Evolution of the Global Notional Cash Pool

Rightly or wrongly, global notional cash pooling has often been seen as a highly specialised and even secretive cash management service. This has not bothered the many cash managers who use and swear by the product in their day-to-day treasury activities. As the makers of a well-known soft drink will also testify – the secrecy of a recipe is no deterrent to consumers who like and trust a product. Global notional cash pooling has earned a faithful following of consumers and it is now set to become a more prevalent and altogether more essential cash management tool. The platform is gaining currency in the marketplace by providing ancillary services similar to those of an in-house bank or as a structure for inter-company netting.

This evolution of the global notional cash pool owes much to client requirements and to market conditions. So-called ‘add-on’ features, such as the in-house bank or inter-company netting, have seen more demand in the past year due to the liquidity crisis. Considering the turmoil in the global financial markets, it is little wonder that many corporates have re-evaluated their cash management priorities. The cost of getting credit from banks has risen considerably so now, more than ever before, companies have to be careful about how they allocate their funds within the group. As a result, treasurers are now more focused on reporting their global liquidity. They know that they need full control over their cash, because that enables them to minimise their need for borrowing.

A further characteristic of the global notional cash pool, as offered by a specialist provider such as BMG, is that, contrary to the cash pools offered by most global banks, the structure does not involve swaps or foreign exchange (FX) transactions. This is crucial in the current financial environment where banks are concerned about counterparty risk and are therefore raising prices in the swaps market (making it difficult to enter into foreign exchange deals, especially if the swaps are longer term). The global notional cash pool enables companies to avoid swaps altogether.

In short, the recent market upheavals have led to companies ranking global cash pooling initiatives as their primary project for 2009. Using excess liquidity effectively and keeping borrowing costs at reasonable levels, many corporates are keen to establish a global notional cash pool that will provide benefits such as:

  • A one-stop global concept.
  • Centralised visibility of global bank account balances through a single report.
  • A global liquidity platform providing all of treasury’s needs.
  • Full control over the group’s multi-currency cash positions, both debit and credit.

The Basics of Global Notional Cash Pooling: What is it and How Does it Work?

  • In a traditional notional pool, credit and debit positions are offset, reducing the expense of paying interest on overdrafts. There is no physical movement of funds.
  • A global notional cash pool uses a global overlay structure based on either a notional or inter-company loan cash pool (physical or zero balance cash pooling) where in both cases the need to perform FX and/or swap transactions is eliminated and no funds are physically moved.
  • This offsetting process results in a total consolidated cash position, which is used to apply proper interest conditions to all of the cash pool accounts. The cash pool bank re-allocates the cash pool interest margins, which effectively is an inter-company margin, to its customers on compensated balances in the cash pool.
  • The global notional cash pool is supported by a browser-based Internet suite of applications. It includes comprehensive bank account reporting, third-party payment abilities, as well as full integration of data into treasury workstations, enterprise resource planning (ERP) systems and other proprietary systems.
  • The cash pool can be achieved without dismantling existing local bank relationships.
  • The notional cash pool is able to mitigate the cost of fluctuating account balances and captures interest spread. Moreover, the cash pool combines well with inter-company financing requirements, investment and borrowing needs, growth resulting from overseas acquisitions, payment systems and treasury management systems.
Figure 1: Global Overlay Cash Pooling at BMG

Extended Uses of a Global Notional Cash Pool

As already mentioned, the global notional cash pool is developing with the shifting markets and the demands of the companies that use the product every day. Some of the ancillary uses of the pool are proving to be valuable tools for taking control of working capital and optimising liquidity.

In-house banking

BMG works closely with its clients and collaboratively develops the products they need. Through using the global notional cash pool, companies realised that it could be used effectively as an in-house bank, including for the reporting of global positions. This is of particular interest in current market conditions, where many companies are now shying away from setting up their own in-house bank due to rising IT costs and compliance with the increasing number of rules in recent years.

For example, one company that recently set up a treasury centre and in-house bank in Switzerland took five years to complete the process. The centre employs 100 staff and the cost of the project has been estimated between US$10-20m per year. This obviously represents a huge amount of resources, both in time, people and cost. It is not surprising, then, that fewer companies are choosing to set up an in-house bank.

An alternative is to use the functionality of the global notional cash pool structure to provide services very much like those of an in-house bank. The global notional cash pool is able to provide the following functionality: notional or hybrid cash pooling, global multi-bank reporting, inter-company loan administration, settlements and exposure management activities.

The cash pool is also used by companies as a platform where global reporting is established, inter-company loans are administered and international payments and receivables are routed for vendors, customers and FX transactions. Furthermore, merger and acquisition (M&A) transactions can be executed using the different tax jurisdictions of the cash pool. When looking at the cash pool’s overall use, it can be used in every respect as an in-house bank platform for corporate companies.

