International Corporate Cash Management

 Why and what is international cash management?

What are the key corporate cash management offerings; and how do they work?

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 Introduction

Please Note: This article assumes some basic knowledge of cash management and the products used; in particular “pooling” and the required matching, unmatching, netting processes, and cross-border “sweeping” of funds. Also: account configuration re local “in-country” sub-Accounts (subsidiaries) and local Master Accounts; and centrally “pooled” Mirrored (subsidiary) Accounts, and Treasury Centre Master Account.

In spite of all the regulatory changes in the banking and payments industry such as SEPA, the introduction of the Euro, the development of new technologies, the innovative products and solutions now available; the core requirements of the corporate customer and its Shared Service Centre, or Treasury Centre, have not changed that much over the years. A domestic and multinational organisation from a financing perspective still needs day to day cash surpluses to run its daily working capital management needs. Salaries, heat, light, power, and other office overheads etc., still require payment here in the UK and, in an international corporate’s geographical locations, where the subsidiaries and affiliates reside.

In the corporate world: “cash availability”, or more accurately “cash liquidity” is king!”  For a Group Treasurer of a multinational corporate to arrange as near as possible real time viewing and control over a raft of current accounts in different jurisdictions, subject to disparate local legal regulations, different banking arrangements and fees, in addition to concern about currency fluctuations, and also having to undertake commercial activity in different languages, is certainly a huge challenge. For a corporate to maintain its business share in the international market place, ensure accessible liquidity in all parts of the organisation, and also safeguard shareholder confidence, are even more of a challenge.

When the CEO or CFO a few days before the Corporate’s Annual General Shareholders’ Meeting asks the Global Treasurer: “what is our “true” exposure today, across our 150 global subsidiaries?” ……the Treasurer better have an answer! To have that answer, the Treasurer needs up to date real-time information. This means that the corporate’s financial infrastructure, its bank relationships, credit lines, and logistical interfaces, and use of RTGS payment infrastructures have to be structured in such that they can all contribute to the provision of this detail in a speedy and timely manner.

To be forewarned (with the correct information) is to be forearmed; and the possession of advanced information is key. This detail can – if used correctly – be potentially more of a powerful intangible asset to possess, than the liquidity solution itself! When forewarned, this data can be utilised by the Treasurer thereby ensuring that the correct liquidity is in right place within the multinational corporate’s infrastructure for all day to day working capital management needs. Data therefore is the catalyst to reaching this desired goal.

Contrary to some thinking in the industry, a Treasurer does not wake up in the morning and worry about the cost of an individual payment, or what infrastructure the payment transaction itself is intended to be routed down in order to reach the beneficiary; no, of course not! A Treasurer simply wants to know that at any time of the day or night, irrespective of the beneficiary’s location, he or she can see view, control, move, transfer, net, concentrate, sweep, off-set, pool and undertake a whole range of transactions across all accounts held at numerous banks at home and overseas, without any local or remote encumbrances. The Treasurer wants to know that once the payment is made, it has reached its desired destination securely, safely, and without any delays and additional unforeseen “Correspondent Banking” fees on route. Herein lies the issue!

To achieve all the above needs, or even part, cash management is the overarching methodology to be used. It is a valued and an effective mechanism, and should encompass absolute transparency, and real-time accuracy. So, the question is: how? The answer is: deploy the required cash management tool that suits the corporate customer’s business flows and working capital needs, which is often easier said, than done.

Therefore, to begin with; we need to be sure that we understand what is meant by the term: “cash management”.

What Is Cash Management?

My personal definition is:

  • “Cash Management is the process of collecting and managing cash inflows and outflows, in a timely manner thereby ensuring a corporate has enough liquidity to: (1) meet both its immediate domestic and cross-border obligations, and (2) make best use of long and short currency positions through the minimisation of interest rate spread, (within an agreed period), and ensure a net positive contribution to the corporate’s working capital management”.  

