Multicurrency liquidity management in a volatile economic environment is a challenge but tools are available to help mitigate risk, lower costs and maximise efficiency. Treasury Today goes back to basics with the notions of pooling and sweeping.

If there was just one single currency for international trade, life would be so much easier. Instead there are around 167 official national currencies recognised as legal tender. Of course, in global trade many of these are little used, if at all. But even amongst the world’s core currencies, for an international business, having the funds available to meet all commitments in the right place, at the right time and in the right currency can be a challenge, especially considering the trade-off between maintaining readily available cash and the costs of maintaining this asset.

In order to optimise the corporate cash structure, affording a stronger degree of visibility and control, the practical response to this essential balancing act commonly boils down to the use of a cross-border cash pooling structure. This may include a number of options around the concepts of physical pooling (also known as cash concentration) and notional pooling (sometimes referred to as virtual pooling).

Physical pooling sweeps funds into a central and (preferably) tax-efficient location. A notional pool calculates interest on the combined credit and debit balances of accounts but there is no physical transfer of funds between accounts. Combinations may be used and a multi-banking corporate may choose an overlay provider (based perhaps on convenience, footprint or share of wallet).

From the outset it should be understood that some forms of pooling or automated sweeping are not permitted in certain jurisdictions.

Overlay structure

An overlay cash pool is the top layer of a cash pooling structure in which liquidity is concentrated. It provides a mechanism to enable the physical concentration of cash across borders to a central liquidity pool. Liquidity and interest can be offset through this top layer, which operates as an umbrella-type structure above a network of underlying regional and local accounts or account pools, which can be with the same bank as the overlay pool or with different, local banks. The aim is to have one top-layer per group and then under this have a network of other structures. This allows the treasurer to connect to any other accounts in the structure below, more or less anywhere.

Cross-border cash pooling

A cross-border cash pool is a cash management structure that allows a business to concentrate the cash it holds in different countries, across separate bank accounts, in one location. This technique provides corporates with an effective way of interest optimisation and improved liquidity management. Excess cash from one subsidiary can be moved (swept) to offset debit balances in another. Periodic sweeping to a central account typically uses a ‘zero balance account (ZBA)’ approach where the account is completely emptied (see below for alternatives). Physical transfers of cash are treated as intercompany lending for tax and regulatory purposes.

Pooling per legal entity

When a subsidiary maintains multiple bank accounts in different currencies and countries, pooling the bank balances in each country on a legal entity basis can offer benefits to the group treasury. Cross-border sweeps are delivered to a pool in one country – concentrating all the subsidiary’s cash into a single position and providing visibility and control over all accounts.

Pooling per country

If the decision is made to set up pooling per country, each pool will see the various subsidiaries’ bank account balances swept to a master account in each country. These master account balances are then swept cross-border into a central pool in the main country of operation. Depending on factors such as the scope of operations and type of business, the corporate will have to weigh up the benefits of potential locations, as well as carrying out a thorough evaluation of the tax and legal issues that may exist in each.

There are a variety of ways in which a cross-border sweeping arrangement can be set up:

• Cross-border sweeping by legal entity

  Automatic sweeps from the subsidiaries’ bank accounts in the different country branches of the concentration bank go directly to the master account at the central pooling location. Should the subsidiary have multiple bank accounts in the same country, the balances need to be consolidated or netted to one account to limit the cross-border sweeps to one per country. If a corporate uses cross-border sweep by legal entity, it needs to be aware of the tax issues that can arise from cross-border inter-company loans being created between the master account holder and the operating companies.

• Cross-border sweeping with initial domestic sweep

  If the corporate has a number of subsidiaries in each participating country, a two-step process can reduce the number of cross-border transfers involved in the sweeping arrangement. In this case, the master account holder would open a non-resident bank account, or target account, with the concentration bank in each participating country. The purpose of this is to enable cash concentration to take place on a domestic basis within each country first, prior to a second cross-border sweep from the target account in each country to the master account held in the final pooling location. Once again, the tax status of cross-border inter-company loans must be considered.