Inter-company netting and loans

Inter-company netting is another ancillary use of the global notional cash pool. It is an advanced payment vehicle, where companies can simultaneously settle their inter-company invoices and vendor payments on a chosen day of each month or week, rather than making payments on an ad hoc basis. The treasury can easily track the company’s vendor payments going out of the pool accounts and its customers’ receivables coming into the pool.

Inter-company lending can have tax advantages for corporates and the loans can be done through the global notional cash pool. Companies can also create a hybrid pool, which is a notional pool combined with a physical pool, through inter-company lending.

Some Myths About Global Notional Cash Pooling Dispelled

Perhaps partly due to the fact that few people understand the exact mechanics of how a global notional cash pool works, there are several misconceptions in the market about what it actually entails. In fact, the global notional cash pool is firmly based on legal agreements, fiscal laws and – in the case of BMG – a transparent fee structure. Here are some of the main misunderstandings prevalent in the market with clarifications on how the global notional cash pool actually works.

1. Global notional cash pools use costly FX transactions

This is one of the most common misconceptions. There are no FX spreads in a true notional cash pool. There are no swaps or FX transactions because funds are not physically moved.

2. All global notional cash pools use cross-guarantees

While most global notional cash pools do use cross-guarantees, BMG’s pool has deviated from this concept. It is based on full legal right of offset under Basel II and is not based on cross-guarantees. This means that credit facilities are not needed and that subsidiary surpluses may be offset with borrowing needs within the group without creating an inter-company loan. If you use cross-guarantees, the notional pool concept will quickly run into difficulties.

3. Banks need capital reserves to offset each debit position within the pool

BMG’s cash pool operations are set up in such a way that assets and liabilities can be netted by the client. Banks do not need excess capital for a notional pooling arrangement when set up properly.

It is possible to work through the accounting rules and find a way that allows companies to off-set assets and liabilities on the balance sheets, without having to hold a capital reserve in proportion to an overdraft. However, as with any financial structure or transaction, any cash management platform or pool needs to be firmly based on a proper legal agreement. If you don’t structure a legal agreement properly, then banks can run into this capital reserve issue.

4. Offering a global notional cash pool is a lucrative business for banks

In fact, the opposite is true. Banks lose money in cash management due to their size and cost of investment. Margins are very thin and if banks want to become rich, they should not offer pooling. The market is changing rapidly as global banks face severe pressure and heavy cash losses – as a result, many players are leaving the market. Many cash management service providers don’t make money from cash management, but they will always look for a return in other areas, such as credit lending, interest margins and swap prices. Avoid this by choosing a provider with a transparent fee structure.

5. Legal documentation can pose a problem for a global notional cash pool

It is vital that legal documentation properly supports the system that the corporate is implementing. This means that legal agreements have to be tailored to ensure they fit each organisation – this can be a lengthy process, but it is essential to get right. For example, an insurance company will have very different legal needs to a fast food chain.

6. Transfer pricing, thin capitalisation and arm’s length rules can also cause problems in a global notional cash pool

There are certainly tax issues that pool providers and users need to address but, with expertise, it is possible to construct the pool correctly from a legal perspective to avoid tax problems. A proper set-up should respect thin-cap rules in each country where there are bank current account overdrafts and inter-company loans.

How a Global Cash Pool Meets Corporate Objectives

The key objectives of global companies today include:

