Using Surety Bonds to Secure FBO Funds in Europe

And the winner of the 2021 Gold Alexander Hamilton Award in Working Capital & Payments is ... eBay. Congratulations!

eBay Inc. is the textbook definition of “multinational.” The online platform connects buyers and sellers of all kinds of goods, across more than 190 markets.

It also collects payments on behalf of sellers around the world. When someone sells an item on ebay.com, the transaction is processed by eBay. Then eBay distributes the sales price to the seller, less credit card or other payment processing charges and whatever fees the seller owes eBay for the transaction. This managed payments strategy gives eBay responsibility for safeguarding funds due to sellers in certain jurisdictions.

“We have millions of sellers globally and facilitate a significant number of transactions every day,” explains Alan Kubitz, senior manager of global risk and insurance for eBay. “So, at any point in time, eBay is holding money for many thousands of sellers—from individuals to small businesses to global corporations. These seller funds have to be held in a ‘for benefit of,’ or FBO, account that is separate from our operating accounts, or else they must be safeguarded in a method that complies with local regulations.”

The rules around managing these funds vary by jurisdiction, but a common theme is that if eBay isn’t simply holding cash, it must ensure that sellers could still collect what they’re owed should eBay become insolvent. In the United States, all FBO funds are secured with a surety bond, a three-party contract in which one party (the surety) guarantees the obligations of a second party (the principal) to a third party (the obligee). If a surety bond is triggered, the surety pays the obligations immediately, for subsequent repayment by the principal.

Surety bonds are not common in many countries, though, so most payment intermediaries outside the United States just hold FBO funds as cash. That’s what eBay’s European payments shared service center used to do. However, Kubitz says, “from a treasury standpoint, some folks were pretty adamant that we shouldn’t be holding so much cash. eBay generates a lot of free cash flow; that’s how we operate our business. Parking large amounts of cash in FBO accounts where we couldn’t touch it seemed to our treasury team to be very inefficient.” Because he manages the company’s risk management processes, Kubitz knows insurance companies and brokers around the world. “It seemed like there must be a better way to manage these funds,” he says.

He researched eBay’s options and came up with three alternatives: an insurance policy, a letter of credit, or a surety bond. “I read the applicable country regulations and determined that any of these three would fit,” Kubitz says. Still, most companies licensed as payment institutions are simply holding FBO funds in cash accounts. eBay had no model to follow, and each alternative had pros and cons.

“There was no insurance policy like this in existence, so if we wanted to go the insurance route, the policy would have to be created from scratch,” Kubitz says. “Insurance would clearly also be the most expensive option.” A letter of credit or surety bond would require the issuing bank to pay the seller if eBay couldn’t, but eBay would have a contractual obligation to repay the bank within a short time frame. “That’s why it’s a lot cheaper than an insurance policy, which has no mechanism for reimbursement if the insurer pays a claim.”

Kubitz also found that a surety bond would be less expensive than a letter of credit. eBay uses letters of credit frequently to safeguard rent obligations in Europe, but the purpose Kubitz was considering was so different that the company would have to start over with writing new letter-of-credit language. Plus, he says, “a letter of credit ties up credit capacity for the company. If we had 50 letters of credit that were worth $1 million apiece, then they would reduce our borrowing capacity by $50 million. A surety bond would not.”

Once Kubitz decided a surety bond was the company’s best option, his team began shopping for an insurance partner to serve as the surety. “It took a little effort on the part of our broker to find an insurer that understood what we wanted to do,” he says. “From a practical standpoint, there is virtually no risk. We don’t hold the funds for long, and our cash flow–to–revenue ratio is very high. But, again, this is new. It took a while, but we were able to find an insurer that worked with a law firm which had experience with this setup in a different country. So they had a template to use in building our contract.”

Throughout the process, Kubitz spent a lot of time educating stakeholders, both internally at eBay, within the insurer that is acting as the surety, and among regulators. “One issue that came up frequently was that I had to be very specific about word choices,” he says. “The way the regulation is laid out, FBO money can be held either in cash or in what they call ‘the insurance method.’ So people kept talking about ‘using insurance.’ I would immediately correct that because it’s not insurance.”

In fact, he says, the project team stopped referring to their approach as “surety bonds”: “In the U.S., in industries like construction, the term ‘surety bond’ is very common. But in Europe, it’s less common. We decided we would cause less confusion if we just referred to our surety bonds as ‘guarantees.’”

After years of planning, eBay rolled out the first surety bond for its European shared services center in 2021. The amount of money eBay holds for sellers fluctuates widely. Every day, the shared services group compares the balance it owes to sellers against the outstanding amounts of the surety bonds the company has in place. When the amount owed comes within a certain percentage of the total size of the surety bonds, Kubitz and the treasury team determine whether to increase the size of the bonds.

The surety bonds have freed up a significant amount of working capital at eBay. Although Kubitz declined to specify the amount, the company has already initiated over US$100 million worth of surety bonds.

“Anything is better than having that much money sitting in a cash account that earns zero,” Kubitz says. “We could insert the interest rate we would have paid if we had taken out a loan, or the return we could make on an investment that size—either way, there’s a favorable spread compared with the cost of the bond. The bottom line for eBay is that we’ve freed up working capital the business can put to much better use.”

Kubitz has a few words of wisdom for treasury, finance, and risk management professionals looking to do something truly new. First, he says, cross-functional communication can be very helpful in sparking innovative ideas. “As a risk manager, I’m not involved in our working capital day to day,” he says. “I saw this opportunity because I sit within treasury. I talk frequently to the cash management team and the treasury member who oversees investments and foreign exchange. Through discussions with them, I understood the problem of tying up so much cash. From there, my experience in risk management led me to this solution.”

Another piece of advice is to get granular with regulators. “Walk them through every detail, assuming they don’t know what you’re doing or why,” Kubitz says. “Treat everything like it’s a completely new process.” At the same time, though, don’t worry about things that aren’t necessary. “When the regulators weren’t comfortable with the language in our guarantee form, we didn’t push them to accept what we thought was ideal. We changed the language, used simpler and clearer verbiage, so that it would make more sense to them and address their specific concerns.”

His final recommendation for an innovative peer: Don’t give up. “There were times where some people weren’t convinced the setup could be implemented,” Kubitz says. “But we kept working on it, we kept trying, and eventually we launched successfully.”

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