Cash pooling – old hat or cutting-edge concept

This article looks at the latest innovations in cash pooling. Looking at the developments in recent years, what new solutions are being offered? We believe that every Treasury should regularly review whether its current cash pooling concept still corresponds to the current Treasury structure and whether the organization is fit for the future. More specifically, we are examining how a notional overlay structure actually works in practice.

Keeping on top of a company's overall liquidity is the most important task that treasurers are faced with daily. Therefore, many companies establish a cash pool, which ensures that liquidity is bundled within the company. While this creates transparency, it also reduces costs by optimizing interest rates, for example. As companies become more international, cash pooling structures can become highly complex. In this context, forms of structuring such as cross-border, cross-currency or cross-banking are crucial. As a result, treasurers are faced with challenges not only because of the different liquidity requirements of the individual group companies, but also because of the different countries, currencies and banking partners that need to be considered. Therefore, the question should often be asked: Can the existing cash pooling solution still serve the company's needs?

Essentially, there are three basic instruments for cash pooling:

• Virtual Accounts
• Physical cash pooling
• Notional cash pooling
  

Under certain conditions, virtual accounts are used as an instrument for efficient liquidity management. With virtual accounts, a single account number can be assigned to an individual customer or a product. The virtual account numbers, in turn, are tied to a real master account. Any incoming payments made to these virtual accounts are automatically reflected in the master account on file in real time. This allows liquidity to be managed centrally, provides intraday transparency of existing cash movements, and eliminates the need to balance accounts at the end of the day.

Physical cash pooling entails a physical transfer of funds between the bank accounts of the cash pool participants and the cash pool leader with the aim of pooling the free liquidity in a master account. The standard form of zero sweeping involves the daily central settlement of all accounts in the cash pool. But an individually defined target closing balance can also be parameterized in the form of target balancing. The clear advantage, however, is the physical concentration of liquidity in a central account with the possibility of making strategic investments and creating as much transparency as possible. This is offset by costs that can result from both internal loans and currency conversions.

Anyone who does not necessarily require a physical transaction on a master account, on the other hand, can use the instrument of notional cash pooling. Notional cash pooling consists of a purely virtual balancing of bank account balances with a view to increasing transparency and optimizing internal interest settlement. Optimization of interest rates is achieved by notionally offsetting the value date balances of the accounts. As there is no effective transfer of liquidity, there is no central provision of liquidity. Notional cash pooling is often used when a physical cash pool is not to be introduced or cannot be implemented due to legal regulations. In practice, notional cash pooling tends to be implemented separately per currency and used as an overlay structure.

In the market, notional cash pooling has so far been regarded as an established alternative to the physical variant. In contrast, multi-currency notional cash pooling has so far been offered by banks only sporadically. The underlying concept here is also a non-physical cash pool, with the difference that different currencies are included. The foreign currency holdings are virtually converted and aggregated to a balance in the desired local currency. The first step is to select an overlay bank partner. This does not necessarily have to be the company's own bank, as this service is offered only by specialized banks. Subsequently, the participating corporate entities are identified and either the pooled master accounts or all individual, relevant liquidity accounts per currency are mirrored in the infrastructure of the company's own overlay bank partners. These mirror accounts then reflect the cash pool of all relevant liquidity holdings, irrespective of the currency in which the cash holdings are denominated. This gives treasurers an overall view of the organization's liquidity within a banking infrastructure. By means of the managed mirror accounts, treasurers have an overview of all liquidity holdings immediately, regardless of where the liquidity is actually held. Finally, the overlay partner calculates a total virtual balance across all currencies. The conversion is based on the ECB fixing. By implication, this means that requirements in foreign currencies can be settled independently of the currency's current liquidity position. It allows the treasury organization to dispose of the desired amount in any agreed currency of its choice and to execute transactions. There is no physical transaction involved in this calculation of the total balance and the provision of all relevant currencies. As a result, there are also no conversion costs at master account level. The respective actual currency holdings remain unaffected. The advantage of this is that classic risks that occur, for example, in currency management for forex transactions are considerably reduced. It eliminates the need to hold specific currency pairs or analyze secondary currency pairs. As long as the technical possibilities are available, the virtual calculation process or account balancing can take place several times a day, thus providing treasurers with an up-to-date overall picture of the situation.

In this context, one must always ask whether and when which cash pooling method is worthwhile for the company organization. This largely depends on the individual business case. So, to determine the appropriate scenario for the business organization, parameters such as costs, fees, taxes, regulatory issues, the right bank partners with the appropriate banking services as well as volume of balances/transactions need to be considered. That is, the higher the balances that could be offset against each other and the higher the spread between borrowing and investing money, the greater the financial benefits of a cash pool. In this respect, multi-currency nominal pooling is attractive for companies that already have cash pooling in different currencies with substantial positive and negative balances that justify renewed interest netting.

Keeping an eye on a company’s overall liquidity is and remains a complex issue. Not only are corporate liquidity requirements constantly changing, but banks' cash pooling options and offerings are also evolving. This is why is it of utmost importance for treasurers to stay up to date on this topic so as to find the best possible cash pool solution for a resilient and future-proof treasury in this complex environment.