From Desirability to Practicality: Cross-border Liquidity Optimisation

Traditional Liquidity Management Techniques

Many companies aim to centralise their cash into a single account for each currency using zero or target balancing techniques. However, this is not feasible in jurisdictions where there are restrictions on transferability. Similarly, companies with a decentralised approach to cash management do not necessarily wish to transfer funds physically, but still want to achieve the benefit of balance sheet and interest offset.

Notional pooling, as a form of domestic interest optimisation, is well established as a technique. Companies typically use notional pooling for offsetting same-currency cash balances, reducing interest costs, maximising net returns and providing greater visibility over cash positions from a central location. As there is no physical movement or commingling of funds, the integrity of account positions remains unchanged and local autonomy within decentralised organisations can be preserved. Companies are able to combine single currency notional pooling, or other interest optimisation tools, with other techniques such as target balancing and automated investment solutions. Using this technique, companies can create a liquidity management strategy that is specific to the needs of the business whilst respecting local conditions in each country. While the benefits of notional pooling are considerable, extending this technique across borders is typically considered as highly desirable but unachievable, with apparently insurmountable hurdles such as the right of set-off on a cross-border basis.

The Cross-border Challenge

Companies with cross-border liquidity management requirements face a variety of tax and regulatory complications. For example, using techniques that involve a physical movement of funds, such as target balancing, is likely to result in an intercompany position that may be difficult to reconcile. Additionally, the physical movement of funds may cause internal problems in a decentralised organisation, particularly if the treasurer does not have the authority to direct the local finance team to transfer their cash to another business entity. Withholding tax issues, such as replacing local bank financing by a non-resident group entity funding, also exist. By incurring withholding tax in this way, an intercompany liquidity solution may prove financially disadvantageous.

While traditional notional pooling may theoretically address some of these issues, treasury may still not have the necessary authority, and such a solution has limited applicability as a result of difficulties in enforcing the right of set-off. In addition, there is a high level of uncertainty in accounting treatment, with the risk that it may still be treated as an intercompany position. Irrespective of available solutions, companies operating in regions such as Asia-Pacific have still been confronted with the dilemma of how to deal with non-convertible or restricted currencies, also known as trapped liquidity. They have therefore been seeking a simple solution to optimise liquidity and net currency positions, while avoiding regulatory or tax complexities in each country.

The Next Step in Liquidity Management Innovation

Notional pooling has traditionally been restricted to same-currency accounts in a single location. However, some cross-border notional pooling solutions enable companies to apply interest optimisation techniques across borders and multiple currencies. Any currency or country can be included in this structure, subject to local laws and regulations.

Multi-currency, cross-border notional pooling provides a highly convenient solution. Companies can better leverage on an aggregated basis the balance of their funds in multiple currencies and minimise the interest costs within a group. Without the need to physically move funds cross-border, it helps to avoid potential tax and regulatory issues. This is a major step forward for companies seeking to reduce cost and risk, manage foreign currency liquidity requirements and enhance visibility of cash across the group.

Some of the key benefits of a multi-currency, cross-border notional pooling structure include:

  • Minimal legal documentation.
  • No need to transfer funds across borders.
  • No creation of intercompany positions, avoiding potential tax and regulatory considerations.
  • Account autonomy while achieving simplified account reconciliation.
  • Participation of joint venture and minority-owned operating entities.
  • Credit and debit balances, in multiple currencies, at multiple locations can be included in the structure.
  • Timely implementation, enabling immediate benefit.
  • Requires little or no change to existing systems and processes.

Example 1: Addressing a Liquidity Dilemma in a Multi-currency Environment

Subsidiary A has an urgent local payment in a currency that is restricted in convertibility and transferability. Subsidiary A does not have sufficient cash in the short-term to fund the obligation, although cash is due to be collected shortly. Before multi-currency cross-border notional pooling, the company had three available options:

  1. Draw down on an existing credit facility. The company would pay a high rate of interest and would repay the loan when the expected collection materialises.
  2. Perform a foreign exchange (FX) swap. It may not be feasible to achieve surplus funds within the group in day settlement on the near leg of the other currencies swap, particularly late in the day.
  3. Perform an intercompany loan. There may be regulatory or tax shareholders’ loan as a medium to constraints which prevent this, and it long-term solution would not solve the immediate issue.

By putting in place a multi-currency, cross-border notional pooling arrangement, Subsidiary A could optimise its liquidity position without a physical movement of funds or the need to enter into an FX contract. The overdraft interest would be optimised by leveraging credit balances in other currencies within the region, resulting in a highly efficient, cost-effective and convenient solution.

Potential for Multi-currency, Cross-border Notional Pooling

Across industries and cultures, companies have significant potential to benefit from new liquidity solutions in this area. As cash remains on each entity’s accounts, cross-border notional pooling can be particularly appropriate for decentralised organisations or those with a complex ownership structure. In Asia-Pacific, for example, many companies form joint ventures or have minority holdings, which cannot typically be centralised or included in liquidity management structures. In this region, there are also advantages in being able to optimise balances and interest across currencies, while retaining operational cash flow in each currency. Notional pooling can even change corporate finance practices, by replacing shareholder loans with local bank financing, an early but vital step in developing new ways of managing cash in countries characterised by trapped liquidity.

Delivering a New Generation of Liquidity Optimisation Solutions

In some respects, it may seem surprising that such a solution has not been available to corporate treasurers before now. There are various reasons for this. For example, Citi’s interest optimisation solution launched in 2008, which was an essential building block in developing and delivering our multi-currency, cross-border notional pooling programme.

Secondly, banks need to have an extensive network across the locations involved in the cash pool.

Thirdly, banks have adopted different strategies in terms of how they serve their clients’ needs both now and in the future. Experience has shown us that maintaining access to liquidity across currencies and borders, is pivotal to clients’ ongoing success.

Finally, it is important to develop the expertise required to understand the legal and regulatory constraints in countries across Asia-Pacific and adapt solutions according to the needs of each client. Multi-currency cross-border notional pooling is likely to become an increasingly important element in clients’ liquidity management solutions.

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