For many MNCs, an emphasis on effective management of working capital has translated into renewed urgency in rationalizing liquidity structures.

(Editor’s Note—Original publication date: June 16, 2003)

The tight credit market—combined with general economic weakness—has forced a strong focus on cash and liquidity management for both cash-rich and cash-poor companies.

As the ability to generate cash (or borrow it) has declined, MNCs report an increased need to have a clear view of their cash position globally. Visibility, however, is not enough. Treasurers also need effective techniques and procedures to manage their global liquidity. That task increases in complexity as a result of geographical spread, multiplicity of banking relationships, cross-currency flows and corporate structure issues (e.g., tax).

A consolidated view of cash

One of the most useful liquidity-management tools in the treasury toolbox is cash “pooling,” an arrangement whereby the credit/debit positions of different accounts are viewed from a single summary perspective.

This approach gives treasurers a chance to view cash on a regional and global basis, at the same time allowing affiliates to utilize their collective liquidity more effectively (i.e., instead of one subsidiary borrowing while the other is flush with cash).

Companies planning to centralize cash for multiple international subsidiaries have two basic options available:

• Zero balance accounts (ZBAs); or

• Notional cash pooling.

While both achieve the same ultimate objective, there are technical differences, which can then have significant organizational and tax consequences to either approach.

Zero-balance accounts (ZBAs)

ZBAs refer to linked accounts at the same bank and in the same currency and country. Funds are physically transferred in/out (zero-balanced) from subaccounts to a main account daily.

ZBAs: Key Aspects

The following are the key characteristics of a ZBA pooling arrangement:

• Same bank/same branch

• Same country

• Same currency

• Segregation of subaccounts which are then linked to a main account

• Completely automatic (bank), no manual transfers required

• Intercompany lending arrangements if separate legal entities participate, which means an arm’s-length interest rate must be assessed.

This primary account is usually held in the name of the Corporate Parent, Country or Area Headquarters/Holding Company or a Regional Treasury Center, such as a BCC, IFSC or OHQ.

If the subaccount holders are divisions of the same legal entity (such as branches, sales offices or plants), there are no tax issues. Indeed, often companies use ZBAs as a simple method to segregate different types of activities, such as receipts and disbursements, even if there is no regional or organizational segregation already in place.

However, if the subaccount holders are separate legal entities (i.e., subsidiaries), the funds movement into the main account constitutes an intercompany loan from the subsidiary to the main account holder and vice versa; this, in turn, generates some tax and accounting issues.

Audit trail and accounting. For example, documentation must be maintained for audit trail purposes and the main account holder (e.g., central treasury) must charge an “arm’s length” interest rate to the participating subsidiaries. Although banks provide separate statements for each subaccount, they will not typically do the accounting, manage the loan portfolio or assess/pay interest. (Some banks do run separate businesses which provide these services on an outsourced basis, usually out of Dublin.)

So unless this aspect of recordkeeping etc. is handled by a bank or third-party outsourced service, it must be done internally. Many treasury workstations and ERPs provide intracompany loan-management functionality as part of their core offerings. If the activity is at all substantial, spreadsheet solutions may not be sufficient (and certainly won’t provide the layer of automation of both interest allocation/payment and reporting that makes this cost effective).

Cost benefits. In-country ZBA arrangements are very common and have been a staple of managing US cash for years. Yet they are not universally possible. In certain countries, such as Korea, ZBAs may not be permissible at all, and in countries where there is an assessment of debit tax on transactions out of a bank account, such as Australia, a ZBA arrangement may end up being not cost effective.

For treasurers managing subsidiaries in multiple countries/currencies, the ZBA structure can be set up as an overlay, but funds must first be physically transferred from country A, B or C to the concentration location.

Two-tier approach. Often there is a daily pooling/ZBA in the originating country first, and then a sweep or manual transfer to the location of the main account, with less frequency. Thus the cross-border ZBA is usually a two-tiered structure. Weekly transfers are fairly standard. Daily transfers cannot be cost justified except with the very largest multinationals.

