Cash & Liquidity Management

Cash pooling structures

Published: Apr 2022

Two business people discussing charts on their laptops

A fresh approach to the working capital challenges driven by market and regulatory factors

Rupa Mankad, Citi’s Asia Regional Liquidity Products Head explains how hybrid cash pooling structures support today’s working capital challenges. The impact of recent tax developments also needs to be closely followed and considered, says Rohit Narula, EY’s Asia-Pacific Financial Services International Tax and Transaction Services Leader in Hong Kong.

Portrait of Rupa Mankad, Asia Regional Liquidity Products Head, Citi

Rupa Mankad

Asia Regional Liquidity Products Head

Citi logo

Portrait of Rohit Narula, Asia-Pacific Financial Services ITTS Leader in Hong Kong, EY

Rohit Narula

Asia-Pacific Financial Services ITTS Leader in Hong Kong

EY logo

Cash pooling structures are in demand as companies continue to manage supply chain disruptions and consequent pressures on their working capital amidst the pandemic. Major reforms to the international tax system were suggested by the OECD in December 2021. These OECD published detailed rules will assist in the implementation of a new global minimum 15% effective tax rate. These changes are also likely to impact the design and management of cash pooling structures.

The rise in volatility and broken supply chains has created challenges of forecasting working capital requirements and FX handling. These factors are showing a clear need for companies to have adequate liquidity and working capital buffers to manage the volatility and seamlessly fund payment obligations. This is driving an increased focus on cash pooling solutions to achieve liquidity and funding efficiency.

Business and treasury models

Cash pools, are often hybrid in nature and consist of a combination of multi-currency notional pooling, physical cash pooling and virtual account structures with value-added services like interest re-allocation services. Such hybrid cash pooling structures allow corporates to have a firmer grip on their liquidity. Today, corporate treasurers need to demonstrate resilience by extracting liquidity and ensuring it is available in the right place at the right time, and in the right currency. This strategy minimises the corporate’s bank borrowing costs across group entities, and helps corporates centralise investments and bridge the cash flow cycle mismatch across entities and currencies.

In another trend, growing direct-to-consumer sales are also driving the demand for physical cash pooling structures. As they go global, Asia’s fast-growing unicorns have increased their focus on online and real time collections and this puts increased pressure on their working capital, accelerating working capital velocity and in turn adding to their forecasting challenges. Flows are no longer predictable, and online sales have also ushered in FX challenges as companies sell more in local currencies which is an important contributor to sales growth. Demand for physical cash pooling structures with embedded automated FX solutions and improved near-real time visibility of entities is becoming pivotal.

Mature corporate clients generally have a formally established treasury centre, or in-house bank entity, and operate with well-defined, centralised liquidity structures with embedded “on-behalf” collection and payment structures. Such large corporates also have well-defined, investment borrowing and FX policies, and prefer single entity multi-currency notional pooling structures to enable group funding from the in-house bank entity. In fact, in-house banks which have FX netting arrangements in place generally prefer physical cash pooling structures given their “ownership treasury model” and automated inter-company FX netting. Banks are also strategically pivoting to single-entity multi-currency notional pooling and physical cash pooling structures given regulatory costs and risks associated with multi-entity notional pooling structures.

Large companies have in recent years grown wary of single country risks and many of them are increasingly favouring multiple pooling structures across regions instead of one single global pool. This started with Brexit and the demand to diversify away from a single, London-based, cash pool structure. During the pandemic many corporates opted for a second pool in Asia to simplify the currency and time zone management.

In contrast to large corporates, many of the Micro-Small-and-Medium Enterprises (MSME) and going-global digital unicorns prefer physical sweeping structures across entities in the form of multi entity physical cash pooling structures. Their primary focus tends to be centralised funding, operational efficiency, and seamless funding of group entity payment obligations. The implementation of these physical cash pooling structures is simpler from an accounting, tax and legal agreement execution perspective compared to complex notional pooling structures.

Tax

We at EY have analysed cash pooling structures from a tax perspective and have observed that tax developments are also impacting these structures. Over the years the impact has been driven by developments on tax treaty eligibility, concepts of beneficial ownership, substance over form and anti avoidance measures. The recent Base Erosion and Profit Shifting (BEPS) actions initiated at an international level, and anti avoidance measures historically implemented by specific countries in their domestic tax laws and judicial precedents, continue to change the tax landscape, preventing companies shifting profits to low tax jurisdictions and requiring a review of pooling structures.

