There are several common myths in the banking industry today. One is that managing directors have actually earned their colossal annual bonuses, or that customers will stick with you through thick and thin if your fees are low enough. Another myth is that the global notional cash pool does not really exist or is not possible due to tax or legal reasons. While we are not in a position to dispel the first two myths, the third we can prove to be untrue.
As a result of increasing global pressure to manage working capital and excess liquidity effectively, while also keeping borrowing at the most efficient levels possible, corporates are now demanding the following treasury benefits:
- A one-stop global concept.
- A multi-bank and multi-currency approach.
- Visibility of their centralised global liquidity positions through a single report.
- One account and one currency to manage all of it.
A true global notional cash pool meets all of these criteria.
What is a Global Notional Cash Pool?
Traditional notional pooling involves the offset of credit and debit positions, with the benefit of reducing overdraft interest expense. There is no physical movement of funds. However, global notional cash pooling adds a new dimension to this concept by making multi-currency notional pooling possible without the use of FX transactions and by leaving current bank account structures in place. The main way this is possible is by using a global overlay structure supported by a browser-based Internet suite of applications. It includes comprehensive bank account reporting, third-party payment abilities, as well as full information integration into treasury workstations, ERP systems and other proprietary systems.
The cash pool is achieved through 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. The cash pool bank can fully offset account balances in multiple currencies to calculate the net balance in the currency of choice without the customer having to execute a single foreign exchange transaction. This reduces the much sought after foreign exchange and bid/offer spread on interest applied to these cash balances and yet increases interest income as well as adding significant value to other liquidity management requirements, such as improved visibility and control of global cash. The cash pool can be achieved without dismantling existing local bank relationships and enables companies to function as their an in-house bank without having to add resources or invest heavily in internal systems.
How a Global Notional Cash Pool Works
The local cash balances of each of the company’s local entities/subsidiaries are centralised automatically using the local entity’s local relationship banks. The centralisation is, in most cases, an automated process where cash surpluses are zero balanced to the notional pool and local deficits are funded from the notional pool. After centralising the global varying cash surplus and deficit positions of the worldwide group companies, the cash pooling system offsets credit and debit balances on a multiple currency basis without moving or converting currencies. 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 reallocates the cash pool interest margins, which effectively is an inter-company margin, to its customers on compensated balances in the cash pool. Internet reporting of all account positions is available in real-time, after which a single money market investment or borrowing results in a zero balanced global cash position.
Companies integrate their international transactions, exposure management strategies, FX payments and receipts as well as highly sensitive tax transactions (in case of mergers and acquisitions) as well as accounting requirements such as the administration of inter-company loans resulting from an in-country cash pool. In most cases, companies have a hybrid cash pool in place to include working capital cash as well as inter-company loans to ensure that the liquidity management tool works in tandem with internal tax requirements.
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.
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 single global multi-bank solution to overlay on the ‘best-in-class’ local or regional infrastructures.
- Attaining a true global footprint through central control and visibility.
- Eliminating local borrowing facilities to be replaced by a central credit facility.
- Improved returns on cash investments and reduction of cash borrowing cost.
- Redirecting foreign currency accounts.
- Enhanced global liquidity and tax management.
- Eliminating FX swap transactions.
- Full integration with other systems and solutions.
- Full compliance with current standards and security.
Streamlining in-country requirements
It is possible to set up a global notional cash pool without incurring drastic internal changes or dismantling existing in-country bank relationships or cash management structures.
Using ‘best-in-class’ bank relationships
A cash pool does not require group companies to close their existing local bank accounts nor existing cash management structures that have already been put in place in certain regions. The total solution 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 global banking infrastructure and where possible establishes a relationship with the respective local bank enabling seamless and efficient transfers to and from the in-country bank to the cash pool bank. This unique overlay approach avoids added in-country accounts and banks and gives corporates the flexibility to change existing bank relationships when necessary without disrupting the operation of the pool.
Attaining a global footprint
Once clients have established their 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.
Full off-set of debit and credit balances on a multi-currency basis
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.
