Liquidity management and cash pooling at the crossroads

Just as this spring got underway, two proposed changes in regulations attracted much attention and are causing corporate treasury and tax departments to pause before they decide which direction to turn in their high performance strategy for liquidity management.

1. US Treasury proposed regulations under IRC 385

On April 4, the US Treasury proposed rules that would shine a bright light on inversions and earning stripping, but these rules also have the potential to re-characterise many ordinary course intercompany loans from debt to equity for US tax purposes. Also, the “Funding Rule” – in combination with the “Bifurcation Rule” of the proposal – can look back in the rear-view mirror three years and also three years forward to re-characterise certain debt-to-equity, either in full or in part with potential costly tax ramifications.

Furthermore, the requirements of the extensive “Documentation Rule” of the proposal, if not met, can also result in the relevant debt being treated as equity for US tax purposes.

The proposed rule, if passed in its current form, may significantly impact many multinational US and non-US parented companies that engage in intercompany loans; including such widely-used physical pooling solutions such as the zero or target balancing and cash concentration services offered by banks. It could also impact on companies that subscribe to pay-on-behalf-of (POBO) and collect-on-behalf-of (COBO) services or, potentially, virtual account solutions where intercompany loans are directly integrated with treasury’s consolidated and controlled transaction management.

While it is unclear whether notional pooling services – which are not normally treated as intercompany lending – will also be affected by the proposed rules, banks continue to see a high level of interest in corporate liquidity management. “We have had historically high levels of clients exploring expansion of their liquidity management solutions,” reports Igor Podbolotov, Citi’s EMEA liquidity management services product manager. “There is no specific data to point to right now that shows this has slowed, but obviously some are pausing to see how these and other regulations will unfold.”

The proposed rule is being widely discussed – many companies and industry associations have been providing comments to the US Treasury during the “comment period” through July 7th 2016. In a recent webinar that Citi conducted on the topic, six in 10 of nearly 150 participants had global or regional physical and/or notional pooling structures.

Of those, 46% highlighted that they were “just beginning to review and understand the information” and 37% were “actively gathering understand[ing] of the regulation and consulting with their advisors”. The audience overwhelmingly noted that no one aspect of the regulation would be difficult, but that all aspects of the regulation would be challenging – as outlined in Figure 1 below.

Figure 1:
Citi - Michael Botek fig 1

From many conversations with treasurers of both US and non-US parented multinational corporations (MNCs), it appears that many were actively made aware of this proposed regulation by their tax partners, industry peer groups and the like. Many corporations are actively advocating to make their voice heard by the US Treasury and Internal Revenue Service (IRS) on the topic. Nishami Dharmaratne, Citi’s Asia liquidity management services product manager, reports that she hears “the proposed US regulation and other global regulations like Basel III being discussed quite often.

“The entire Asia region is highly sensitive to regulations that emerge and evolve quite frequently. Recently, specifically in Asia, there have been tax laws that have been favourable of liquidity management and regional treasury centre (RTC) activity in certain jurisdictions. Corporate treasury will need to examine the entire landscape holistically.” Equally, banks and technology providers are examining these proposed US regulations to see how, or if, their products and solutions are impacted.

2. Basel Committee on Banking Supervision (BCBS) proposed revisions to leverage ratio

The second proposed regulation, which was also published in April by the Basel Committee on Banking Supervision (BCBS), proposes revisions to the Basel III leverage ratio framework. Specifically related to this article, the proposal describes how banks should treat notional pooling balances. If implemented as proposed, the new rules would significantly increase costs and could impact banks’ notional pooling pricing. It also highlights the proposed treatment of repurchase agreements (repos), derivatives and others. This proposed regulation is directed at banks, but a has significant impact on corporations that subscribe to notional pooling.

In short, the proposed changes to the leverage ratio related to notional pooling would require balances in accounts to “be reported on a gross basis”. Banks that offer these products will be offering feedback to the Basel Committee, noting that currently notional pooling is not a netting of loans and deposits, but rather a group of accounts with long and short balances in a formalised arrangement with a legal right of offset. They will also include feedback that details why a bank’s ability to offer this important client solution helps reduce its balance sheet exposure and attract “sticky” client relationships.

The Basel proposal might have received less attention by corporate treasury for several reasons. For one, there has been so much talk over the past two years about the “rocky road” ahead for notional pooling, due to accounting and regulatory standards. Some corporate treasurers might have missed the new development in this proposal. Again, the proposal has specifically mentioned “notional pooling” (and not just “netting of loans and deposits”, as in the past).

Another reason may have been that notional pooling, although a highly prevalent service, is used less frequently than intercompany lending within the in-house banking (IHB) construct and related subscription to physical pooling solutions. “Generally we see the ‘80/20 rule’ apply and most multi-entity liquidity management structures are physical, pooling incorporating intercompany loans rather than the true notional pooling” says Parimal Hemkar, Citi’s global liquidity management services product manager.

With comments due back to the Committee by July 6, banks are actively working with their advocacy groups and among themselves to provide feedback on the proposal. In the US, banks have also made regulators aware of the potential impact to total leverage exposure under the supplementary leverage ratio (SLR).

According to Hemkar: “It is frequently misunderstood in the market which rules apply to foreign branches of different banks. In the case of the Federal Reserve, they have historically looked specifically to US generally accepted accounting principles (GAAP) for the determination of assets under SLR and time will tell if that continues.”

For example, Citibank NA’s London office is a branch of a US bank and would be subject to the Fed’s implementation of Basel III under the “Final Rule” and specifically the SLR as it relates addressing the Basel Committee’s proposal on revisions to the Basel III leverage ratio framework.

Conclusions

Clearly a deep and independent view of the potential risks and opportunities are necessary. Key activities which will provide benefit to corporate treasury include:

• Becoming well-briefed on the proposed regulations and understanding how these regulations impact corporate and liquidity and risk management.
• Working closely with internal and external advisors to review options, contingencies and compliance. Within that review, also considering opportunities to increase centralisation, rationalising points of liquidity leakage across the banking and liquidity management structure, and optimizing foreign exchange (FX) and investment management.
• Engaging with banking and other service providers for “right fit” solutions and infrastructure to satisfy both their near- and long-term needs.

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