Independent industry analysis from our corporate treasury insider.
David Blair was formerly Vice President Treasury at Huawei and Group Treasurer of Nokia. He also has previous experience with ABB, PriceWaterhouse and Cargill. With his extensive experience of managing global and diverse treasury teams, as well as playing a leading role in e-commerce standard development and in professional associations, Blair has counselled corporations and banks as well as governments.
A number of recent articles on cash concentration seem to be sounding the death knell for notional pooling. Their main line of argument is that regulatory, tax and accounting issues are making notional pooling increasingly difficult.
I disagree. In my opinion, notional pooling remains the most elegant and cost-effective way to concentrate cash for most corporates. Before I explain why, let’s clarify some terminology.
Sweeping (also known as zero balance account (ZBA) and physical pooling) involves moving money from subsidiary accounts to a designated master account. Basically, treasurers outsource to banks the daily money transfers that they might otherwise do manually.
And just like manual money transfers, sweeping creates inter-company loans. Inter-company loans create accounting requirements (they must be booked in the general ledger (GL)) and tax consequences (withholding tax, thin cap rules, etc).
In contrast, notional pooling – as its name implies – is purely notional. No actual money moves between accounts and each participant’s bank balance remains untouched, which means that there are no inter-company loans.
Notional pooling is basically an agreement that your bank will not charge interest on gross debit balances nor pay interest on gross credit balances. Instead, the bank agrees to pay interest on the net credit balance only (notional pools are normally run in a net credit balance). This saves the spread between the bank’s debit and credit interest rates, which is normally the sum of market spreads plus the bank’s cost of capital and the corporate’s credit spread.
Of course the bank needs to be able to avoid the cost of capital on the gross balances, which means that regulators (who decide capital allocation) drive the rules of notional pooling. In many countries, regulators require banks to obtain a cross guarantee whereby each notional pool participant is liable to the extent of its credit balances for the debit balances of its fellow participants. Other techniques such as pledges are also possible.
Sweeping and notional pooling are not mutually exclusive. They can, and often are, combined in an overlay structure. A cash concentration or liquidity management overlay structure normally sweeps from operating accounts at different banks and different locations to an account owned by the same legal entity (so no inter-company loans) with the notional pooling bank.
There are some things that simply don’t work with sweeping. For example, the plethora of overnight currency swaps required to do multicurrency cash concentration with sweeping are not cost effective. Multicurrency notional pools (MCNP), on the other hand, provide an elegant and easy to operate solution – allowing cross-currency balance offset without conversion.
What is driving the alleged demise of notional pooling? The first issue is the wave of regulation hitting banks, notably Dodd-Frank and Basel III. Regulators in some countries are tightening their requirements for allowing banks to report net balances rather than gross balances (which is required to make notional pooling cost effective). In some cases, they are requiring sweeping cross guarantees and aren’t accepting guarantees limited to participants’ credit balances. Some regulators are also asking for parent company guarantees.
The topic also extends beyond bank regulation per se to, for example, bankruptcy law (ie what is the liability of a participant in a bankruptcy situation?) The situation is compounded by regulatory vagueness in many countries. To avoid liability, some regulators refuse to specify exactly what is permitted. This leaves bank compliance departments in a difficult position and often makes them choose differing and conservative interpretations, to avoid regulatory liability.
But ‘some regulators’ is not the same as ‘all regulators’. Some regulators allow non-guarantee support for notional pooling arrangements, and are willing to be explicit and even give written opinions on capital arrangements. As a result, the old maxim that all global banks offer pretty much the same cash management services is no longer true.
Therefore, it is crucial that treasurers understand the nuances of different notional pooling techniques and dive deeply into bank capabilities with appropriate legal and tax support.
A second issue driving the alleged demise of notional pooling is tax. The logic is that since many tax authorities deem third-party loans covered by related party guarantee as inter-company and since notional pools need cross guarantees, as a result notional pooling is not tax effective.
The error here lies in the second assumption. As you now know, notional pools do not need cross guarantees, or any guarantees at all. Some banks need cross guarantees to meet their regulatory requirements, whereas other banks can use other techniques, such as pledges.
Compounding the issue, it is obvious that few tax advisers really understand notional pooling. They therefore tend to take a conservative view and pronounce it as tax ineffective. I have seen tax partners within the same office disagree on this.
Therefore, it is critical to have good advice and robust support for your notional pooling project – and even to find tax advisers who have already approved notional pooling to explain it to their peers.
The bottom line is that hundreds of multinational companies (MNCs) are happily using notional pooling for cash concentration and tax effective subsidiary funding. (Of course, I am not a tax adviser, so you need to do your own due diligence on this.)
A third issue driving the alleged demise of notional pooling is accounting rules. The idea here is that International Financial Reporting Standards (IFRS) (specifically International Accounting Standards (IAS) 32) and US-Generally Accepted Accounting Principles (GAAP)) require periodic physical offset of balances if you want to net pool balances in your financial reporting. Again it is a matter of choosing the right bank – market leaders provide a service to physically offset balances (with a two-way sweep) whenever required by your auditors. The requirement varies because this is another issue on which individual auditors differ.
Therefore, when we look closer, all three issues are not intrinsic issues with notional pooling, but rather they are issues that specific banks may have because of the regulatory and/or system limitations.
The first regulatory problem is specific to banks whose regulator requires cross guarantees or more.
The second tax problem is specific to banks whose regulator requires cross guarantees. The third accounting problem is specific to banks whose systems do not support periodic physical offset by two-way sweep.
Hence, I maintain my opinion that notional pooling remains an elegant and effective solution for cash concentration, subsidiary funding and, in the case of MNCs, for foreign exchange (FX) risk management as well.
Beware of bankers sounding the death knell for notional pooling. Their arguments might be based more on their own constraints than on what works best for their corporate customers.
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