Cash Management is important for individuals and companies. In business, it is a key component of a company’s financial stability. For individuals, cash is also essential for financial stability while also usually considered as part of a retail customer’s total wealth portfolio.

Individuals and businesses have a wide range of offerings available to use across the financial market place currently, to help with their cash management needs. Banks are typically a primary financial service provider for the custody of cash assets. However, with the rise of FinTechs, new technologies, innovative products, solutions, and “Challenger Banks,” one could say that retail and corporate customers are spoiled for choice. There are now so many different cash management solutions and providers for individuals and businesses offering supposedly the best return on cash assets, and the most efficient use of cash, that cash management providers now have a challenge in differentiating their product offerings to the market from other providers and competitors. Despite all the new legislative requirements and a more sophisticated payments landscape, the payments and cash management industry are still fragmented; and probably more so in the retail space, than the corporate space.

Understanding Cash Management

As I mentioned earlier; cash is still the primary asset that companies use to meet their obligations on a regular basis. Businesses have a multitude of cash inflows and outflows that must be managed, in order to meet payment obligations, plan for future payments and investments, and maintain adequate business stability. For individuals, maintaining cash balances while also earning a return on idle cash, are usually their top concerns; although challenging in this era of almost flat and zero interest rates.

In corporate cash management, Business Managers, Group Treasurers, CFOs etc., are typically the main individuals responsible for cash management strategies, cash related responsibilities, and stability analysis. Many companies may outsource part, or all of their cash management responsibilities to different service providers. Nevertheless, there are still several key metrics that are monitored and analysed by cash management executives in-house on a daily, monthly, quarterly, and annual basis. As such, it is the corporate cash management needs, analytics, and services on which I wish to concentrate in this article.

Therefore, let us now consider the main tools and components within the corporate cash and treasury management areas that enable a more effective and efficient method of working.

 The Cash Flow Statement

The cash flow statement is a central component of corporate cash flow management. While it is often transparently reported to stakeholders on a quarterly basis, parts of it are usually maintained and tracked internally on a daily basis. The cash flow statement comprehensively records all of a business’s cash flows. It includes cash received from accounts receivables, cash paid to accounts payables, cash paid for investing, and cash paid for financing. The bottom line of the cash flow statement reports how much cash a company has readily available.

For the corporate, the cash flow statement is a central component of cash flow management. It is broken down into three parts: operating, investing, and financing. The operating portion of cash activities will vary based heavily on net working capital, which is reported on the cash flow statement as a company’s current assets minus current liabilities. The other two sections of the cash flow statement are somewhat more straight forward with cash inflows and outflows pertaining to investing and financing.

Internal Controls

There are many internal controls used to manage and ensure efficient business cash flows. Some of a company’s top cash flow considerations include the average length of time allotted to account receivables and payables, collection processes, write-offs for uncollected receivables, liquidity, and rates of return on cash equivalent investments, credit line management, and available operating cash levels. In general, cash flows pertaining to operating activities will be heavily focused on working capital, which is impacted by changes in accounts receivables and accounts payables. Investing and financing cash flows are usually considered “extraordinary” cash events that involve special funding procedures.

Working Capital

A company’s working capital is its current assets less current liabilities. Working capital balances are an important part of cash flow management because they show the amount of current assets a company has and needs, in order to cover its current liabilities. Companies strive to have current asset balances that exceed current liability balances. If current liabilities exceed current assets, a company would likely need to access and draw down its reserve credit lines for payables and meeting debt obligations.

In general working capital includes the following:

  • Current assets: cash, accounts receivable within one year, and stock that can be speedily sold and turned into cash
  • Current liabilities: all accounts payables due within one-year, short-term debt payments due within one year
  • Current assets less current liabilities; on the cash flow statement, companies usually report the change in working capital from one reporting period to the next, within the operating section of the cash flow statement. If the net change in working capital is positive, a company has increased its current assets available to cover current liabilities, which in turn increases total cash on the bottom line. If a net change in working capital is negative, a company has increased its current liabilities, which reduces its ability to pay them as efficiently. A negative net change in working capital reduces the total cash on the bottom line.

