30
Jul 2015

The Ins and Outs of Cash Pooling 1: physical cash pooling

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Of the various topics in treasury, few exceed the popularity of cash pooling - and for good reason: it is often one of the best tools in the treasurer’s tool belt for short term liquidity management. Today, I want to highlight a specific type of cash pooling - physical cash pooling - the advantages it brings to the treasury, and a few of the factors that must be considered when you try to set up pools.

The basics

Functionally, cash pooling is simple to understand. Typically, a cash pool will be implemented on top of existing accounts - often within a single bank.  One account becomes the “header” account, which cash “sweeps” into,  and the rest associated as “sub accounts” which cash “sweeps” out of the main account to. The header account is often that of the main office, or the treasury, but it could also be that of a shared service center, finance company, or special purpose vehicle. (A caveat on header account selection though: you obviously want to make sure the accounts are maintained in a country where pooling is permitted and there are efficient payment and bank systems allowing electronic movement of money between accounts.)

Day to day banking proceeds as usual, and at the close of a defined period, an upward sweep of the sub accounts moves all cash into the header account. The net position is then either invested or funded depending on balance. This upward cash flow is treated as an intercompany loan - with many-if-not-all of the same controls and requirements of any other intercompany loan.

The role of the Treasury Management System (TMS)

A TMS brings major advantages to cash pooling. For example, a loan created by an upward sweep needs to be tracked so that it is incorporated into financial reports for the subsidiary and for the parent - for both regulatory reasons, and business performance evaluation. A TMS will allow intercompany balances to be easily tracked, and provide on-demand reports about intercompany balances. Further, as the subsidiaries are essentially providing loans to the parent, it is in good practice and at times legally required that they receive compensation - just as if it was invested at the bank. A TMS helps corporations calculate interests on these intercompany balances and allocate interest revenue/expense across the various subsidiaries. While banks can handle some of this, they usually cannot allocate interest for you.

A TMS also opens up the potential for cross bank pooling. Say that JP Morgan gives you 2% interest while Citi only gives you 1%. You may want to establish the header account with JP Morgan, and maintain sub accounts with Citi bank. Yet, if you ask Citibank to sweep your accounts into a JP Morgan account at the end of the day, they’re probably not going to be happy about it.

If the pooling is handled within your TMS, then you can schedule sweeps from sub accounts across banks by simply initiating a transfer. From the bank's perspective, all they’re doing is moving your money around - though as a warning, you will probably lose the advantage of the reduced transaction fees you get by using a single bank solution, and transfers may not be as quick.

tm5 actually has an additional neat feature: you can use target balance rules to set an account to be transferred based on a pre-determined amount. So maybe your accounts stay within Citibank until they reach $10 million, at which point they’d automatically be set to sweep over to JP Morgan.

The advantages

Obviously cash pooling provides a number of advantages for a corporation. These include:

Improvements to net interest income/expense

Cash pooling brings all of the net increases and decreases to group cash balances together, opening up the possibility for all companies to take advantage of central treasury’s interest terms.

Increased visibility and management of cash positions

By reducing the number of accounts that need to be looked at, cash pooling reduces the effort required to get an overall picture of the group’s cash position.  Further, you can keep a certain amount to cover costs within an account, then sweep up, giving you total available cash instead of total cash position.

Reduced overdrafts

As accounts are zero balanced, individual accounts will not go into overdraft. Instead, debt will be taken to the central treasury, which can apply its more advantageous interest rates.

The complexities of setting up a pool

One of the key factors you need to think about is the transactional requirements of the cash pool. Depending on your account structure and how frequently you sweep funds, there’s potential for significantly more transactions per time period than you would have with a vanilla account structure. Due to this, simply adding a pool bank on top of your normal cash structure may add considerable cost.

There’s also a multitude of legal factors (both regulatory and civil) that can affect your business depending on the offices you’re in. For example:

Germany:

Any cash pooling arrangement must keep up to date information on the liquidity and equity of the parent company and the other participating companies in order to assure that the money they contribute will be repaid. For example: a parent company might provide participants with monthly financial statements.  

German companies have to be careful with how they use pooled money lest they be found to be “plundering” subsidiaries. In Bremer Vulkan (2001) it was found that subsidies to one group being pooled for the benefit of other members constituted “plundering”. However, this decision was reversed later on. (This is also why some countries reinforce a “minimum interest” on intercompany balances.)

Again, a TMS is helpful here, as you can just add all involved companies, giving them read access to the appropriate reports.

 

Finally, participants must be able to terminate the cash pooling agreement at any time.

USA

In the US, the controls are usually fee and tax related.  For one, fees related to current account overdrafts are prohibited. Also, US entities need to be careful if they are a “net user” of funds as this would most likely be viewed by the IRS as a deemed dividend. If the header account is that of a US parent, subpart F restrictions may mean that treatment of pool earnings are deemed dividends – meaning that the US Corporate parent may not be able to directly participate in the pool.

Brazil, China and India

All three nations disallow unrestricted cross border movement of funds. This might make pooling with offices in these nations impossible.

Mexico

Tax regulations on intercompany loans mean that while physical pooling is possible, it’s not really worthwhile.

Despite its complexities, physical cash pooling brings a great number of advantages to the treasury. By sweeping accounts upward, it can bring together your cash, allowing greater interest payments, and better management. By sweeping down, it can assure that accounts do not go into overdraft. And, of course, like all good treasury tools, cash pooling brings greater visibility to your cash management. Just make sure you keep an eye on regulatory issues.

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