Get back to basics with the pros and cons of cash pooling in all its forms.

According to the ECB, pooling cash within a group represents a “significant opportunity to ensure that the use of internal funds is maximised and the cost of capital is minimised”. It is perhaps unsurprising then that cash pooling increased in popularity in certain locations following the onset of the financial crisis. Indeed, the source of this quote – the ECB’s July 2016 Statistics Paper – noted that increased adoption was driven by limited access to capital markets, reduced bank lending, low returns and higher risks on banks’ deposits with corporates intent on maximising their use of internal sources of financing.

The basics

Cash pooling is an essential liquidity management technique. It brings together a number of individual bank accounts to pool balances, optimise interest and improve an organisation’s liquidity management. This could be across multiple jurisdictions, currencies and entities, depending on the type of cash pool in place.

Cash pooling falls into two main types: physical and notional.

Physical pooling

This is often referred to as physical cash concentration, target or zero balancing (ZBA) or sweeping. Balances are physically swept to a header or master account on a periodic basis and may have certain parameters, for example a minimum or maximum balance, a percentage sweep, target balance and a variety of other parameters depending on the provider capabilities. Physical pooling is available on a domestic, cross-border, cross-region and multi-bank basis and is also dependent on the provider capabilities.

The acceptance of pooling structures is not clear cut in every jurisdiction. Because direct inter-company lending in China, for example, is not permitted, physical cash pooling cannot be practiced using the traditional techniques, since this sort of arrangement generates inter-company loans. In order to achieve physical cash concentration, an entrusted loan structure must be used.

Notional pooling

This is primarily a tool for interest enhancement. Notional pooling structures are typically overlay structures. Debit and credit balances on a series of accounts owned by the same or different entities and domiciled in the same country are notionally netted for interest calculation purposes, without a physical movement of cash. Multicurrency notional pooling offers the ability to achieve a net notional position in a single currency without the need to perform traditional FX or swaps, and extends the benefit of further interest savings as a result of compensating balances in different currencies.

Additionally, an overlay cash pool can be provided by an international bank offering physical or notional pooling on a multinational, multi-entity company level in country, in region or globally. Overlay cash pools allow changes to existing bank relationships when necessary without disrupting the operation of the cash pool and allow changes to the cash pool to take place without disrupting the underlying banking structure.

Regulatory impact

Under Basel III the cost structures of notional pooling solutions have come into question where some banks have increased their pricing for operating deposits to help meet liquidity coverage ratio requirements.

Corporate global or regional liquidity and funding structures such as notional pooling may be impacted by the OECD’s Base Erosion and Profit Shifting (BEPS) Action Plan in the countries where such structures operate.

Where International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS 32) apply, bank account balances are seen as financial instruments that must be disclosed and presented individually. However, US GAAP allows banks to net the balance sheet.

Digging deeper: physical pooling/cash concentration

Main benefits

Control funds centrally

The concentration of all of a company’s surplus cash into one account, generally managed by the group treasury, will improve its control over cash. If the net balance of the cash pool is positive, this aggregated balance can be used to invest in overnight or short-term deposits, such as money funds. Indeed, companies with large treasuries often have dedicated staff managing these investments.

The establishment of a physical cash pool enables treasuries to exercise greater control over cash flows. Ideally, all subsidiaries should participate in the cash pool, as this provides the centre with more information about the daily cash flows that exist throughout the company.

Reduce credit facility requirements

Establishing a physical cash pool means that the treasurer need only negotiate one credit limit for the entire group. This avoids the need for separate credit arrangements to be set up for each subsidiary participating in the cash pool.

The treasury has a high level of visibility over the balances of subsidiaries’ accounts in this type of arrangement and can thus control the disbursement of cash. A subsidiary experiencing cash shortfalls can be funded from the master account at a cheaper rate than could be arranged locally. The treasury should be able to reduce borrowing costs significantly by using the balance aggregation to arrange inter-company funding.

Disadvantages

Inter-company loans created

The physical movement of cash between accounts creates a series of inter-company loans between the master and participant accounts.

This can have complex implications, particularly with regard to:

Withholding tax

In some countries, withholding tax may be levied on inter-company loan interest. This is because tax authorities regard the payment of interest on inter-company loans as an inter-company payment rather than as a bank payment.

Thin capitalisation

In some countries thin capitalisation rules apply – these restrict the level of financing a subsidiary can receive from its parent/major shareholder. Companies are often able to offset the cost of such loans by deducting the interest charged as an expense for income tax purposes. In order to prevent abuse of this advantage, many countries have introduced thin capitalisation rules.

The ratio of debt to equity a company is allowed before it is classed as being thinly capitalised varies considerably from country to country. Thin capitalisation levels need to be closely observed when running a physical cash pool to ensure that the redistribution of funds from the header account amongst the subsidiary accounts does not breach these rules. This is of particular concern when cross-border cash pooling is implemented.

Legal issues

The transfer of monies between a company’s subsidiaries creates legal issues due to the co-mingling of funds. Care must therefore be taken with the structuring of inter-company loans to ensure that they are legal. Often separate credit agreements will need to be put in place for each loan.

Higher banking costs

The physical transfer of cash between accounts will incur high banking costs, particularly if a large number of movements takes place and/or cross-border transfers are involved.

Cash flow forecasting

The master account will fund any cash shortfalls and invest in surpluses on a daily basis. Some degree of cash flow forecasting will therefore be required to manage these positions effectively.

Concentrated banking arrangements

Most cash pooling arrangements require that all participant accounts are held with the same bank. This may cause problems for companies with operations in many countries – a bank which is strong in one country may offer a more limited service, or indeed no service, in another.

