Designing a structure to help FX hedging effectiveness, address tax and regulatory issues, and reduce leakage.

Establishing centers of excellence or global capabilities centers is one way a growing number of multinational corporations are transforming themselves into more efficient enterprises that tap skilled talent in overseas markets with lower labor costs to perform value-added services. These corporates must make decisions about where to locate the centers, their functional currencies, how to fund them and how they invoice the parent or subsidiaries.

• Many NeuGroup member companies have set up these centers in India, introducing exposure to the Indian rupee, often requiring the use the non-deliverable forward market to hedge. NDFs are offshore dollar-settled currency derivatives.

Billing in INR or USD? One NeuGroup member company is establishing an innovation hub or global capabilities center in India. A US-based assistant treasurer explained to NeuGroup Insights that “the initial intent is to hire technical talent in order to provide ‘value add’ work; the intent isn’t to move ‘low value’ work to this operation.”

• The AT recently posed a question to peers on NeuGroup’s members-only, online community platform: “For companies that have global capabilities centers in India (or elsewhere) that are providing services to your companies headquartered in the US: In what currency does your global capabilities center bill or invoice (cost-plus) your US operation? INR or USD?”
• In elaborating, the AT told NeuGroup Insights that the question concerns financial reporting and which entity “we want to incur the FX risk.”
• The majority of members responding said their companies’ centers in India bill in USD. And one member advised, “generally, you should bill in functional currency of the beneficiary. I think a good conversation to have with your tax team is about export of services/what the controlled currency is and if there are any risks or benefits in settling in USD and having that conversion onshore.”

Tax enters the picture. No surprise, treasury’s decision on billing and functional currencies for the capabilities center in India has to take tax and accounting considerations into account.

• “It was the desire of our accounting team to have the Indian operation (which is not in a Special Economic Zone) be INR functional and for the billing/invoicing to be in INR,” the AT said. “There is an argument that if the revenue of the Indian entity is USD, the functional currency should be USD as well. Our new operation in India is a branch of an existing Indian subsidiary. We didn’t want to impact the functional currency of the sub.”
• Adding to the complexity, a non-US (and non-Indian) subsidiary has administrative oversight over the Indian operation. So the Indian subsidiary bills that non-US/Indian subsidiary, which in turns bills the company’s US parent. “Ultimately, it is the Indian operation performing services for the US businesses,” the AT explained.
• One reason that matters: “Since this work is being performed in India on behalf of our US operations, it is considered an export, exempt from goods and services taxes,” the member said. “Depending on billing currency, the India government might not consider it an export (which would have an impact on GST).”

A nostro vostro process. The AT’s company consulted its US auditing firm and its banking partner in India to find a way to retain the exemption from GST while billing in INR. “We can do this through the use of the banking nostro/vostro process,” the AT explained. Here’s how that will work:

• “While billed in INR, our non-US/Indian subsidiary will send USD equivalent to the nostro account of their correspondent bank in India. Through the nostro process, USD will be converted to INR and deposited in our Indian subsidiary bank account.
  • “We will have the audit trail of USD being sent into the country and then converted to INR, which meets the export regulatory requirements. And we are centralizing the FX exposures at a parent entity which helps simplify future hedging activities.”
• The bank, the member added, will provide the documentation of the conversion (credit advices) to the corporate’s tax team, “which will be the required documents to be filed for our GST refund.” One other achievement: “Regarding leakage, we are able to competitively bid out the FX conversions versus having a single counterparty monopolize the economics.”
• One of the peers responding to the AT’s question noted other benefits of this approach: “If the GCC is INR functional and the billing is in INR (even though settling in USD), then it eliminates P&L volatility for US GAAP in the local entity and centralizes the FX exposures at HQ. Any other option will give rise to volatility that may/may not be hedged out efficiently.”

USD-denominated Bopreal bonds offer a way for subsidiaries in Argentina to pay debts owed to US-based parents.

The Argentine subsidiaries of some NeuGroup member multinationals are buying so-called Bopreal bonds that Argentina started selling late last year to help importers pay off debt—including money subsidiaries owe parent companies. The bonds are providing relief to corporates with cash trapped in a country with strict capital controls, hyperinflation and a heavily devalued currency.

• Bopreals are dollar-denominated but can be purchased with Argentine pesos at the country’s official FX rate. They can only be used to pay outstanding invoices for goods delivered before December 12, 2023.
• The bonds offer an attractive option to corporates with limited ways to get money out of Argentina. One of the more popular, called a blue-chip swap, carries an unfavorable, unofficial exchange rate and requires companies using it to wait another 90 days until accessing the country’s official FX market.
• In recent NeuGroup sessions and online conversations, members have raised questions about Bopreals. To clear up any remaining confusion about these complex bonds, NeuGroup’s Argentina Crisis Community will meet in a virtual session on February 7 with experts from Banco Comafi to discuss upcoming auctions.

Buy, then sell. This week, one member based in Argentina bought Bopreals that will be used to make a payment to foreign vendors. The member plans to sell the securities in the secondary market.

