoft Teams). Traditionally, this would require the analyst to access another system. For example, a bank portal or TMS would initiate, approve, and release the payment. The power of open APIs enables such requests to originate. And be approved, and released within the context of the messaging system. Providing real-time visibility into the account’s beginning and ending balance. There is no reason to switch contexts. Treasury professionals can securely execute the entire process within the context of the messages exchanged. This example captures the essence of embedded finance as payments. Financial services deliver efficiently and seamlessly at the point of need, i.e., through a conversation over a corporate messaging platform. APIs can also act as catalysts for upstream or downstream process / system modernization. For instance, an existing system (e.g., a web portal) may be supporting a slow FTP-based legacy process. You can modernize managing intercompany loans without needing to rip and replace the entire system. With APIs, the same system can process real-time requests for intercompany loans. And stay in sync with the treasury management system. Embedded Finance to Embedded Treasury The rise of embedded finance and the adoption of APIs have transformed how financial services are delivered and consumed. Businesses can now seamlessly integrate financial services into their existing systems and processes. With the help of software enablers and banks. This improves efficiency and reduces complexity. Those that embrace this trend are likely to enjoy a significant advantage in the years to come. Corporates should consider adding APIs to their transformation strategy and should proactively speak with their bank / provider. In order to explore the possibilities.
FranklinOECD BEPS and Transfer Pricing: Differentiating In-House Bank Interest Depending on Balance Sheet
When companies set up a Zero Balancing Cash Pools structures, tax authorities scrutinize in-house bank solutions and apply interest spreads. To support this, a number of countries are working together through the OECD organization. They aim to streamline economic market forces and have defined guidelines accordingly. This measure aims to prevent tax base erosion and profit shifting resulting from non-realistic spreads applied in in-house bank structures. The guidelines are known as OECD BEPS. Understanding OECD BEPS Guidelines In short, the OECD BEPS guidelines specify that in-house banks must provide solid and realistic justification for the spreads they apply. In addition, local tax authorities may interpret a solid and realistic substantiation of the applied spread differently. This interpretation suggests that spreads should differ per legal operating entity. It is akin to how external commercial banks assess terms and conditions for customers legal operating entities individually. Challenges and Solutions Corporate Treasury and Tax departments tend to “keep things simple.” This is because of the workload involved when differentiating interest spread per operating entity. Interest spreads on InterCompany loans are rather easy to differentiate as: Compliance and Documentation This may potentially be sustainable for companies with little history of cash pool structures. However, for mature companies, there is an increased tendency for local tax authorities to scrutinize in-house bank structures. They aim to understand whether interest spread settings comply with OECD BEPS Transfer Pricing guidelines. To further comply with transfer pricing principles, with an increased focus on OECD BEPS, more companies are implementing methodologies. These methodologies aim to differentiate interest spreads based on the individual balance sheets of legal entities. Are you an experienced treasurer or someone looking to enhance their knowledge of financial management? We extend a warm welcome to TreasuryMastermind.com. Join our vibrant community and become a valued member of a network that prioritizes collaboration, expertise, and the pursuit of excellence in corporate treasury. Let’s initiate discussions and together elevate the art and science of treasury management! Preparedness for Tax Authority Reviews External banks run a risk analysis for each company that wants to bank with them and is additionally looking for financing (part of the Know Your Customer requirements). Similar to external commercial banks, an in-house bank may be required to apply larger spreads for legal entities that have a financially stable balance sheet. Assessing each individual operating unit and applying a separate risk related interest spread can be too labor intensive and counterproductive. A more practical and accepted approach to this is to introduce a limited number of “risk” classes, e.g., A-level means a healthy financial balance sheet, B-level means the balance sheet is on the watch, and C-level is technically bankrupt. In-house bank spreads will need to be differentiated according to risk classes. Periodically, e.g., once a year, legal entities are reviewed to reassess the risk class (and potentially apply a renewed interest spread). In Conclusion… Any risk class review and assessment will be required to be documented. The better the documentation (including the rationale behind the applied interest spread), the more likely it is that local tax authorities will be less inclined to scrutinize legal entities. Documenting the rationale behind interest spreads and the review methodology can be included in the cash management agreement. (See white paper “Legal Aspects of In-House Banking” 2024, March Maarten Steyerberg, Solutius.). Many treasury management systems will be able to support this approach. When an operating entity or the in-house bank is under review by the local tax authorities, Treasury and Tax will need to be prepared to provide answers on why the current methodology for interest spreads has been applied and how that matches transfer pricing principles. The better the rationale behind the current methodology is explained and documented, the fewer discussions are expected with local tax authorities and, therefore, fewer tax consequences. Paul Buck is a Treasury Associate with one of our partners, Percunia Treasury and Finance and is available for any project. Fill out the contact form below to get in touch for more information about Paul and his capabilities. Thanks! Notice: JavaScript is required for this content.
Paul Buck