There are several things a company can do to improve both receivables and payables efficiency, ultimately leading to higher working capital, and better operating cash flow. Companies operating invoice billing can reduce days payable, or offer discounts to customers for quicker payments. Different methods of  Supply Chain Finance, International Factoring for example, and the more effective “Purchase to Pay/Order to Cash” tools are all available to assist in such scenarios. Innovative technologies that facilitate faster and easier payments such as automated billing, and front-end Electronic Banking facilities, are all useful. Companies may choose to make automated bill payments, or use direct payroll deposits to help improve payable cost efficiencies. The use of advanced technology by corporates for their supplier payments can also be used for “Repetitive Payments” with regards to such items as domestic and cross-border salaries, dividends, pensions and royalties.

The International Corporate Cash Management Products

Having now considered the main components that support cash management from a generic perspective, I now wish to consider the more sophisticated international corporate cash management products used in the corporate market. These are technically complex tools and take some understanding. Nevertheless, they are an essential tool for the multinationals whose subsidiaries across the globe sit in many geographical locations and disparate legal jurisdictions.

 The key products are:

  • Single Currency Pooling
  • Cross Currency Pooling
  • There are also Netting, Concentration, and Overlay services; but these are not dealt with in this article

The above “Pooling” products are considered the most advanced offerings currently, and as mentioned earlier; a basic knowledge of these products and supporting account structure is assumed for the purposes of the following detail.

The Single and Cross-Currency Pooling products are sophisticated and complex tools, which are often confused and misunderstood by both providers and users. Therefore, I will use this opportunity to discuss in detail these two services, which are crucial to all key corporate cash management requirements. Given my own professional experience in this area, I will look at this topic from the perspective of a US Bank in London, servicing US based multinational companies with subsidiaries overseas.

Single Currency Pooling

Single Currency Pooling is the notional off-setting of working capital debit and credit balances for accounts in the same currency, and same geographical location for interest purposes. The effect of pooling for the corporate customer is to maximise interest earned, or minimise interest expense, as it eliminates the debit and credit interest rate spread on balances. This means that pooling reduces the revenue that would have been earned by the bank had such a tool not been in place to service the customer.

Pooling is the vehicle used for managing the day to day liquidity needs of a corporate group’s related entities, given their account balances will vary on a daily basis. It is not a mechanism to facilitate any form of structured financing, and should never be sold on a “stand-alone” basis. It does not earn a revenue stream for the bank, but acts a defence mechanism on behalf of the corporate customer to achieve a sophisticated “cost-saving” end result for those accounts located at differing banks across one, or multiple jurisdictions; but for a single currency only. This is achieved by deploying a procedure of off-setting “matched” and “unmatched” balances across all participating accounts in the pool.

 Cross-Currency Pooling

This is a more sophisticated tool than the Single Currency Pooling mechanism, and is often known as: “Multicurrency Pooling” given the product deals with more than one currency. This product enables a corporate to manage effectively their working debit and credit balances across multiple currencies and geographical locations on behalf of its many subsidiaries, whom maintain current accounts “on the ground” in local jurisdictions, at the local “in-country” banks. The principles and benefits of the product are similar to Single Currency Pooling, except for the fact that cross-currency pooling allows for the essential FX notional converting of debit and credit currency balances (at the agreed FX spot rate) from the local “in-country” currency accounts, into the corporate’s “base currency”. This is then again followed by the subsequent “matching” and “unmatching” of individual long and short balances under the Single Currency Pool module in the corporate’s base currency. The “base currency” is the “home” currency of the corporate; as such, this is USD for a US Company, or GBP for a UK Company.

What is the Cash Management link to Operational Credit?

