An Introduction to Cash Pooling Agreements
A cash pooling agreement is a contractual arrangement among corporate group members, typically groups of entities within a multinational enterprise ("MNE"), to manage and control their liquidity needs and financial resources. Its purpose is to control and maximise the level of group liquidity, in order to optimise the internal and external interest cost of the MNE. Cash pooling arrangements should be set out in a formal cash management agreement.
A cash pool involves the full and/or partial management of and/or access to the liquidity of the group. Cash pools can be ‘single tier’ (or ‘basic’), whereby the management of group liquidity is organised at a local level, or ‘double tier’ (or ‘master netting’) whereby the management of group liquidity is organised at a central level. A cash pool allows the incoming cash received by entities within the group to, essentially, be swept to a bank account for that the entity or group rather than being deposited with that entity’s own banker. This allows for the liquidity of the group and the interest costs of the group as a whole to be reduced.
Gathering the liquidity of a group under a cash pooling arrangement may, under normal circumstances, be expected to reduce the group and/or its members’ interest costs. Similarly, a case could be made that a cash pooling arrangement should be expected to lead to a lower overall interest rate charged for loans to and borrowings of the group and/or its members. Certain variations of cash pooling arrangements may involve one or more member (or external) counterparties to the arrangement. Depending on the particular arrangement, counterparties could include: the parent company; a subsidiary; a third party (for example, a bank or other financial institution) .
In order to facilitate the management of liquidity the pooling arrangements may be accompanied by services. Such services can include electronic banking, forecasting, cash concentration, interest set-off and interest payment services. The nature and volume of services will depend upon the pooling need of the group companies that are party to the pooling arrangements.
Certain providers of cash pooling arrangements may, from time to time, refer to their arrangements as cash management services, interest rate set off, interest treatment set off, cross currency interest rate set off, interest equalisation, liquidity management, global cash management, concentration services, cash concentration, zero balance accounting, general ledger accounting, sweeping or centralised cash management.
As stated above, a cash pooling arrangement is typically utilised by MNEs. Cash pooling arrangements may, however, be used by less complex corporate groups including those groups where the pool is managed locally. A cash pool may also be used to optimise both the internal and external interest cost of the group. Thus an ‘insider lender’ may lend internally to other entities within the group which may be paying interest on third party lending.
Groups may enter into cash pooling arrangements voluntarily and/or involuntarily; alternatively they may enter into arrangements as a requirement of a third party. In certain situations, MNEs are required to enter into cash pooling arrangements by third party banks, so as to enable the bank to lend more efficiently to corporate group members. For example, it could be a requirement of a MNE that is seeking financing, in order for the financing to be provided by a third party bank.
Categories of Cash Pooling
Cash pooling is divided into two categories: notional cash pooling and physical cash pooling. Each method has its own sets of advantages and disadvantages which must be taken into consideration when deciding whether or not to implement a cash pooling system.
Notional cash pooling transforms into a single bank account in a certain currency, the balances on all account balances of its sub-participants. Notional cash pooling is split into two different systems: balance compensation and interest compensation. The first system is commonly used by companies that use a single national currency in their financial accounting; the latter is typically used in international groups with balances established in more than one currency.
The advantages of a notional cash pooling system are relatively simple. It is easy to implement because it can be set up with the use of legal agreements; companies are not required to enter into complicated contracts with the banks involved. Notional cash pooling allows companies to transfer money to and from individual accounts without technical difficulties. Finally, pools can be set up quickly. Notional cash pooling systems can be altered as needed; for example, a company can ease out of the system when it finds it is unable to keep up with the demands of the global network.
However, while notional cash pooling is convenient, it is not flawless. Notional cash pooling limits the number of transactions a company can make through its global network. Similarly, notional account balances are not always calculated with 100 percent accuracy, which can affect the borrowing costs of the participants. If the system is not maintained properly, or if the documentation involved is flawed, a company might lose its notional pool after spending years developing it.
Physical cash pooling, on the other hand, gives the group companies involved the ability to restrict their cash into single bank account which then allows the bank to make short term investments with the funds. Physical cash pooling works over two basic models; the first model takes that the participating company does not own the funds they pool, rather the bank owns the funds but grants the companies a credit limit whenever they need to use the funds.
