With Libor rates spiking (one month USD Libor pierced 5.80 percent at one point vs. 5.59 a month ago), corporate treasurers may be either dreading or looking forward to repricing “risk” on Libor-linked liabilities and assets.
However, should such short-term rate spikes (which may be temporary) also affect internal polices on setting rates for intercompany liquidity management, e.g., rates on short-term interco loans, in-house bank (IHB) arrangements and cash pools? Most are linked to Libor, but how quickly should treasury be obliged to adjust them, and to what extent? For example, should a month-end rate be good enough for the prior month’s transactions, or even the next month’s? Alternatively, would an average be better suited?
Discussions with NeuGroup peer group members over the past year revealed increased sensitivity among companies with IHBs or similar interco lending programs to the arm’s length nature of the arrangement, as required by many local and US tax laws.
Some companies, in consultation with their tax departments, said they are comfortable with a lowest common denominator—i.e., global Libor reference rate. Others see adjustments for country risk and other credit-based considerations as required to justify a “market equivalent” rate for transfer pricing purposes. One compromise has been to use the local currency Libor equivalent for affiliates, based on the subs’ location.
In most instances, however, treasury policy leans toward simplicity with the least amount of administration (i.e., a single global rate).
In a placid rate environment, the differences between the admin-heavy vs. admin-lite approaches may be immaterial enough to stay off the tax group’s radar screen. However, given the recent market gyrations, treasury should run a quick materiality check to see whether its uniform approach has veered too far off course for a market equivalence test, as tax authorities require. The same thinking can be applied to outsourced in-house banking or pooling arrangements, where a bank is providing a net interest credit based on some reference rate. Ideally, the policies should be consistent and not overly favorable to the bank.