It is important to note that at the end of 2021, 137 countries agreed to a two-pillar solution to reform international taxation rules and ensure multinationals pay a fair share of tax wherever they operate (popularly now referred to as BEPS 2.0)1. Pillar Two of the two-pillar solution, which will apply a global minimum 15% effective tax rate, is likely to come into effect from 2023. Treasury teams need to be cognizant of such changes to tax laws and the associated enhanced costs of compliance. On the back of these developments, we expect treasury teams to revisit their cash pooling structures and in particular, the cross-border intra group funding arrangements within such structures with a focus on the location of the treasury or in-house bank entity, mix in capital structures and the types of financial instruments used.

Given the developments, existing treasury constructs such as treasury centres or in-house banks, which involve intra-group lending through intermediate entities in favourable tax treaty jurisdictions, will need to be re-examined. In any case, given the introduction of the principal purpose test (PPT) in many of the existing tax treaties, any such intermediate entity that does not have substance but manages the risk and an appropriate amount of capital, could be questioned on its claim of tax treaty benefits.

When it comes to cash pooling structures, companies also need to review the eligibility of inter-company offsets considering restrictions such as thin-capitalisation rules on interest deductibility. Thin capitalisation rules augment the transfer pricing legislation which has been implemented across the Asia Pacific region and aids tax authorities in challenging interest free loans between related parties. Moreover, as more formal transfer pricing legislation has come into play, zero interest loans for related party financing are now no longer sustainable in the post-BEPS environment.

Major Asian economies, Hong Kong and Singapore, are gearing-up for BEPS Pillar Two implementation, evident in their respective budgets earlier this year. Hong Kong is looking to introduce a legislative proposal to implement global minimum tax rate and a domestic minimum top up tax. Similarly, Singapore is exploring a top up tax called the minimum effective tax rate or METR. Both countries are also likely to introduce several non-tax related measures to retain their competitiveness in terms of remaining the location of preference for regional treasury centres.

From an impact assessment and implementation perspective, the BEPS regulation is also seeing corporates focus on documentation around intra-company flow of data across locations. Consequently, there is an increased adoption of technology and value-added pooling features to drive compliance with the developing tax landscape.

We at Citi, have curated solutions such as Citi’s ‘Inter-Account Limit Alerts’, Inter-Account Limit Controls’ and ‘Principal Reset Features’ which support clients in complying with their thin-capitalisation requirements. We notice increased activity when it comes to changes requested on interest re-allocation rates for intergroup borrowing and lending amongst mature corporates and equally so with MSME clients.

The new regulation may influence invoicing models, and as a consequence thereof, holding company details and treasury entity and funding structures will change. However, it is also important to note that corporates facing a tax bill that is likely to exceed the benefits of centralised investment may shift to liquidity sweeping only on a ‘need-to’ basis.

Digitisation and efficiency

During this pandemic clients have increased the frequency of review of their entire banking footprint across group entities, countries, and currencies, seeking to maximise the entities and accounts under liquidity structures, in the interest of better visibility and efficiency. Banks have been supporting corporates up-tier their cash pooling structures by delivering a digital end-to-end user experience, as well as offering value-added products and features:

  • Digital and frictionless account and structure on-boarding.

  • Self-service tools to make dynamic changes to structures.

  • Balance inquiry APIs for increased visibility of group liquidity.

  • Improved global liquidity structure and balance visibility dashboards.

  • Insights and alerts on inter-company limits.

  • Virtual accounts to help them segregate cash by business unit and product.

  • FX and hedging solutions to manage operational excess in non-functional currencies.

  • Multibank visibility and concentration of liquidity from local collection banks.

In conclusion, corporates across the board are undertaking more regular reviews of their cash pooling structures. While the objectives of these reviews begin with internal factors such as the need to have improved visibility, control, operating and working capital efficiency, there are also external tax and regulatory lenses influencing these changes. Just as new accounts and entities continue to be added to widen the base of these cash pooling structures, new and enhanced pooling features and controls are being availed to up-tier cash pooling structures and to make them more efficient. We are seeing active interaction between corporates and banks in this space and believe this may be just the beginning of a new journey.

IRS Circular 230 Disclosure: Citigroup Inc. and its affiliates do not provide tax or legal advice. This information provided in this article is for informational purposes only and may not represent the views or opinions of Citigroup Inc. or its affiliates (collectively, “Citi”), employees or officers. The information contained herein does not constitute and shall not be construed to constitute legal, investment, tax and/or accounting advice by Citi.

All tax related information and views are those of EY and Citi makes no representation as to the accuracy, completeness, or timeliness of such information. The readers of this article should obtain guidance and/or advice, based on their own particular circumstances, from their own legal, investment, tax or accounting advisor.

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