Increased globalisation has put subsidiary cash management in the spotlight. Treasury needs to ensure that interest on this cash is maximised and fees and taxes are minimised, while maintaining an overview of group liquidity. This concept is nothing new in transaction banking. Global companies have long used both physical and notional cash pooling. This involves either physically moving balances to a parent account (also known as zero balancing) in the case of the former, or pooling surpluses virtually to reduce interest payments in the case of the latter.
With a long history of international trade behind them, banks and companies in the Nordic and Baltic regions have developed a sophisticated form of cash pooling known as balance netting, which has historically been restricted to the region. Now Nordic banks are attempting to follow their customers beyond their traditional home markets by introducing sophisticated netting models also on a global scale.
Doing it the ‘Nordic Way’
Balance netting is a form of cash concentration, whereby funds from subsidiaries are moved to a parent account. However, where in the similar process of zero balancing this occurs at the end of each day, with balance netting the transfer occurs in real time. In both cases, the cash concentration improves the net interest position by offsetting debit and credit balances.
Balance netting is also known as single legal account pooling as, from a legal perspective, only one bank account (the ‘parent’) is held with the bank and all the subsidiary accounts are off-balance sheet. It removes the need for local bank accounts, and therefore credit, in the individual locations, as all the money in the transactions is credited immediately to the main account without needing to be collected in the regions in question. In the same way, withdrawals are instantaneously covered from the parent account. This in turn allows cash to be concentrated in one place. As the company opens subsidiaries in more countries, these can be included in the global cash pool.
Therefore, using the example of the Nordic countries, a company with four cash pool agreements (one in each country in the region) can reduce this number to one. Clearly this is only possible with a bank that provides multicurrency functionality to allow the cash from each of these locations and currencies to flow to the same master account in real-time.
The key advantage of balances aggregated in real-time is the reduction of uncertainty and the need for approximation by gaining an overall liquidity picture. This in turn increases operational efficiency. Compared to traditional cross-border sweeping, the real time cash pool will give treasury direct access to group liquidity up to a day earlier.
Effective cash forecasting therefore, complements balance netting – and cash concentration more generally – in helping corporates achieve efficient liquidity management. Since they support the same process, the tools for managing pooling and forecasting are set to become more integrated. Because they are driven by different types of organisations – cash forecasting has historically been corporate-led and cash pooling bank-led – this integration has not yet occurred, but it is only a matter of time.
For a large corporate with large balances, balance netting has much to offer as a financial instrument in its own right. However, treasuries at smaller companies with a global customer base can also benefit from the added operational efficiency and reduced operational risk it provides. While their manufacturing processes are international, their financial processes often do not provide adequate support.
The number and scale of the subsidiaries of Nordic corporates is increasing, spurred on by rising business volumes in countries such as Germany, the UK, Spain, France and Italy. This has led to increased demand in the Nordic region for global – rather than regional – cash pooling solutions.
Cash pooling in the Nordic region has developed in a different way from the eurozone, where the introduction of the single currency drove the move from local to cross-border zero balancing. Thanks to the advanced cash pooling technique, Nordic companies have long been able to make use of group liquidity, despite the four different currencies used in Norway, Sweden, Denmark and Finland. It has also allowed Nordic corporates to reinforce the historically strong trade links between these countries, as well as the Baltic countries (Estonia, Latvia and Lithuania). Firms’ expectations have also been raised by the growth of cash pooling solutions in their dealings with countries in the rest of the eurozone.
In order to match their customers’ geographical coverage, Nordic banks use correspondent banks in the areas where they are unable to open branches. These partnerships will be key to providing global cash pooling to Nordic corporates as they continue their international expansion. For example, Nordea has established a cross-border cash pooling solution with a partner bank in Europe to extend its reach beyond their traditional home market in the Nordics and Baltics.
As companies’ operations widen to include more countries, their cash management needs become more complex and increase the need for cash to be managed globally, using standardised processes. This is part of a general drive towards greater operational simplicity and efficiency that has seen treasurers seek out also bank-agnostic solutions such as SWIFT’s corporate offerings. Without a strategy that relies on standard or strongly centralised solutions, integration will become increasingly challenging.
Balance Netting and Local Regulation
The use of balance netting for Nordic firms’ subsidiaries does, of course, depend on local regulation. There are still countries where multicurrency cash pooling is prevented by local regulations. For example, the scope for cash pooling is restricted in Poland. There are no specific laws governing cash pooling agreements but the general legal framework does not permit it. However, when the Polish economy becomes less localised as corporates start to buy companies or open subsidiaries outside Poland, the need for economic growth is likely to spark regulatory change. The speed of growth in the Polish economy could see this happen in as quickly as two years time. A similar picture exists in Russia, where cash pooling in general is a relatively new concept.
One issue that needs to be considered when using balance netting is the automatic generation of intercompany loans. These are generated between the parent account and the ‘mirror’ accounts paid in at subsidiary level. This could potentially create legal or tax issues in certain jurisdictions. For example, in Poland, loan agreements – although not specifically cash pooling – are subject to 2% tax, with a 20% fine of the principal for non-payment. It therefore makes sense to clarify individual agreements with the tax authorities to avoid disputes.
The use of balance netting is currently restricted to companies based in the Nordic countries. One reason for this is that the process often does not work with the enterprise resource planning (ERP) systems used outside of the Nordic region. Because the funds are moved in real time to the parent account, rather than being temporarily held in a subsidiary account, as happens with zero balancing, the daily total from subsidiaries might not be recognised.
One potential obstacle specific to smaller companies is that, to fully optimise cross-border payments, they need to work with a single bank vendor. This could prove difficult if the company were financed through a syndicate, potentially giving rise to conflicting aims. Where optimising liquidity typically calls for a company to reduce the number of banks and bank accounts it uses, the increased bank credit risk caused by the financial crisis has seen many companies spreading this risk by increasing the number of banks they do business with. This trend could have implications for balance netting if there is not a clear way to allocate different company revenues to different banks. This could, in any case, defeat the purpose of balance netting.
Balance netting is not a new tool for Nordic corporates. However, as companies in the region continue to globalise, the technique gains in value and the benefits attached to it multiply. As banks further develop this technique, non-Nordic corporates could also start to benefit from it.
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