Eliminating local borrowing facilities
An important feature of the notional cash pool is that local entities can be funded (in both the long and the short term) by making a single currency transfer to the central cash pool or another group entity that holds excess cash. This enables group companies to borrow from the cash pooling centre against deposits by simply overdrawing their respective currency accounts in the cash pool. The interest rates on account are daily market borrowing and investments rates.
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 as well. Collecting the group’s customer receivables using foreign currency accounts in the pool creates a natural hedge, adding further efficiency in minimising FX due to disparity in payments and receipts.
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. The cash pool meets the company’s needs from both a treasury and tax viewpoint.
Full integration with other systems and solutions
In today’s corporate environment it is crucial that companies can download and upload the required cash pool and other information into their treasury workstations and accounting systems. This allows for simple assembly of executive reporting requirements and facilitates the accounting of cash balances and the transactions routed through the cash pool. It is not uncommon for corporates to reassess their finance and holding company structures from time to time or change jurisdictions, so it is important to integrate these changes into the cash pool easily.
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 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, Croatia, Malta and the Ukraine. In Asia, countries such as China, India, Indonesia, Malaysia, Pakistan and Vietnam do not allow cash pool participation. Korea, the Philippines and Taiwan allow participation in US dollar. In the Middle-East and Africa Israel, Saudi-Arabia, United Arab Emirates, Kuwait, Tunisia and Bahrain can participate in local currencies.
Case Study 1: G4S
Group 4 Securicor (G4S) provides security solutions, offering security services (including manned security, security systems and justice services) and cash services. G4S employs over 500,000 employees and operates in more than 100 countries. It was formed when Securicor and the security business of Group 4 Falck merged in 2004 and this is when the newly formed treasury adopted a global notional cash pool. Assistant group treasurer John Ambrose, at G4S, says: “We were specifically looking for a partner with the capabilities of providing a cross currency notional cash pool structure, but it was surprising that many banks didn’t have a true cross currency notional cash pool product available.” The company’s pool contains multiple currencies in one cash pool, rather than separate currency pools running alongside each other, which Ambrose describes as “unnecessarily complicated from a customer perspective in the current regulatory environment.”
When the group merged in July 2004, there were several local single currency cash pools already in place, but there was no centrally managed cash pool to link them. It currently has 74 entities participating in its cash pool. The cash flow is relatively volatile in many of its participant countries, and regularly moves between credit and debit positions.
G4S’s cash pool is domiciled in Amsterdam in the Netherlands, which has a large number of tax treaties with other countries, so there are fewer withholding tax issues. All the currencies are in one cash pool, which is then notionally converted into a currency of choice, which in G4S’ case is sterling. According to Ambrose, one of the key advantages is the automatic offsetting of the accounts in different currencies, rather than just offsetting other accounts in the same currency.
G4S sets local bank account cash balance and overdraft limits for each of its cash pooling participants and when balances exceed this amount the companies are required to transfer the funds into or out of the cash pool in Amsterdam by the defined cut off times for that currency. Group Treasury then review the net cash pool position and then remove any net excess or fund any shortfall through their G4S plc pool accounts.
The group continues to offset the debit and credit balances of different legal entities within each country by pooling locally, but the net German debit position, for example, is then offset in turn with a net French credit position within the central pool. This additional layer of pooling and balance offsetting creates further efficiencies.
Ambrose says: “Interest savings are the main benefit, but there are many other advantages. It increases flexibility for the subsidiaries that have instant access to funding, within internal limits set by treasury, rather than entering into timely local bank negotiations. We arrange nearly all of our inter-company transfers through the system, which is very cost effective and when there are multiple cash flows it’s much more efficient. All of our holding companies have accounts within the pool, so you can flow money through this system. It happens instantly and it’s just far more efficient, rather than trying to flow the funds in and out of different banks cross border. It gives us a better understanding of our participants’ cash flows and of course with notional pooling versus its cash concentration competitor there is no co mingling of funds.” And Nigel Youngman, group treasurer at G4S, adds: “An additional benefit is for inter-company cash flows, such as royalties or insurance recharges, with both payer and receiver participating in the pool there is, in effect, no net movement of cash.”
