Our experience shows us that most legal entity (LE) changes are reactive, and largely aim at achieving compliance or a minimum viable acceptability threshold. However, LE optimisation can realise significant benefits, and opportunities should be assessed regularly.
This series of articles explores the many benefits you can realise when proactively transforming your Legal Entity structure and capability.
Paying for itself
Every year, organisations set budgets for regulatory and discretionary spending but rarely apply a LE lens. This means that financial benefits are not identified as readily in the LE space – and therefore not as routinely realised. In our experience, investments in Legal Entity change can realise significant financial benefits in two broad categories: Financial resource optimisation and Accelerated growth.
Financial resource optimisation
Capital, liquidity and collateral optimisation
Capital allocation
Optimising capital can materially impact your balance sheet. Subsidiaries often require separate capitalisation, so you should assess the regulatory capital required per entity. You may be able to rationalise entities and use branches (where local regulations do not require subsidiarisation). We have helped banks realise material benefits by combining entities within regions, and by migrating business from subsidiaries to branches. Capital saves can also be repatriated to the parent and redeployed.
Collateral optimisation
We recommend reviewing collateral processes to reduce the cost and risk of funding margins. This involves creating a central view of collateral in an entity and then optimising collateral needs and rights for each counterparty. For example, making better usage of existing non-cash collateral for both cleared and non-cleared initial margin requirements to reduce cash funding costs for a legal entity.
Central Counterparties (CCPs) require Default Fund Contributions (DFCs) from members, and savings can be made by rationalising direct memberships. Additionally, using local branches for cleared business can realise further savings as CCP memberships are typically held at the parent, meaning there is no DFC for branches.
Cost saving
Operations, operating models, and technology
Material savings can be realised by removing duplicative processes, functions, and platforms, and building a shared services model. Sionic’s Legal Entity Framework can help quantify savings, e.g., through current state booking and operating model assessments. Streamlined target operating models (TOMs) should be defined alongside target booking models (TBMs) to ensure functions interact effectively, with clear roles and responsibilities.
Technology savings include reduced licensing costs (e.g., centralising instances), and reduced infrastructure spending (e.g., accelerating cloud migrations). You may be able to rationalise or right-shore local tech support. Streamlined TOMs and TBMs can help simplify external connectivity, e.g., reducing direct memberships at venues and CCPs. However, the overall cost modelling will depend on the size and shape of your book. We would recommend assessing location strategy for your operations and technology functions as a fundamental part of your Legal Entity analysis.
Legal and regulatory
In jurisdictions where you want to retain a presence, the most material regulatory savings would likely come from converting a subsidiary to a branch, as branches often receive less scrutiny from local regulators (noting they still require and expect high levels of attention and accountability). The parent retains high scrutiny in its home jurisdiction, and while it would become responsible for compliance with its new branch, you can benefit from economies of scale.
Simplified structures may also need less professional services support, e.g., external counsel or consultancy. Closing an entity will realise savings by relinquishing regulatory licenses and permissions, and by no longer requiring regulatory filings or registrations. Reduction in trading staff would likely result in trader mandate savings. While these are not material, there are non-financial benefits which we address in the next article.
Finance and Accounting
Non-material cost savings may include lower statutory audit costs and reporting overheads. You can likely rationalise your agent bank network and close dormant client accounts.
Resources and HR
Headcount reductions often see the most material resource-based savings, plus proportional reductions in administrative and shared HR services. Additionally, significant savings can be realised by moving roles within jurisdictions (e.g., to lower-cost cities), and across jurisdictions (with smaller in-country teams where essential). Strengthened procurement practices can also centralise and manage external vendor and resourcing contracts and realise savings through economies of scale.
Sionic is experienced in the mechanics and the cultural elements of resource management and near/offshoring. We also have significant experience closing entities and exiting physical offices and have built detailed practices to realise savings in an efficient and phased manner.
Cost avoidance
Investing only in strategic entities and capabilities
Deciding to exit a market or business can be difficult and is not a decision that banks take lightly. However, delaying decisions means that you continue to invest in non-strategic entities. In addition to the costs of doing business as above, you will have to invest to ‘keep the lights on’ e.g., periodic technology upgrades, and meeting new regulatory requirements.
Increasing the likelihood of successful legal entity change programmes
Legal Entity change is often initiated once issues materialise, e.g., when your capital position becomes unsustainable. Waiting until an issue is ‘bad enough to address’ means the situation is more complex and more expensive, and the intervention is less likely to succeed.
Understanding emerging risks means you can course-correct earlier and avoid additional remediation costs.
Accelerated growth
Strategic focus
A simplified LE landscape can increase focus on your strengths, e.g., in a post-merger scenario, the acquirer exiting non-core businesses. The quicker that non-strategic products or locations are exited, the quicker that growth can be accelerated
Client alignment
You should look to align your entity structure and client needs, i.e., offering the right products to the right clients in the right locations. For example, you can increase clients’ ease of doing business by consolidating their businesses into one entity. Sionic’s Legal Entity Framework specifically focuses on client data to enable informed decision-making. Our experience shows that banks struggle to accurately calculate client profitability. We have helped clients improve data analysis to establish their most profitable clients and align the level of service they provide across their client portfolios.
Sionic’s Legal Entity Framework
Factors in quantifying potential cost savings
Location: Different jurisdictions have different costs to do business, including often within a jurisdiction (for example, federal vs. state taxes in the US). Rather than focus on headline figures such as FTE cost or tax rate, we recommend a holistic jurisdictional cost analysis covering the components we discuss in this article.
Business activity: There is more opportunity for savings in an active entity vs. a dormant entity, but more work will be required to unwind the business. We recommend fully closing dormant entities as many savings only occur once the business is fully wound up.
Amount of post-M&A integration/divestment to complete: You will see diminishing returns as you progress on your change journey. In a future article, we talk about setting up your strategy and delivery ‘engines’ to continually optimise your legal entity landscape
Summary
You can realise significant financial benefits by proactively undertaking a Legal Entity optimisation exercise. The most material benefits are in capital optimisation, and cost savings related to operations, technology and people. However, your business case should factor in a much wider range of savings to get a more accurate cost-benefit analysis. Importantly, financial savings can provide the business with fresh impetus by reallocating time, effort and money into your strategic growth areas.
There are almost always incremental benefits to be realised. Starting now rather than waiting will realise higher savings more quickly, and with a greater chance of success. The first place to start is by undertaking a current state assessment of your LE structure and change capabilities.
The next article in this series will cover the many significant non-financial benefits of legal entity change.
How Sionic can help
Sionic has extensive experience in Legal Entity change. We have extensive diagnostics expertise and can support the definition of your LE strategy and design. Importantly, we work with you to build your LE change capability so that you can continually assess the changing landscape and deliver the change you need.
Overview of Sionic’s LE services
If you are interested in finding out more about our legal entity change expertise, please contact us.