Part 1: What is centralised financing and why do companies use it?

Combining financing with a decentralised operating model

In this first article, we explain what we mean by centralised financing and why many companies use it. In the follow-up articles, we will discuss the pitfalls, the requirements that centralised financing places on the structure of the treasury function, and how to properly design internal financing.

What is centralised financing?

Most companies consist of a group of legal entities managed by a holding company, where the group’s executive management and various support functions are located. The group may consist of multiple legal entities, possibly operating in different countries, sometimes organised into divisions, business activities, or country organisations.

Centralised financing refers to organising the vast majority of the group’s funding through a centrally negotiated financing agreement. Depending on the financing volume, this may be a bilateral agreement with a single bank or a club deal involving multiple banks. Because banks want control over underlying cash flows and assets, centralised financing is usually accompanied by joint and several liability for most group members. For this, a guarantor cover is agreed, requiring that the jointly liable entities represent at least 80–85% of the group’s consolidated EBITDA and balance sheet. Banks will also want to limit or strongly restrict other financing or security arrangements at the local level.

Why do companies use centralised financing?

Companies may choose centralised financing because it offers several advantages over local financing. Centralised financing:

Increases the group’s financing capacity

The group, based on the guarantor cover, typically has a stronger credit profile than the individual group entities. As a result, the group can raise substantially more funding under a single central financing agreement than the combined total of what the individual entities could obtain locally.

Provides purchasing advantages

Due to the lower overall credit risk and the larger financing volume, the group can negotiate much better terms than individual entities would be able to secure. The increased scale also gives the group access to a broader range of financing markets and lenders.

Allows freedom of action within the group

Within a single financing agreement, there are no restrictions on transactions between group entities. This is essential, for example, for centralising liquidity in a group cash pool.

Offers uniform documentation and financial covenants

With centralised financing, the group can rely on one set of documents, governed by the law of the holding company’s jurisdiction, forming the basis for all financing arrangements within the group. These agreements include one set of financial covenants based on the group’s consolidated financial statements. Under local financing, each entity would instead need its own agreements under local law, local security packages, and individual financial covenants.

Despite these advantages, they are usually not the primary reason a group decides to move to centralised financing. The transition is often driven by necessity. A major acquisition, for example, may not be financeable through the local credit facilities of individual entities. The scale of the required funding forces the group to enter into a central financing arrangement based on the group’s consolidated financial strength.

Once this shift toward centralised financing is made, companies often fail to adapt their treasury function and internal financing structure accordingly. That is the central theme of this series.

Rolf Michon

Partner Debt Advisory