Variations on the theme

Zero balancing

Cash movements into and out of the header account are structured so that all subsidiary accounts are left with a balance of zero. Typically, zero balancing cash pools operate on an intraday basis, with sweeps occurring daily (usually at the end of the working day). The net balance in the header account is therefore available for overnight investment.

Target balancing

In this arrangement, cash sweeps are arranged so that accounts in the pool are left with a pre-determined target balance after the sweep. Different target balances can be set for the constituent accounts in the pool. In fact, it is often possible for the treasurer to set negative target balances (ie an overdraft facility) on some of the participant accounts.

Interest reallocation

Some banks allow the interest payable to the cash pool to be redistributed between the participant accounts. The bank calculates the interest payable after balances have been swept from the participant accounts to the header account. Central treasury can, if the net balance of the cash pool is positive, benefit from a ‘turn’ (the difference between the credit and debit rates) which may be shared with the operating subsidiaries.

Mirror accounts

Some banks offer a service whereby mirror accounts can be set up for the participating accounts in a cash pool. Sweeps on the participant accounts would be booked through the mirror accounts, leaving the operating accounts to function as if they were not part of the cash pool. Each participant account and its mirror account will net to zero after the sweep has been performed. This arrangement can help operating subsidiaries to reconcile their account balances and track the inter-company loans created by the cash concentration.

Digging deeper: notional pooling

Main benefits

Subsidiaries maintain autonomy

As no physical concentration of cash occurs, subsidiaries participating in a notional pooling arrangement maintain autonomy over their bank accounts and retain their cash balances. The group however achieves similar economic benefits as it would with a physical cash pool.

Less administration

As balances remain with each legal entity (ie no inter-company loans are created), notional pooling requires far less administration than physical pooling.

Lower banking costs

Notional pooling incurs lower fees than physical pooling as the bank operating the pool is not required to transfer cash between accounts.

Disadvantages

Balance sheet enlargement

The balance sheet of both the bank and the company involved in a notional pool can become unnecessarily large. This is because there are no physical cash transfers occurring between the various accounts in the cash pool.

Specifically, a bank offering notional pooling services may find that it is unable to offset fully the debit and credit balances appearing on its balance sheet. This will affect the way in which the bank allocates capital, which will in turn affect the interest compensation paid to the pool. This can become a very important issue as banks have to allocate capital to all their lending. If the gross overdrafts on the participant accounts have to be carried on the banks’ balance sheet, there will be a charge to reflect this, which may or may not be made explicitly. This will partially offset the gains that are made.

Legal issues

In some countries notional pooling is prohibited. Additionally, the way in which net interest is calculated may vary from country to country.

Credit facility requirements

Separate overdraft facilities and credit agreements will need to be negotiated for each account participating in the cash pool. This can make managing liquidity across a company more complex.

Main variations

Interest optimisation

This is a limited form of notional pooling whereby a bank offers a company preferential credit and debit rates (ie it returns to the company some of the ‘turn’ it would normally benefit from). This service is usually offered in jurisdictions where full notional pooling is not permitted.

Margin pooling

This arrangement is a variant of interest optimisation. In a margin pooling arrangement, a bank pays the company the benefit accrued by applying interest optimisation as a separate fee. The service allows for a bonus determined by the ratio between the debit balances and credit balances of the participating accounts. In effect, this operates as a sort of ‘loyalty scheme’ – the greater the offset between accounts, the larger the benefit paid to the company.

Other pooling arrangements

Single legal account pooling

A form of cash concentration, in this arrangement a company maintains only a master account with a bank. This master account – which is generally managed by the group treasury – contains all the company’s cash and is effectively an in-house bank.

The bank maintains sub accounts for all the entities participating in the cash pool. These accounts are used by the group’s operating subsidiaries as if they were not part of a cash pool (so they control their own balances). However, all transactions on the sub accounts are booked to the master account. The master account is thus a summary account for all activity occurring in the sub accounts. The bank calculates interest on the master account balance, although this can often be allocated to sub accounts.

Single legal account pooling is not especially widespread, being mainly offered by the Nordic (and some UK) banks.

Reference account structures

Reference account structures are a method of including the accounts of subsidiaries which are not officially a part of the cash pool in a pooling arrangement. Subsidiaries may be unable (eg for legal restrictions in place in their home country) or unwilling to participate in a cash pool. In this arrangement, each subsidiary has – in addition to its normal domestic operating account – a reference account in the central pooling location. Balances on the local operating accounts are manually or automatically transferred to the subsidiary’s reference account in the central pooling location. These balances will then be notionally pooled, allowing for the full offset of debit and credit balances.

Overlay cash pool

An overlay cash pool isn’t necessarily distinct from a notional, conventional target or ZBA cash pool, but could contain components of all three. It is a cash management service that facilitates the aggregation of liquidity from a series of multiple underlying banks or accounts into a single bank or banking structure. This could be within a single bank, but typically an overlay structure refers to a multi-bank structure.

Where balances are held at two different banks, the cash has to physically move from the local bank to the overlay bank. This can be done by the corporate instructing its local bank to push the funds to the overlay bank – where every day at a particular time the bank pushes excess cash into the overlay bank account structure. The alternative is for the overlay bank to pull the cash from the local bank at a predefined time and within certain parameters.

A virtual alternative

Given the potential for regulatory issues around the structure, an alternative to notional pooling is provided by virtual accounts. These have already been deployed for the streamlining of collections. By opening virtual accounts for each entity within a group and appending sub-level virtual accounts to these, clients of those entities can effectively remit to a central account (whether national, regional or global) using their own unique virtual account identifier. Like notional cash pooling, virtual accounts could enable corporates to allocate cash without segregating it physically.

By integrating virtual bank accounts with administrative sub-accounts called virtual ledger accounts (which populate a multi-bank cash management dashboard), a new type of liquidity management tool is created, allowing full cash concentration and visibility right across the group.