A Strategy for Setting Free Trapped Cash

Figures show that corporate cash balances at many businesses have grown over the past few years. Companies aimed to ptotect their lifelines and reduce liquidity risk during the prolonged financial crisis that developed more than five years ago. At present, with the financial landscape still unclear, cash balances remain very high; in fact many companies appear to be holding more cash than before the crisis. It is likely that some of them hold their cash with fewer banks than before because of credit concerns, or that they do not wish to invest heavily in their production capacity until the economic slump lifts. Alternatively they may hold more cash as they have created efficiencies in their production value chain, meaning less of it is tied-up in work-in-progress inventories.

Whatever the reasons, companies still retain significant amounts of cash in various locations. Attractive as this may seem at first sight, it could be seen as a drawback in disguise. Not all cash balances are as favourable as they appear to be; in fact, a significant portion of your cash balance may be ‘trapped’. And trapped cash is not easily accessible, either for making investments or paying dividends. This indirectly influences not only the financial performance of your company, but also its value.

How Does Cash Become Trapped?

There is nothing unusual about the way multinational companies (MNCs) maintain sizable cash balances at subsidiary level. As a MNC you generate revenue, earnings and cash flows in foreign markets, and very regularly hold these cash flows locally – at least over the short term. This doesn’t necessarily mean that your cash balances are trapped. In theory, cash pooling arrangements may be employed to redistribute cash and provide funds for group liquidity requirements. Bank Mendes Gans’ own observations have been that this doesn’t always work out all that efficiently. The main reason is that joint ventures and subsidiaries in emerging markets are usually disregarded, because their local currencies aren’t incorporated in the cash pool. Many banks have a limited scope and the currencies they capture are restricted to the few ‘usual suspects’; namely the euro, US dollar, sterling and Swiss franc. As a result, cash gets trapped from a group liquidity perspective.

Is trapped cash bad?
The answer is yes and no. If a company has plenty in surplus, resolving trapped cash may not be high on its ‘to do’ list, but this applies only to the lucky few. Are significant portions of your cash trapped in certain countries? Do other subsidiaries need to postpone investments or to raise new financing? If so, it is more than likely that these constraints will either limit your decisiveness, increase your cost, or both. While cash remains idle in one country, working capital is dearly paid for in other parts of the world. Furthermore, trapped cash may not earn a fair market return, reducing yield and worsening matters even more.

Is trapped cash adequately addressed?
Not always; and as the issue usually transcends individual countries and regions, the reasons are twofold. On the one hand there might be a lack of ‘cash awareness’ at the local subsidiaries. Often there is no awareness that the cash held at local banks, could be used more efficiently elsewhere. Likewise, subsidiaries that habitually approach their local banks for a credit line for new financing, are not aware of an abundance in other parts of the company that might enable them to get funded more efficiently. On the other hand sophisticated cash utilisation expertise and tooling may not be readily available at the central level.

To address the issue and bridge the gaps, companies need a centralised global treasury or an efficiently intercommunicating set of regional treasury hubs. The challenge is getting insight in excess cash and funding needs globally and, more importantly, creating awareness of how excess cash can be immediately un-trapped or set free. Once set free, consider how you can efficiently utilise these funds for cash needs elsewhere; that is without triggering adverse accounting, tax, legal and exchange consequences as well as avoiding swaps.

How to Set Cash Free

First and foremost, focus on unregulated countries and currencies. Bring them together in a single global platform whilst maintaining local bank relations. It is recommended that this platform operates in a multi-currency, multi-entity and fully notional mode. This will not only resolve most of the tax, legal and accounting concerns usually associated with cash pools, it will also increase visibility to a point where information on your group’s liquidity is available 24/7, real time.

Selecting a cash pooling platform:
A successful platform should be multi-currency and multi-entity. Multi-currency means that up to 40 currencies can be included without having to swap, which entails getting an exhaustive listing of all currencies supported and all countries available. Multi-entity must mean no inter-company loans or related party debt. Because all subsidiaries participate in the cash pool individually under their own legal name, funds are not co-mingled, zero-balanced, or swept to a master. In addition the cash pool should be fully notional. This means that debit and credit balances are fully offset. The crucial benefits are evident – on the one hand the need for financing will be significantly reduced and on the other the need for repatriation of funds to the parent will be totally eliminated. As every corporate treasurer can attest to, repatriation of funds – when considering taxation – can become very costly.

Discerning fully notional cash pools:
Fully notional cash pools avoid foreign exchange (FX) transactions altogether. There are no swaps or FX transactions because funds are not physically converted or swapped to a single currency and, in addition, they should not require cross-guarantees or cross-indemnities. For corporate tax, particularly in the US, this simplifies things hugely: companies are no longer obliged to juggle a complex structure of controlled foreign corporations and branches around the world. Last but not least, there should be no need for your company to hold a capital reserve in proportion to an overdraft.

Selecting a cash pool provider:
In general, when in discussions with banks, do not shy away from other tricky topics such as transfer pricing, withholding tax, thin capitalisation, interest allocation, accounting rules and legal issues. Each of these issues will prove critical in determining whether a cash pool, or even better a liquidity management structure, can be utilised to its full potential. Limitations in knowledge and experience on the side of the provider should never limit your scope. In other words, select a banking partner experienced in setting up the type of structure that adequately meets your requirements. Ask them to share best practices on how to address complex tax and varying jurisdictional issues, and how to mitigate their effects. This also should apply to integrating your existing liquidity management solutions. Don’t proceed if you’re not fully satisfied about the benefits that a certain bank can guarantee. And be determined with respect to flexibility and transparency about profit margins.

Include all the currencies you need:
As a next step, your focus could be on regulated countries and currencies. On this issue, while it is important to recognise that FX controls should never be circumvented you should not necessarily accept ‘no’ as an answer from your banking partner. Because ‘no’ could very easily mean: ‘Because we as a bank cannot offer this or that specific currency or country’. Which is not nearly the same thing as: ‘Because it is not permitted by exchange regulations’.

Bridging Liquidity on a Global Scale

Though local cash pools might be easily implemented domestically or regionally, the challenge lies in bridging liquidity between regions (between parent and all subsidiaries) on a global scale. The number of currencies, countries and banks included in a liquidity management structure is therefore a selection criterion in itself.

If your company completes the steps as described in this article, you should be able to get significantly closer to a wider basis enabling access to cash which otherwise could be considered as trapped. 

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