Since the fundamental principle of pooling is the notional combining (or co-mingling) of debit and credit balances, there will be a requirement for the bank to consider the appropriate credit approval internally for all the customer’s/corporate’s participating entities in the centrally held pool by way of overdrafts, which should and where possible “mirror” the local subsidiary accounts’ overdrafts at the “in-country” bank level. But it is important to note that: this will be subject to the pooling banks’ credit policy, which may differ substantially from the credit policy of the local banks; and therefore the size of overdrafts provided locally in country when compared to those required by the “mirrored” accounts held centrally in the pool. The information obtained from the customer for credit consideration here will need to differentiate between working capital needs, and longer-term requirements. This matter is significant and needs to be made clear to the Corporate Treasurer. This is because under a pooling arrangement, we are generally considering a corporate’s working capital management requirements of approximately three months out, and not any longer. Anything longer should be financed by alternative means.

Tax implications; local and cross-border

With pooling, there are often tax implications such as withholding tax if the local authorities in each of the subsidiaries’ jurisdictions closely scrutinise “short term off-setting” in the pool, and re-characterise this activity as “back-to-back” financing.

Please Note: Any corporate undertaking pooling with an international bank must always speak to their tax specialists, in order to obtain expert knowledge on this transactional activity, and any related impending tax issues.

From my professional experience, I would strongly suggest that it is incumbent upon the bank as the”pooling service provider” to confirm in writing as part of their pooling offer to the customer, that the latter must obtain tax advice on all pooling mechanisms used. It must be made clear to the corporate customer that although the bank is providing this cost-saving service, the bank is a bank; and not a tax specialist!

However, where a US Bank Holding Company is dealing with a US concern whose head-office and ultimate Parent Company reside in the US, but has subsidiaries in countries outside the US with a Shared Service Centre domiciled for example as a “Belgian Coordination Centre” – as just one of many options  – and whose “mirrored” accounts are held in the central pool, the bank should share what information it has about any tax implications with the corporate customer. This is especially relevant in the case of the “Deemed Dividend Rule”  for US Concerns, where such activity will be subject to IRS tax obligations. Therefore, in such circumstances, the general rule is that the US Parent should remain outside the pool. The Shared Service Centre should only be present in the central pool as owner of the “Master Account”, and in its role as overseeing the “mirrored” subsidiary accounts also in the central pool. If the US Parent Company for compliance and tax purposes is present in the pool, then the corporate customer will have to budget in advance for any “Deemed Dividend;” otherwise known for IRS tax purposes as: “sub-Part F Deemed Dividend.” However, such information and assistance is provided by the bank as guidance only, and should not be treated by the corporate customer as exhaustive. They should still seek their own corporate tax advice.

Accounts in the Pool

Generally there is no set time period for when working capital balances on current accounts become “structured finance”; it is a judgemental issue, and will depend upon the nature of the customer’s business, volume of cash, number of transactions and the nature of each, and the currencies passing through the corporate’s accounts. However, the aforementioned “three months” timescale, or thereabouts, is considered a good criterion in the industry to use.

Pooling, Credit Lines and Debt Obligations

The credit element is essential for the structure of the pool and the transactions to operate successfully in an environment that is free from all internal corporate’s financial impediments, and external obligations to other third parties. Without credit, there is no pool! The bank needs clear and complete assurances from the corporate customer that there are no covenants, loan structures, forms of collateral and particular indebtedness in existence with other banks, that will potentially prevent the corporate and its subsidiaries from participating in the proposed pooling structure.

Regulatory Capital and RAROC

Credit lines on each current account in the pool are no different from overdrafts, and carry the same balance sheet capital weighting as normal overdrafts; but generally, there will be a charge to the corporate customer for use or the bank’s balance sheet, which must exceed RAROC (i.e. the bank’s agreed internal “Risk Adjusted Return on Capital.”) This is a risk-based profitability measurement tool used for analysing risk-adjusted financial performance, and providing a consistent view of profitability across businesses. It is used to calculate return in relation to the level of risk taken on. It is also used to compare the performance of multiple investments with differing levels of risk exposure, and calculated by dividing the expected return by risk. As such, this metric essential internal information for the bank, and often known in the industry as “Hurdle Rate”.