  • Streamlining of local banks, accounts and in-country cash management requirements. A global notional cash pool enables treasury and group companies to use their preferred banks for day-to-day operations. The cash pool forms an umbrella on top of the existing banking infrastructure and where possible establishes a relationship with the respective local bank. This overlay approach avoids added in-country accounts and gives corporates the flexibility to change existing bank relationships when necessary without disrupting the operation of the pool.
  • Attaining a global footprint through central control and visibility. Once the company has established its in-country and regional requirements, the platform is established and the building blocks to establish a global cash pool are realised. In a relatively short timeframe, treasury and regional treasuries obtain control and visibility to manage their global cash positions.
  • Eliminating local borrowing facilities to be replaced by a central credit facility. Corporate treasury can use the overall excess balance in the pool by simply overdrawing its treasury or finance company account in the pool. Corporate treasury can use these funds to cover short-term debt, have these funds transferred to various investment vehicles or choose to allow their central pool to invest the overall cash pool balance for treasury.
  • Improved return on cash investments and reduction of cash borrowing cost. Interest is calculated on the balances held in each cash pool account. In addition to the basic account calculations, a separate calculation is made based on the summation of all accounts in the cash pool. This, in essence, is a recalculation method used to determine the ‘interest result’ after pooling. The corporate determines the interest margins to be applied to the currency accounts, all in accordance with arms-length transfer pricing rules. The accounts in the pool are viewed as one account with one balance and the cash pool bank fully refunds the interest margin to its clients on all compensated balances.
  • Eliminating FX swap transactions. In a multi-currency notional or inter-company loan cash pool structure, there is no need to convert or swap the different currency balances in the cash pool to a single currency. By means of a simple translation mechanism, BMG determines the net-cash pool balance in a currency.
  • Redirecting foreign currency accounts. Corporates can execute international payments to third party suppliers out of their cash pool accounts even when this results in an overdraft. Clients should maintain their foreign currency accounts in the cash pool as local foreign currency accounts are known to be costly and in many cases non interest-bearing.
  • Enhanced global liquidity and tax management. The solution optimises global cash positions by enabling the offset of credit and debit balances irrespective of currency without creating inter-company loans that are not driven by global tax management. Without a centralised multi-currency notional cash pooling system it is difficult and costly to use credit balances in one country to offset debits in other countries. In many cases, inter-company loans need to be put in place. However, this requires settlement, administration and in some cases forward hedging to cover future currency exposures on the re-payment of loans. Surprisingly, it is often the company’s internal tax team that recognises the benefit of a global tax perspective and provides valuable input into the ultimate structure of the cash pool.
  • Full integration with other systems and solutions. It is important for companies to have a system that can be easily integrated with different departments. Treasury workstations, accounting systems and controls all need to be able to interact with data from the pool, as well as the risk analyst who needs to look at exposures and the cash manager that will deal with the balances. However, not all providers in the market, even if they can provide ‘plug-and-play’ systems, are able to keep their costs low. In the current climate, many cash management providers are changing their legal agreements and increasing their prices. Companies now need to be aware of cost.
  • Flexibility of structure. The cash pool structure can be customised to meet the company’s needs for visibility and control. More importantly, the system can be expanded with relative ease when new group companies, currencies or countries need to be added. This is very common when companies grow through mergers and acquisitions requiring a flexible liquidity platform to accommodate such growth.

Countries That Can’t Participate

Some countries in Africa, Asia and Latin America, are precluded from participating because of their central bank regulations. Some are not allowed to open an account overseas or participate in a cash pool. Some can do it in a functional currency, such as the US dollar for example, but not in their own domestic currency if they are not freely transferable. Canada, the US, Puerto Rico and Mexico allow their currencies to participate in a notional cash pool, but the other countries in the Americas are included in US dollars. In Europe, all countries allow their residents to participate on a local currency basis in a cash pool but exceptions include Belarus, Malta and Ukraine. In Asia, countries such as China, India, Pakistan and Vietnam do not allow cash pool participation. Korea, the Philippines, Malaysia, Indonesia and Taiwan allow participation in US dollar. In the Middle East and Africa region, Israel, Saudi Arabia, United Arab Emirates, Kuwait, Tunisia and Bahrain can participate in local currencies.

Case Study 1: Thermo Fisher Scientific

When Stacy Cordier, assistant treasurer at Thermo Fisher Scientific, joined the company in 2004, the global notional cash pool had just been set up. But it was still in its early days and, with just 12 companies participating in the pool, it averaged a daily net balance equivalent to US$7m. However, while the company was growing through M&As, the pool provided a flexible structure that enabled the treasury to add new entities easily – and keep a close eye on the company’s cash. Cordier says that the pool gave the company “much better visibility of our cash around the globe.”

Since the early days of the notional cash pool, Cordier has sought to expand it as much as possible – in fact today’s pool has more than 130 accounts and a daily net position of US$300m. It has seen huge growth. Cordier explains that they achieved this by adding as many companies and opening as many accounts as possible. She says: “That was an effective way to redirect the cash to where it could be used for the company’s purposes even though the local business units were still in theoretical control of their cash and could maintain their local banking relationships.”

To maximise their use of the pool, the company first of all targeted subsidiaries or entities that borrowed through inter-company loans or through private facilities. “We then balanced them against entities with excess cash positions – in other words, potential lenders to the pool,” says Cordier. She adds that the pool has been a huge bonus in terms of eliminating a lot of inter-company lending: “It is automated and tax efficient, so our tax group likes it. It also gives us great visibility of our cash, which is important since we are still a very acquisitive company. We need to know exactly how much readily deployable cash we have.”

For Thermo Fisher Scientific, one of the main benefits is that the company is now self-reliant in terms of funding and doesn’t have to borrow externally for working capital. Another benefit of having the pool is that the company no longer has to do its own swaps or hedge its own inter-company loans for the pool participants who need to borrow or invest. Cordier adds: “Where we have excess cash, we can move that into money markets to increase the return a little bit – even though, in today’s markets, excess cash does not generate much return.”