Therefore, in assessing the efficacy of overlay ZBA arrangements, a cost/benefit analysis is essential to establish the target level of cash required at the local level, and the frequency of transfer to the main account. Also overlay options may require opening additional in-country accounts, which can get expensive.

But perhaps the main drawback or limitation of ZBAs is that they’re only available on a single-currency basis. Thus, at the treasury level, there must be a main account for each separate currency.

Notional cash pooling

That’s where notional cash pooling enters the picture. With notional pooling, there is no physical movement of funds between accounts; rather, credit and debit interest are offset. Interest is paid/charged on the net balance position, but the legal/tax separation of separate subsidiaries owned by the same parent is maintained.

The initial (or direct) benefits of pooling come from the reduction of overdraft interest expense by centralizing the company’s liquidity position (see example in table below).

Legal hurdles. Notional pooling is great in theory. In practice, however, this pooling arrangement is not permitted in all countries. In these countries ZBA arrangements are used.

The big benefit to this arrangement, however, in the countries where it is most common, such as the UK, Netherlands and Belgium, is that there’s minimal or no withholding tax on interest earned. Often, too, (unlike physical pooling/ZBA arrangements) it’s not necessary to have a main or header account; the offset is simply among the participants. However, some countries (such as France) do require that there is a holding company in place.

The key advantage of notional pooling is that it allows for a multicurrency view of cash.

Notional: Key Aspects

The following are the key characteristics of a notional pooling arrangement:

• Same bank/ different branches

• Same country is most common

• Multicurrency pooling is extremely sensitive from a tax and accounting perspective—Spain can’t participate, for example due to local tax regulations

• Cross guarantees are required by the bank, regardless of the cash position of the participants

• Interest actually charged/paid to participants is optional—but may be advisable from a tax perspective.

However, in order to pay/charge interest on a single consolidated basis, the bank will use an interest rate differential to avoid currency conversion, similar to how a short-dated swap is handled. From a company’s perspective, this may ultimately affect the cost effectiveness of the arrangement. The company typically ends up paying forward points, thus reducing the interest-rate earned for a positive consolidated balance.

There is also a risk factor involved, as treasury is actually outsourcing this activity (to a bank). This means treasury may lose some control over the counterparties involved in the transaction.

Virtual pooling. In reality (or in virtual reality), treasury can achieve similar effects by using internal systems to execute the loans or interest offsets, and then generating the appropriate entries into the accounting system (i.e., an in-house bank). Also the rates achieved for investing excess cash would be higher. In fact, although a few large banks do offer multicurrency pooling, they are not entirely comfortable with it. (One of the very large banks simply decided not to offer notional pooling, only ZBAs are used; notional pooling was too fraught with difficulties).

In all cases, however, the bank will not act as a tax advisor, will insist on a sign-off from the company’s tax counsel and require cross guarantees between the participants. (That’s a hurdle for many MNCs.)

Loan by every other name. Pooling ostensibly gets around the issue of putting intercompany loans into place, because it is notional. However, it is a variant of a short-term intercompany loan arrangement, allowing a bank service to handle the periodic cash-reserve ups and downs of different entities.

If there were a permanent or long-term mismatch in liquidity, companies would more effectively use intercompany loans as the mechanisms. That’s why tax authorities will look carefully at pooling arrangements, and still may require some type of arm’s length interest depending on the amount and tenor of the offsets.

Also, if the company is always in an excess cash position, the concept of a notional offset makes no sense. And using a notional multicurrency pool as an investment vehicle is counterproductive, as the interest rate paid on the pool will be far lower than what individual currency pools will be able to achieve.

As a treasury management technique, cross border pooling is primarily used in Europe and to a more limited extent on Asia, where there are still regulatory issues that limit the participation of certain countries.

It is not used at all in Latin America (regionally) where there are significant regulatory issues and withholding tax restrictions on intercompany lending. Thus, the essential first step in evaluating any cross-border pooling arrangements is to focus on the management structure of the company and what tax implications may arise.