Physical cash pooling is quite versatile and can be used with any number of currencies. In contrast to notional cash pooling, physical cash pooling allows the participating companies to move money between accounts and countries faster, and to do so with more ease than notional cash pooling. Physical cash pooling also allows companies the luxury of having a greater degree of certainty when tracking the cash that moves between accounts, because no distinction is made between the individual account or the balance that is pooled. Companies have the ability to see how much money is used for investment or debt reduction and how much is available at a given point. Similarly, physical cash pooling is far easier to dissolve than a notional cash pooling, which is especially important for companies that operate in more than one country and are subject to multi-national law.
The disadvantages of physical cash pooling are similar to those of notional cash pooling. Because physical cash pooling creates an actual account, it may not be the right choice for companies that are wary of sharing their confidential financial data with a bank. Physical cash pooling also requires the companies involved to submit a number of legal documents. These documents are often scrutinized by the tax authority in each country where the company operates. Companies tend to find that physical cash pooling is not suited for their needs during their first settlement and reconciliation deadlines. This is especially true of smaller companies that either do not have the ability to invest large sums of money or are not willing to do so.
Advantages of Cash Pooling
The implementation of a cash pooling agreement often comes with several financial and operational benefits to the group and its entities. These include efficiency and sophistication in cash management, a reduction in borrowing costs, and a centralisation of control.
Cash management efficiency and sophistication
The cash pooling provider typically deploys a sophisticated algorithm for the calculation by the group’s financial institutions of each entity’s autonomous cash position and all-day exposure within the cash pooling arrangement. The cash pooling provider can also regularly adjust the terms of the cash pooling agreement to account for changes in market circumstances.
Borrowing cost reduction
Because the group’s collective cash position is higher with a cash pooling arrangement, the group benefits from a reduced interest margin payable to the cash pool provider. In addition, the mismatching of cash as described above can give rise to lower cost borrowings through only short term fund transfers between connected entities or by means of bilateral credit relationships between the cash pooling provider and the lending entities.
Centralisation of control
The cash pool provider provides the group with centralised control over all incoming and outgoing cash flows at the level of the cash pool. This may also provide greater visibility over the general liquidity of the cash pool entities, greater stability by preventing liquidity shocks, and greater netting possibilities for inter-company cash flows.
Drawbacks and Pitfalls
A potential concern relating to regulatory compliance is that the non-prefixing of dividends by the head office bank may trigger legal prejudices in relation to local taxation of the sub-banks in each of the jurisdictions where such sub-banks are located. This is a particularly acute issue in the context of withholding taxes applicable to dividends distributed by sub-banks to their head offices. The possible impact of these taxes, together with other local taxes that could be triggered as a result of a cash pool arrangement and may not have been considered in the design of the arrangement, should be considered by the companies involved.
Another potential concern relates to the nature of the security to be provided by the companies involved, especially if such companies are linked to each other within a group structure. To the extent the envisaged security for cash pool arrangements would create a ranking of creditors that is contrary to the legal principle of equal ranking (pari passu) among creditors of the same class or the legal principle of limited recourse, the risk of such principles being disregarded by local courts may need to be addressed.
Other areas of concern may include the impact of stamp duties, documentary taxes or transfer taxes on the cash pooling arrangements; the application of regulatory and/or central bank restrictions; and the risk of corporate authorisation requirements being disregarded by the courts in certain jurisdictions.
Legal and Regulatory Implications
Cash pooling arrangements can be structured so as to maximize the legal and tax efficiency of the group. However, in structuring cash pooling arrangements, it is important to carefully consider the relevant legal and regulatory issues which may arise.
Authorisation/Regulation
There are a number of regulatory issues which may arise in relation to cash pooling arrangements, including compliance with authorisation requirements. Where cash is swept into a centralised cash pool, this may enable the bank which acts as agent to hold large amounts of client cash within a single segregated account. This in itself may not necessarily raise specific regulatory issues. However, where interest is paid on the cash held within the account, such payment may trigger certain regulatory requirements, such as:
Out of court accounts: In addition to bank account requirements under the German laws, domestic regulation impacts the rules regarding the ‘genuine settlement of third-party funds’ measures. If such rules apply, a credit institution must obtain a permit from the German Federal Financial Supervisory Authority (BaFin) for any out of court agreements to manage accounts and control settlement payments. The bailiwick of BaFin includes supervising and regulating cash accounts managed by a third-party service provider for clients. This includes the management of trust accounts, estate accounts, escrow accounts, cash-pool accounts and compensation accounts. It is important to note that the handling of funds is associated with a high degree of risk. Any misuse of this type of account could result in misuse of liquidity and credit risks.