Case Study 2: VWR
VWR is a diversified company that manufactures and distributes laboratory equipment and chemicals to pharmaceutical firms and research institutions all over the world. VWR has had a global notional cash pool in place since early 2005. The company has 23 subsidiaries, most of which participate in the global cash pool. Those that don’t are either based in countries with restrictions on cash pooling, such as China and India, or the company has minimal operations in that country making it uneconomic to include them in the cash pool.
VWR’s notional pool operates daily and is overseen by VWR’s centralised treasury function in the US. VWR established the US dollar as its currency of notional conversion for cashpool reporting but it is possible to choose certain other major currencies – for example, a multinational company in the UK might choose sterling.
According to Scott Smith, VP and corporate treasurer at VWR in the US, using a notional cash pool has a number of benefits across the treasury, accounting and tax functions. These are highlighted as follows:
- Simplified structure: one benefit is that the notional cash pooling structure is very simple. All the bank accounts are held with the same single bank and the company can add or subtract subsidiary participants as it wishes relatively quickly.
- Incremental income statement improvement: The second key benefit is that the company gets an incremental income statement improvement because the cash pool eliminates the typical bid-offer spread lost on its various deposit and overdraft positions and largely eliminates the need to arrange local overdraft lines with local banks in each country. The yield on deposits is almost always favorable to rates offered by traditional commercial banks.
- Avoidance or reduction of float costs: Having a competitive float agreement with the bank is also essential. As VWR’s Smith says: “When you have money coming into your account, a lot of the traditional banks do not give you availability for a day or two, or even three days.”
- Real-time visibility of global balances: Another benefit of having the cash pool is the increased visibility to cash on the balance sheet. Smith says: “All of the cashpool accounts are with the single cashpooling bank and we have access to all of our account data – our transaction and balance reports, via their online banking tool. We can enter and approve transactions, we can get historical information, we can get our statements online.”
- Transparency of deposit and borrowing rates: Smith says: “Since we’re dealing with a single institution, we can see with perfect transparency what our deposit and borrowing rates are, by currency, at any time”
- Adding and subtracting entities from the pool: Smith says: “If we go out and make an acquisition, and we buy a company that has operations in Europe; we can fairly quickly bring them into the cash pool, in a matter of one to two weeks, whereas, if you have other physical cash pooling systems, those systems will, typically, take much longer to integrate and implement. What makes the notional cash pool so flexible in this sense is the agreement between the cash pool bank and the parent company. The agreement stipulates that subsidiaries can be added or subtracted from the pooling arrangement as needed.
- Reduction of inter-company loans: Another benefit of the notional cash pool is that, because the cash doesn’t physically leave each legal entity, inter-company loan and deposit activity is reduced or eliminated. According to Smith: “A lot of multi-national companies have invested or built up substantial in-house treasury banking capabilities, and every day or week, they are accounting for and recording a large number of inter-company loans and deposits between entities. Physical pooling entails a lot of extra work that can be avoided. So the notional cash pool works well because cash is never physically moved between legal entities, and you don’t create these intra-company accounting requirements and the attendant reconciliation administration and audit work.”
- Reduced FX hedging: Another benefit from the treasury perspective is the reduced FX hedging. If you physically pool cash, you often have to convert it from one currency and sometimes multiple times. With a multi-currency notional cash pool, there is no physical conversion of funds, so there is no daily FX swapping or hedging to be done with the pooling itself. Smith, at VWR, says: “In terms of daily cash management, you don’t have to do daily buys and sells of cash the way you would typically do it if you were physically pooling cash.”
- The global notional cash pool reduces or eliminates the need to record daily inter-company accounts. It also means there is no need to employ accountancy staff for this function, which can be a considerable cost saving for the company.
- Furthermore, the company maintains strong accounting controls over cash in its overdraft positions, because those balances remain from a legal perspective with each participating entity and can be validated quickly and cleanly with the cashpooling bank.
