By Geri Westphal and Ursula Conterno
After a brief foray into notional pooling, treasurers are rethinking that decision with many moving away from the structures back to physical pools, in-house banks (IHB) and POBO/ROBO structures.
Several years ago corporates migrated away from physical pooling to notional pooling, which was considered to be the panacea for managing global liquidity. This new structure allowed the offset of debit and credit balances on a notional basis which removed the need for physical transfers and greatly reduced the costs associated with foreign exchange (FX) conversions. Although the initial set up of a brand new notional pooling structure was a bit complicated and time-consuming, once tax and legal approvals were obtained, it was seen as the ultimate solution for efficiently managing global cash.
Fast forward a few years, and now treasurers are rethinking that decision and many are moving away from notional pooling back to physical pools, in-house banks (IHB) and POBO/ROBO structures as alternative solutions.
The urgency for reevaluation might have initially been prompted by regulatory changes, but based on member feedback, in many more cases it was triggered by a proactive approach by corporates to take advantage of the changing business climate.
Although the majority of NeuGroup members report that they have either not been approached by banks about the ongoing viability of their notional pooling structure, or they have been told no changes are necessary, it seems as banks continue to apply incremental charges on negative balances in addition to reducing payout on excess balances within the notional pooling structure, the cost of having a traditional notional pooling structure starts to become prohibitive and thus the need for evaluation of alternative structures.
Notional Pooling, Down but not Out?
Having confirmed with our members that Basel III is not the sole motivation for why corporate treasurers are moving away from existing notional pooling structures, it certainly is impacting how banks are viewing this product offering and its ongoing long-term viability as a premier solution for global liquidity management.
Much of the problem lies in how banks are being forced to interpret notional pooling and that they can no longer net off loans with deposit positions. One of the reasons notional pooling was so popular was because it allowed the corporate to rely less on bank credit lines since overdraft positions were offset against surplus cash positions of other pool members. Basel III is now requiring banks to set aside additional capital against these overdrawn accounts. They no longer get the offset of the positive cash from another pool member, the overdraft stands alone and additional capital is required.
Another added change from Basel III is the need to distinguish between core operating deposits and non-operating deposits. Operating deposits linked to transactional and payment activities have increasingly gained in value. Banks have increased their pricing for operating deposits thus improving LCR, and continue to introduce new deposit products to support a +30-day liquidity coverage requirement. Because notional pooling is considered a pure overlay structure and there is no identifiable link to a specific transaction, the banks are being forced to review the costs of notional pooling solutions. This could result in increased costs, or legal reviews of existing structures.
Throw other global regulations like BEPS ((Base Erosion and Profit Shifting Project) on top of this picture and it might finally be the straw that breaks the camel’s back and compels corporate treasurers to move away from notional pooling to a structure believed to be more stable from a long-term business perspective.
In 2013, the G20 mandated the OECD to review and evaluate solutions to solve what it perceived as issues with the current international taxation rules. The project known as BEPS includes 15 major points that were to be addressed as part of this overall global review and the final report was presented by the OECD to G20 Finance Ministers during the meeting hosted by Turkey’s Deputy Prime Minister Cevdet Yilmaz on October 8, 2015, in Lima, Peru. The OECD’s Explanatory Statement on BEPS can be found here: www.oecd.org/tax/beps-explanatory-statement-2015.pdf
Under this plan, MNCs will be required to abide by new guidelines that will impact how they structure and report on intercompany activity, with things like transfer-pricing guidelines, permanent establishment and interest deductions expected to be most impactful under the BEPS Action Plan. The new Country-by-Country report is due (depending on company size) beginning on or after January 1, 2016, so that corporate tax departments can begin filing the first country-by-country reports in 2017.
There is also a new wrinkle that has entered the equation: new US Treasury rules that could be a damper on traditional intercompany lending (see story page 1). What’s now causing concern among treasurers (and company legal departments) are proposed regulations under section 385 of the US tax code. These proposals, which were meant to limit earning stripping, could have a broad impact on some of the daily go-to cash management tools—like cash pooling—that treasurers use. That’s because debt between entities would have to be treated like lending from a third party, which would entail reams of paperwork to do credit checks and service the loan.