For the purpose of banks being able to net assets and liabilities for regulatory capital needs; a bank can do this under the Bank of Settlement’s guidelines, irrespective of the legal jurisdiction of the subsidiary and account holding local bank. But it will need to ensure the following:

  • The customer signs the pooling contract giving the bank the right to “close-out” (i.e. off-set credit and debit balances)
  • The use of documentation requesting agreement with the corporate customer as regards “close-out” rights means that the need for cross-guarantees is superfluous, which makes life for both parties somewhat easier. What is needed is a Negative Pledge by the ultimate Parent Company in favour of the pooling bank, particularly when the debit balances in the final pool exceed the credit balances. This is paramount given that in this situation, the bank has incurred an unsecured overdraft on its balance sheet.

 Right of “Set-Off”

There is a principle under English Common Law which gives the bank the right to combine assets and liabilities of any same entity without specific legal documentation. The purpose of any pooling documentation is to achieve this objective across all of the corporate’s participating, and wholly owned entities and subsidiaries in the pool.

To undertake the above, it is critical that the accounts in the pool are all held in one central recognised legal jurisdiction, where the local regulatory environment allows for this “off-setting” procedure.  In spite of “Brexit” the City of London is still a significant global financial centre, and is one of the most flexible of all major centres across the globe, which permits this activity. For example; in London there are few encumbrances; there is no withholding tax, overdrafts are common, there are no lifting fees, there is no Central Bank Reserve, UK Common Law “Right of Set-Off exists, and there is no substantial differentiation in the treatment of a UK resident bank account, and a non-UK resident; and debit and credit interest are common place. As a result, the bank offering the pooling service should use its Balance Sheet in the appropriate location – in this example London – to hold the pool, and all participating pooled “mirrored” accounts.

Consider this example: should the Frankfurt subsidiary (locally in Frankfurt) be in financial difficulty, the pooling bank will want to have the right to hold the surplus cash in the Frankfurt entity’s “mirrored” account (held in the central pool in London) and thereby prevent the local entity’s Frankfurt legal team to attempt to take the funds from the pooled/mirrored account, in order to cover any obligations owing by the local Frankfurt entity to various German creditors.

Other issues

As I alluded to earlier, the overall “pooling and operational” details and workings are complex, given the regulatory elements that can impinge upon the pooling structure itself, and its beneficial effect to the customer.

However, there are more complex issues which need to be addressed and lie behind the pooling structure from a cross-border tax and regulatory perspective. These are too detailed and lengthy to explain here. But to assist, I have listed these issues below as an “aide memoir” and each item needs to be considered in absolute detail from the perspective of the bank (as a provider of the pooling service) and the corporate customer (as a beneficiary of the service). Some of these issues have been covered already, but are worth mentioning again due to their importance.

Here are the additional points to be considered:

  1. English Law to be applied to a pooling contract in all cases for London based participating accounts in the central pool
  2. Current EU Law may now have an influence here for those pooled subsidiaries who are non-Resident in the UK, even though they are based inside the EU and SEPA areas. Given the UK is leaving the EU, any previous “harmonisation” agreements may, or may not be applicable. This is especially true where the bank as a provider of the pooling service, will require proof that a participating pooled entity is acting intra-vires if domiciled in a non-EU Country and/or EU Country, where the latter’s adherence to EU Directives may also be an issue
  3. Let’s be clear; the ultimate test in (2) is: what is the UK’s position as regards a pooling operation in London for EU domiciled accounts, now that the UK will no longer be a member of the EU?
  4. The above operational activities have emphasised the use of legally constituted “close-out” agreements between the participants in the pool, as opposed to “cross-guarantees”. Both bank and corporate customer must look at this issue in detail with regards to a mutually acceptable way forward that would also meet regulatory approval, given the location of the central pool
  5. The latest tax detail should be obtained by both bank and corporate with regards to “Double Taxation Treaties” between the UK (if the pool is in London) and the home country of the participating entity, or subsidiary whose account is “mirrored” in the pool. This matter will cover credit interest earned and paid cross-border from the centrally pooled Master Account back to the “mirrored” subsidiary in the pool; and/or locally to the “in-country” bank account (FX rates accepted), and whether this movement of funds is treated as an inter-company loan. Please Note: debit and credit interest apply in the central pool as well as at the local “in-country” bank account level
  6. As mentioned earlier: for US Entities in particular; a pooling structure that involves funds being swept from accounts of foreign subsidiaries in to a Master Account owned by a US Parent could create a loan that the IRS would consider a “Deemed Dividend”. Tax specialist advice required
  7. The Bank of International Settlements view with regards to the use of “cash collateralised assets” for “matched” pooled balances held on the bank’s balance sheet in terms of capital adequacy, should be sought and confirmed
  8. The local relationship and “political” dialogue between the local subsidiary and the local “in-county” bank can become an issue. Credit may be offered to a level locally, that is not offered in the equivalent sum to the “mirrored” subsidiary in the pool, by the pooling bank. Credit policy of both institutions are likely to be different. Differences can arise if the local bank-subsidiary relationship is strong, and the local subsidiary’s cash manager has a good personal relationship with the local bank, and as such may “fight” head office in not wanting the majority on the subsidiary’s transactions to move to the “mirrored” account in the pool.  Meaning; potentially relinquishing or a “loosening” of the local and good “in country” bank-subsidiary relationship. An adverse relationship may then occur between the subsidiary and the local bank, should the latter feel it is indeed losing the day to day business transactions etc., to the pooling bank
  9. The points raised in (8) are all extremely sensitive, and internal discussions will be needed as part of a corporate customer’s global financial configuration and liquidity policy with all internal parties, subsidiaries locally based, and relevant personnel responsible for the local subsidiary’s treasury management activity. The local “inc-county” banks are also likely to be party to these discussion, once the overall Corporate Group Treasury policy has been unanimously agreed
  10. Re (9): this is likely to lead to a further discussion at the Corporate Shared Service/Treasury Centre on how to organise the daily working capital management payables and receivables. For example; will payments out be actioned at the local “in-country” bank account level, or directly from the “mirrored” accounts in the pool? The same thinking would apply to incoming cross-border  local credits. Should these flows credit the local accounts “in-county”, or those “mirrored” account in the central pool.
  11. Further matter such as the need for “arm’s length agreement” between the Group Treasurer as “overseer”of the central pool, and the local accounts, will also need to be considered re debit and credit interest charged and earned respectively by the participating “mirrored” accounts in the pool, as opposed to the subsidiary accounts at the local “in-country” banks.
  12. Re (11): agreement between the Group Treasurer overseeing the central pool, and the local accounts must encompass debit and credit interest charged and earned respectively by accounts in the pool, and the subsidiary accounts at the local “in-country” banks.

To conclude:

I mentioned at the beginning of this article that this topic is lengthy and complicated. I would emphasise again that the legal and tax requirements must be clarified at every level of the pool, well in advance of implementation. The documentation for both bank and corporate customer must reflect accurately all participants’ responsibilities in the overall pooling operation and account configuration.  However, given all the complexities, the fact remains that the sophisticated and financial benefits of pooling to the multinational corporate re costs, day to day liquidity across the global corporation, and the resultant streamlined accounts payables and receivables activity, are considerable; and should be emphasised and appreciated. As such, I trust these advantages can be seen and understood from this article.

Eliot Charles Heilpern                       6th June 2020

elioth@thepaymentsbusiness.com

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