• Cross-border sweeping with domestic notional pooling

  In this set up, the subsidiary balances are notionally pooled in each country first. The cross-border transfer is made from a master account in each of the domestic notional pools to the master account in the central pool location, reducing the balance of each country’s notional pool to zero.In most cases, the group treasury is the master account holder in the pool in each country, as well as at the central pool location. This solution allows local subsidiaries to maintain ownership of their cash balances and removes the need for inter-company loans.

Sweeping options

There are several variations on the sweeping theme beyond the simple ZBA model:

• Constant balancing

  Constant balancing operates on the same principle as zero balancing but a pre-defined residual amount is maintained in the sub-accounts as opposed to a balance of zero. The advantage to sub-account holders of this method is that a balance is immediately available at the start of the trading day to action payments, and interest is accrued on the sub-accounts.

• Target balancing

  Target balancing differs from plain ZBAs in that transfers are made from the master account to the sub-accounts in the opposite direction to which the zero balancing transfers were sent, so the sub-accounts keep a target balance. As the target transfers have a book date of ‘today’ but a value date of ‘tomorrow’, the sub-accounts always have a credit book balance but a zero-value balance.

• Trigger balancing

  Trigger balancing is when upper and lower amounts are set on sub-accounts. Balances that exceed these amounts trigger the zero balancing process to take place, but only on those sub-accounts that meet the limits (these limits may vary for each sub-account). Trigger balancing can eliminate the need to sweep insignificant balances and lower the number of sweeps that take place, which in turn can reduce banking costs.Some banks also offer the possibility to execute zero-balance sweeps at intervals other than the standard end-of-day frequency. This may benefit companies when activity on certain sub-accounts is low during certain periods.

Cross-border notional pooling

A cross-border notional pool allows corporates to optimise interest across a number of accounts in a variety of countries. In this case, the debit and credit balances of the participating accounts in each separate country are pooled for interest purposes. This may or may not involve cross-border transfers.

Multi-entity notional pooling is treated as bank lending for accounting purposes. Structuring notional cash pools on a cross-border basis thus can be problematic because the bank will require cross-guarantees for each participant. This means entities in the pool provide guarantees for each other’s liabilities. The bank also has the full legal right of set-off over pool accounts. It must retain this for reasons of capital adequacy but it also means it can use a client’s funds in one account to settle debts in another and has the option to terminate that agreement. It is rarely invoked but remains a possibility with which some treasurers will not be comfortable.

Once it is established that a cross-border notional cash pool is the corporate’s preferred option, and their chosen bank can provide this in the countries (and currencies) required, an assessment by treasury of the structure being offered is required. Some of the main structures for cross-border notional pooling are outlined as follows, using the zero balancing model:

• Cross-border notional pooling with domestic zero balancing by country

  In this structure, a domestic zero balancing cash pool is set up in each participating country. The balances on the master accounts for each of the domestic zero balancing country pools are then swept cross-border to accounts in the same name in the central notional pool. Sweeps can be two-way or one-way, depending on treasury’s requirements. The country accounts in the central pool are notionally pooled for interest purposes. Using this structure, inter-company loans can be created in country, but not cross-border.

• Cross-border notional pooling with cross-border zero balancing by legal entity

  This structure removes the need for a domestic cash pool to be established, as cross-border sweeps are made on a legal entity basis. Within the cross-border notional pool, separate accounts are opened for each subsidiary using the structure. Sweeps are set up from all accounts held by the subsidiary in every country directly to its notional pool account in the ultimate pooling location. In some circumstances, the subsidiary may have multiple bank accounts in any one country. In this case, it can be beneficial to zero balance on a legal entity basis within the country first.Cross-border notional pooling with cross-border zero balancing by legal entity ensures that there is no co-mingling of funds between subsidiary balances. The subsidiaries themselves retain control of their operating accounts, while their balances are simultaneously used to improve the group’s interest charge. If subsidiaries require funding at the local level, the two-way zero balancing sweeps also enable them to be funded indirectly by the master account holder in the cross-border notional pool.

• Cross-border notional pooling with domestic notional pooling

  In-country notional cash pools are established for each country that the corporate requires in this structure. The master account holder for each of these then arranges transfers to an account in their own name that resides in the cross-border notional pool in the main pooling location. These accounts are then notionally pooled. The main benefit of this structure is on the legal side, as the number of participating accounts in the cross-border notional pool is streamlined.