Evaluations continue
Earlier this year, The NeuGroup published a piece on the anticipated trends in cash management for 2016 (see “Cash Is No Longer King,” iTreasurer, December 2015) and based on a variety of survey results, the compelling take-away was that corporate treasury organizations would continue to reevaluate their existing cash structures by taking a closer look into their current liquidity structures, the associated costs and the ongoing viability of each based on current market conditions.
As noted in the chart below, physical pooling already outranks notional pooling 77% to 55%. With the ongoing alignment and integration of RTCs and SSCs, along with the rollout of SEPA standards, corporates are continuing to reengineer payment and receipt processes to deliver even more process efficiency which is helping to increase the popularity of POBO and ROBO liquidity structures.
As confirmed through member survey responses, liquidity structures are a top priority for NeuGroup functional treasury managers with approximately 30% of the members of the Global Cash and Banking Group (GCBG) highlighting physical pooling, in-house-bank or POBO/ROBO-related projects as one of their top three current projects or priorities during our latest meeting cycle.
In the specific case of IHBs, the latest GCBG benchmarking study survey showed that 36% of members are interested in setting up an IHB, bringing the total percentage of NeuGroup member companies who currently operate an IHB structure to 77%. Many of these structures have been in place for more than five years, but with this renewed increase in evaluating and establishing new structures, 22% of members have created their IHB structures within the past four years with 11% having set up one in the last year.
To support this growing interest in evaluating alternative structures, The Global Cash and Banking Group spent several sessions at its meetings during the last two years understanding the factors affecting notional pooling and its future as well as discussing case studies of alternative liquidity structures.
Taking those case studies as a reference as well as the expertise shared by our members, here is some practical advice that can be applied to setting up either a physical pool, an IHB or a POBO/ROBO structure:
- Understand the coverage of your planned structure. Given country-specific legal, accounting, and market practices, you may not be able to include all entities in your implementation. The value of implementing these structures can be significant even if not all markets/entities are covered. Have a plan to manage the markets/entities outside the structure, preferably leveraging on a standard process. Also, keep track of the reasons why some markets/entities were excluded, so their participation can be reassessed as conditions change.
- Gain the support of Tax and Legal early in the game. In many cases, tax and legal hold the key and have the last word in whether these structures get implemented or not. Having their buy-in from day one and partnering with them along the way are key to the success of the structure.
- Consider BEPS when choosing your location. The location and mandate of the IHB entity is very important, especially based on the most recent discussions regarding potential BEPS impacts. It is critical to show the substance of the entity and to ensure that the activities of key treasury professionals driving IHB operations belong to the legal entity that hosts the IHB and also ensure that all rates used within the IHB structure can be substantiated as arm’s-length rates in support of the transfer-pricing policy.
- Be on top of the implications for intercompany management. With Tax as your partner, make sure that all intercompany agreements are up-to-date and in line with the structure you are choosing. Specifically for intercompany funding, make sure you are in compliance with thin capitalization rules, local legal and tax regulations and the arm’s length principle. Also, keep all appropriate documentation on file.
- Understand what technologies can enable the implementation and efficient day-to-day management of your planned structure. Although some liquidity structures do not need a treasury management system to be up and running, leveraging on one might make the day-to-day management more effective and less dependent on a vendor or banking partner. However, some structures like POBO/ROBO need a robust technology backbone to be implemented. In fact, the absence of very specific functionality on your ERP or TMS might make it impossible to run a POBO structure.
- Beware of documentation heavy lifting. One cost that is generally underestimated is the documentation associated not only with implementing but also operating these structures. When possible, leverage a legal resource that is familiar with treasury activities to negotiate legal terms with banking partners and vendors and to support tax and treasury on the required intercompany documentation.
- Rely on a cross-functional team. Depending on the structure you are implementing, many teams will need to participate in the process, from tax and legal to accounting and AR/AP. Make sure you include the right people along the way to identify the implications for all business partners and leverage their expertise.
- Consider a phased approach. The road to implementing a new liquidity structure is not an easy one. A new liquidity structure will need systems and processes able to support it. In many cases, these systems and processes will need to be in place before the new liquidity structure can be put in place. Then, you might need to implement in phases and add regions or business lines to the structure and even define multiple levels of participation.
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