- Because notional cashpooling by definition involves no physical movement of cash between legal entities, tax departments tend to favour these arrangements. Physical cash pooling transactions can occasionally trigger adverse tax consequences if not reviewed and approved in advance. Sometimes the best of intentions from a pure treasury or cash management standpoint can become very problematic from a tax or legal standpoint.
- Auto-calculation and physical application of interest: Unlike many banks claiming to offer notional cashpooling, VWR’s notional cashpooling bank has automated the calculation of interest (rather than leaving it to the customer) and they do so at the account level with a physical application of funds at month end. From both a tax and accounting perspective, the physical debits and credits to the account make it easy to capture the interest and ensure that proper interest amount is recorded. Smith, at VWR, says: “If you were operating a physical cash pool and had inter-company loans and borrowings between entities, not only do you have to record the principle balance of those inter-company loans and deposits and possibly revalue them into various currencies, but someone in accounting has to calculate the interest accrual while someone in treasury has to initiate the transfers.”
Case Study 3: UPS
UPS is a worldwide package delivery company that has a centralised global treasury structure. UPS has had a global notional cross border, cross currency cash pool in place since 2003. The cash pool structure helps UPS to accomplish its strategic objective of centralising its offshore (non-US) cash balances into one location. Ernie Caballero, senior director, Europe mergers & acquisitions and Eurasia treasury at UPS, says that the cash pool also enables the centralised treasury the to utilise non-US cash balances to fund international projects.
UPS has more than 100 legal entities participating within the cash pooling structure on a daily basis. The daily notional balance totals US$5-600m equivalents. UPS’s entities around the world generate a daily cash flow forecast, which they send to their regional treasury centres in Singapore, London, and Atlanta in the US. Every legal entity globally generates a cash flow forecast by currency. The treasury centres actively monitor the forecast for each of those entities. Each country has a predetermined in-country safety margin, with all excess cash over that limit automatically transferred to the global cash pool. According to Caballero, before the treasury centres approve the forecasts, they make sure each in-country safety margin is maintained as well as looking for opportunities to make reductions to them. The goal is to keep the in-country safety margins as close to zero as possible in order to keep a minimal amount of funds outside the notional pooling structure on a daily basis.
According to Caballero, the system is highly automated, including the legal entity forecasting submission process, the treasury approval process, and transfers to the central pooling system. He says that the only manual operation is setting the in-country ‘safety margins’.
Caballero says that UPS has good visibility over its global cash balances through its treasury system. “We have visibility by bank account and entity. Each of the forecasts also indicate what the in-country safety margin should be. We know how our global funds are being utilised on a daily basis because we have the operating procedures to inform us of what every legal entity wants to leave in their in-country accounts as well as how much cash is either being transferred to or requested from the cash pool.”
The main benefits of the global notional cash pool, according to Caballero, are the ability to centralise cash in one location, on a notional basis and being able to use that cash on a daily basis. The structure also means UPS doesn’t have to do its own foreign exchange conversion and also did not have to change its in-country banking structure. Caballero says: “This is very important to us because we have a lot of cash needs on the ground, as a result we have the flexibility to select the local in-country banking structure that best suits our local operations.”
Under the pooling structure, FX swaps are managed by the cash pooling bank.
The corporate’s treasury has its own set of cash pool accounts, and can effectively facilitate the funding needs of any international entity by overdrawing in the currency of choice. This means that at the end of each day, the cash pooling bank does the swaps internally. According to Caballero, this gives the central treasury time to focus on other elements of treasury that are more important, such as centralisation, control, consolidation or reduction of costs elsewhere.
At UPS, the local entities no longer borrow from local banks – the cash pooling bank is the only source of borrowing unless it’s an entity that has restrictions and can’t be in the pool. Caballero says: “If an entity can’t be included in the pool, we fund it through an inter-company loan or a capital injection but we avoid overdrafts at a local level at all cost, because it’s just too onerous.”
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