Multilateral Netting

Multilateral netting allows a multinational firm to reduce the transaction costs that arise when many transactions occur between its subsidiaries. These transaction costs are the commissions paid to foreign exchange dealers for foreign exchange transactions and the fees charged by banks for transferring cash between locations. The volume of such transactions is likely to be particularly high in a firm that has a globally dispersed web of interdependent value creation activities. Netting reduces transaction costs by reducing the number of transactions.

Multilateral netting is an extension of bilateral netting. Under bilateral netting, if a French subsidiary owes a Mexican subsidiary $6 million and the Mexican subsidiary simultaneously owes the French subsidiary $4 million, a bilateral settlement will be made with a single payment of $2 million from the French subsidiary to the Mexican subsidiary, the remaining debt being canceled.

Under multilateral netting, this simple concept is extended to the transactions between multiple subsidiaries within an international business. Consider a firm that wants to establish multilateral netting among four European subsidiaries based in Germany, France, Spain, and Italy. These subsidiaries all trade with each other, so at the end of each month a large volume of cash transactions must be settled. Figure 20.2a shows how the payment schedule might look at the end of a given month. Figure 20.2b is a payment matrix that summarizes the obligations among the subsidiaries.

Figure 20.2a

Cash Flows before Multilateral Netting

		Paying Subsidy
	Receiving Subsidy	Germany	France	Spain	Italy	Total Reciepts	Net Receipts * (payments)
	Germany	-	$3	$4	$5	$12	($3)
	France	$4	-	2	3	9	(2)
	Spain	5	3	-	1	9	1
	ITALY	6	5	2	-	13	4
	Total payments	$15	$11	$8	$9

Figure 20.2b

Calculation of Net Receipts (all amounts in millions) 

Figure 20.2c

Cash Flows after Multilateral Netting

Note that $43 million needs to flow among the subsidiaries. If the transaction costs (foreign exchange commissions plus transfer fees) amount to 1 percent of the total funds to be transferred, this will cost the parent firm $430,000. However, this amount can be reduced by multilateral netting. Using the payment matrix (Figure 20.2b), the firm can determine the payments that need to be made among its subsidiaries to settle these obligations. Figure 20.2c shows the results. By multilateral netting, the transactions depicted in Figure 20.2a are reduced to just three; the German subsidiary pays $3 million to the Italian subsidiary, and the French subsidiary pays $1 million to the Spanish subsidiary and $1 million to the Italian subsidiary. The total funds that flow among the subsidiaries are reduced from $43 million to just $5 million, and the transaction costs are reduced from $430,000 to $50,000, a savings of $380,000 achieved through multilateral netting.