• In a recent NeuGroup session, Martin Merlo from Banco Comafi said he has seen the bonds sell for 60% to 70% of their original value in the secondary market. The other option would be holding the bonds until maturity, although members have indicated vendors are unwilling to wait years for payment.
• One benefit of selling in the secondary market, according to members, is that a corporate can then access the blue-chip swap market starting April 1 to raise the remaining percentage of the invoice in USD, while remaining exempt from the 90-day required waiting period—a special exemption for the first series of sales.
• So, if a corporate were to buy $1 million in Bopreal and sell the bonds, the amount they transfer to the vendor outside Argentina might only be $700,000. Because the vendor still wants the remaining amount, the Argentine entity could do a blue-chip swap to raise the remaining $300,000 without the 90-day penalty.
• One US-based exporter had been told that accepting the bonds directly from the company’s customers was the only option for payment. But, following conversations with members, he now plans to suggest the buyers in Argentina sell the bonds on the secondary market.

Uncertainty ahead for invoices behind. Two more series of Bopreal bonds are on the horizon, with maturities in 2025 and 2026. The member said these will likely be aimed at smaller companies, as they carry less favorable conditions than the first series, including taxes and restrictions on secondary market sales. (The first series, exempt from the country’s 30% tax on outgoing cash, mature in 2027.)

• “I don’t think you’ll get better conditions than what you will get now if you want access to dollars,” Mr. Merlo from Banco Comafi said.
• A member responded, “If you don’t take advantage, those imports might be locked up for a long time.”

A new regulation makes some blue-chip swaps, used to move trapped cash out of the country, less attractive.

In the run-up to Argentina’s Oct. 22 general elections, the government body that regulates markets issued an official bulletin that has effectively limited outflows of Argentine pesos (ARS). In recent NeuGroup meetings, corporates and regional experts said the regulation increased the perceived legal risk of blue-chip swaps, a type of international asset trade where a multinational in Argentina typically uses local currency to buy sovereign bonds or shares of local companies with US listings and sells the securities offshore for dollars, often through a brokerage.

• Blue-chip swaps offer corporates an option in FX markets in countries with tight controls on cash outflows—albeit at a much less favorable rate: Today, $1 translates to about 350 Argentine pesos (ARS) in official channels; the volatile, unofficial blue-chip rate hovers around 1,000 ARS. Some corporates are willing to accept the rate because these transactions are one of the few ways to get trapped cash out of Argentina.
• The new regulation requires five days of notice for any transaction above 200 million ARS—roughly $200,000 at the blue-chip rate. In a recent session of NeuGroup for Latin America Treasury, Alejandro Haro, CEO of Comafi Bursátil, the brokerage arm of Banco Comafi, said “this is a major change.”

Chilling effects. Mr. Haro, as well as a NeuGroup member who has executed a blue-chip swap in the last week, said a knock-on effect of the regulation is that demand has steeply declined in the blue-chip market. That has essentially imposed a soft cap of about $3 million per swap transaction, down from around $15 million before the regulation.

• He added that earlier this year the blue-chip swap market could see up to $80 million total per day, compared to $30 million now.
• At a recent NeuGroup meeting, one treasury manager said he had plans to execute a blue-chip swap worth multiple millions in USD the week before the election, with an eye on another, larger transaction later. The new requirement to submit notice, in addition to increased regulatory attention, caused the treasury team to put an indefinite hold on the plan.
• This is not the first step Argentina has taken to limit the use of the blue-chip mechanism. Earlier this year, the central bank issued a new regulation on blue-chip swaps: Before a party can execute the transaction, it must prove it has not tapped the country’s official FX market for 180 days; after the swap, it can’t access that market for another 180 days.

Tangled legal knot. Gabriel Gomez-Giglio, the chair of Baker McKenzie’s Latin American banking and finance practice, noted in a recent interview that the new regulations, in concert with a number of other factors, including uncertainty around the Nov. 19 election run-off and ongoing price volatility in the country have “basically been a deterrent to conduct transactions.”

• “Our clients are holding onto many more pesos,” he said, despite noticing rising demand from corporates to get cash out of the country. “It’s a vicious cycle.”
• Mr. Gomez-Giglio, as well as Mr. Haro, noted that the regulation is unclear on how the five-day notice will be implemented, with no clarity on whether the day that notice is issued counts as one of the five days.

Moving forward. There are many parties simply executing daily trades up to the legal limit that don’t require five days of notice, about $200,000 USD—but it’s not ideal, as the blue-chip rate fluctuates often, according to Mr. Haro.

• The member who canceled plans for blue-chip swap transactions is looking for alternate avenues for trapped pesos. “We have been in a holding pattern, investing our excess cash in a money market fund that holds deposit balances,” he said. “This provides some protection.”
• He’s also looking into dollar-linked bonds, as are some of Mr. Haro’s clients. Others are looking into hard-dollar bonds, which are dollar-denominated and issued in Argentina. Parties purchasing these must use the blue-chip rate—but because this does not qualify as a blue-chip swap, it does not require five days of notice or the 180-day waiting period.
• Because of the perceived legal risk of transacting amid increased scrutiny from regulators, Mr. Haro and Mr. Gomez-Giglio each said they have noticed many corporates adopting a wait-and-see approach until after the presidential run-off election later this month. Sergio Massa, the nation’s current minister of economy, who received the most votes in the general election, will face off with libertarian economist Javier Milei, who seeks an overhaul of the economic system, leading to a “dollarization” of Argentina’s troubled economy.