She also acknowledges that the global notional cash pool can work effectively as an in-house bank. The fact that the bank accounts are held with BMG, rather than in the name of Thermo Fisher Scientific, means it is easier to ensure that there is an arm’s length transaction in terms of lending or investing money. That is something Cordier is particularly happy with: “In that way it works as an in-house bank and it’s great for us as we don’t have to go through the legal requirements of trying to set one up ourselves.”

Case Study 2: PSA Peugeot Citroën

PSA Peugeot Citroën (Peugeot) has two global notional cash pools with BMG – one for the company’s industrial activities and one for the banking activities. As with many automotive companies, the manufacturing side of the business is separate from the banking side, which provides financing for the dealer’s network and for final customers. Peugeot’s central treasury is responsible for both cash pools. According to the company’s treasurer, Benoit Mulsant, a global notional cash pool for the industrial side of the company was implemented in 2004, and then two years later a similar structure was introduced for the banking side.

Cash flows are very important in the automotive industry, particularly in view of its current difficulties. Mulsant explains why Peugeot chose the global notional cash pool: “We already had efficient euro cash pools in place so we had to find a way to pool foreign currencies and use the funds. Our options were to either manage the cash pool ourselves, which would necessitate a ‘currency swap factory’, or we could ask a bank to do this for us. We chose the latter.”

A crucial feature of the pool, according to Mulsant, is that it is based in the Netherlands. The Dutch central bank allows Dutch banks, under certain conditions, to offset debit and credit positions of related entities participating in the same cash pool, irrespective of the currency. This means that the net consolidated position of the group in euro is available to the company on a daily basis, without the company having to perform swaps and FX transactions. BMG then offers its customers very tight spreads over money market rates. According to Mulsant, this is a huge benefit for customers.

“The pool has definitely helped us to deal with the difficult financial markets of the past year or so,” adds Mulsant. He refers in particular to Peugeot’s subsidiaries in Eastern Europe, where currencies have been difficult to manage. Through its currency swaps ‘factory’, BMG was able to guarantee Peugeot unchanged, tight deposit and borrowing rates on every currency, even when there was a great deal of volatility in the markets. This was very useful towards the end of 2008. Mulsant says: “The money markets were so disrupted that liquidity management would have been just unaffordable on these markets. With BMG we were still able to manage our cash at money market rates without extra spreads. It has provided considerable protection for us.”

Case Study 3: Sara Lee

Sara Lee has been using BMG’s global notional cash pool for about two years. According to Sara Lee’s director of treasury, Jan Schets, the process of improving the company’s control over its cash began in the late 1990s when the euro was introduced. “At that time we moved to a single bank concept and chose to work with another bank offering single currency cash pooling. We saw it as a big step forward to have one bank and one currency for the whole of Europe.” While the project was interesting and brought some benefits, Schets says that it was not what Sara Lee really wanted. Although there was a new banking structure in place, many subsidiary companies kept their own bank accounts for local purposes, using the cash pooling structure only as an overlay structure. This meant that the central treasury still didn’t have the control and transparency they needed over local bank balances.

According to Schets, the company went through a learning curve: “We realised that one bank will never be able to provide all the services you need in local countries. This lead to us adopting a different strategy: we decided to work with one strong local bank in each country or region. This was done in consultation with the local CFOs while a cash pool structure for each country was also put in place.” This was another step forward for Sara Lee because it gave much better visibility of local cash flows. According to Schets, the multi-currency overlay structure offered by BMG was then imposed on top of the local cash pools. He says: “This gave us flexibility in having a multi-currency pool, as well as being able to work directly with our local banks, which we find preferable to using one bank’s local branch network.”

Sara Lee has found several benefits from using the pool – being able to maintain local bank relationships is one of them. Schets says: “It also helps us to achieve good daily visibility for all our cash pool balances – we are able to see all the MT 940 and MT 101 messages. This really helps us to communicate with the local banks in an efficient way.”

Customer service was also a factor in Sara Lee’s choice of cash pool. As Schets explains, bigger banks often provide customer service through a shared service centre. “This means the relationship suffers because the staff turnover in shared service centres tends to be high. We appreciate having a bank with a small team, which allows you to establish effective operational relationships.”

What is also beneficial is that, because Sara Lee also has a netting structure with BMG, it is able to process the net settlements from the netting through the global cash pool platform. This means that both the netting and the cash pooling are processed through the same bank account.

The pool enables the treasury to have a 95% daily cash visibility of its companies worldwide. Schets says: “Considering the current financial climate we would be in greater difficulties now if we didn’t have this cash pool in place.”

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