Multi-bank cross-border solutions

Cross-border pooling solutions can also be categorised according to whether multiple local banks are used in each country, or a single network that covers the region (or indeed the world) is employed. Using local banks in each individual country may be advantageous if the corporate operates in a relatively small number of countries, especially if it requires highly specific local expertise and services.

Using a larger regional network bank offers the advantages of harmonised services and documentation and the possibility to execute true end-of-day-based cross-border zero balancing. In order for a regional network bank to be a viable option, it must of course have branches or operating subsidiaries operating in all the countries in which the corporate is active.

Certain banks offer multi-bank sweeping services that automatically transfer balances between local bank accounts and the main cash management bank. Since cross-border multi-bank sweeps go through the correspondent banking process, the sweeps usually happen before the end of the business day allowing next-day use at best. Corporate SWIFT connectivity may be used to implement a bank-agnostic in-house pooling structure so that processing and use of the cash within the group is intraday.

This is clearly an advantage but will require the relevant entities to be incorporated into the technical infrastructure of a centralised treasury operation, and the establishment of a base with at least one major bank. The SWIFT network allows connection to almost every bank using various message types (typically MT940s in this instance), the aim being to achieve as much message standardisation and thus automation as possible. Issues with ‘non-standard’ SWIFT messages (in terms of defining the required fields) are common between different banks. SWIFT’s ISO 20022 .camt messages, once fully adopted, will play a crucial role in developing this opportunity.

Trapped cash

In strongly regulated financial jurisdictions there may be tax implications, restrictions on inter-company lending and limitations on foreign currency convertibility and transfers. So-called ‘trapped cash’ creates a challenge for companies looking to optimise global liquidity. Although balances in some restricted jurisdictions can be used to offset borrowing elsewhere using interest enhancement/optimisation products, the rules vary.

China in particular is making inroads into the internationalisation of its currency but only recently has it been possible for wholly Foreign Owned Entities in the Shanghai Free Trade Zone to take advantage of renminbi (RMB) cross-border pooling. The success of such a scheme will almost certainly be predicated on access to in-depth local knowledge.

Legal framework

Because specific statutory frameworks often do not exist in relation to cash pooling, the framework in which it may operate will largely consist of rules imposed by domestic banking regulations and corporate and insolvency laws which also vary between each jurisdiction.

Parties to a cash pooling arrangement may therefore need to devise a legal structure based on conventional legal instruments and concepts such as inter-company loans or those relating to local foreign exchange regulations, in order to establish the parameters in which cash pooling may operate. Matters such as distribution of profits, liabilities, capital maintenance and liquidity protection requirements must be investigated on a case-by-case basis.

Taxation

According to the Treasury Alliance Group consultancy, almost all liquidity management structures will need to comply with the following three basic requirements from a tax perspective:

• Arm’s-length interest allocation: all financial arrangements between participants should reflect market price.
• Business purpose: the entire structure must have a valid business purpose other than tax avoidance or the circumvention of non-tax regulatory restrictions.
• Economic substance: the participants must have formal, legal responsibilities surrounding their participation in the pool.

Specific tax issues likely to be encountered include interest deductibility, withholding tax, transfer pricing and thin capitalisation rules, business tax and surcharges and stamp duty. Perhaps the most interesting initiative of the moment in terms of physical pooling is the OECD’s Base Erosion and Profit Shifting (BEPS). This addresses concerns that the profits of multinationals are being allocated to locations different from those where the actual business takes place in order to reduce their overall tax liability. In response, treasurers should expect to revisit documentation and practices around liquidity, foreign exchange and intercompany financing amongst others.

Decisions

The suitability of pooling must always be part of a discussion with specialist banking, accounting, taxation and legal partners. Of course, not all banking systems are equal and not all entities within a group have the same needs. A centralised approach to treasury may not even be the best approach to multicurrency liquidity management, especially where complex firms come up against tax inefficiencies and difficult local banking and exchange controls. However pooling is approached, regular review is essential to ensure processes remains fit-for-purpose.