Banking Regulation
In Germany, banking services are subject to strict licensing and regulation. Banking may only be carried out in accordance with the German banking supervisory laws , which include the German Banking Act (Gesetz über das Kreditwesen (KWG). Certain non-banking services may require licensing or registration as investment services.
Legal Issues
Cross-border treasury transactions can give rise to a number of legal considerations. These include which law governs the cash pooling agreement, whether documents need to be notarised and registered and whether the cash pool is actually an agency, a joint venture or an account partnership (the latter having potentially serious financial implications).
International Considerations
Additional legal issues may arise where cash pooling arrangements are based in multiple jurisdictions. The EU Basic Principle of Home State Supervision requires that the financial stability of each Member State is safeguarded by ensuring that banks of its Home State operate under rules which are at least as strong as EU-wide minimum standards. However, under Article 47 of the Capital Requirements Directive (CRD), a Member State supervisor can require a bank to maintain additional capital or liquidity locally if the bank poses a risk to the financial stability of the Member State. In practice, this means that a cash pool may have to be "de-committed" if it proves a risk to financial stability. A risk may arise even where the central cash pool may pose no liquidity risk to a non-participating bank, as a participating shareholder in a bankrupt subsidiary of a non-participating bank.
Jurisdictional Issues
The law of England and Wales provides for the appointment of a supervisory officer with broad powers of supervision over parties to a cash pooling arrangement. These powers are supplemented by the powers of the court. The court may order a member of a group company to provide information to a supervisor or administrator. A bank therefore currently has a variety of means by which it can manage the group’s exposure to the home state supervisory authority’s enforcement process. However, as outlined above, there may be significant issues when dealing with non-UK domiciled companies.
Establishing a Cash Pooling Agreement
When establishing a cash pooling agreement, the preferred approach is to apply for an authorization from the National Bank of Belgium (NBB) so as to benefit from the provisions of the Cash Pooling Circular. Alternatively, in the absence of such an authorization, intra-group deposits are subject to the conditions set out in the Bank Act which may make the cash pooling arrangement less advantageous. The technical steps of setting up cash pooling are relatively straightforward and entail only limited contractual requirements. The central treasury offers documentation to the members of the cash pool to sign on joining the cash pool: the formal agreement between the members of the cash pool; the procedures along with the Terms and Conditions (i.e. the central treasury operating rules) of the cash pool; and the Master Encumbrance Agreement. The Master Encumbrance Agreement specifically governs the subordinated security rights over the cash pool balances of the members of the cash pool and the accounts held with the Central Banks. In fact, cash pooling arrangements may be structured in such a way as to reconcile the competing interests of a) security granted in favour of the lender or central treasury and, b) the requirements of the companies to withdraw, spend and/or invest the cash pool balances. Credit institutions must also enter into a secured cash pooling agreement and possibly with several credit institutions at the same time. Under the latest revisions to the Law on Security Interests, this will be subject to a registration requirement and potentially a prohibition on the disposition of the property for the duration of the security right. Under the Cash Pooling Circular and the relevant contractual documentation, the central treasury of the cash pool is tasked with managing the incoming/outgoing payments of members. It will monitor the overall interest paid/received by the members of the cash pool and may withhold any profits from the liquidation of the cash pool (after payment of relevant expenses), thus guaranteeing that members of the cash pool only experience limited netting costs. The central treasury will also generally be responsible for providing the regulatory documentation necessary to comply with all relevant reporting obligations (e.g., tax, notification, etc.) in the countries concerned. The central treasury is not a bank or credit institution, nor any type of regulated financial services provider offering its services to the public. It is not authorized to carry out any other activity other than the management of the cash pool and the discharge of its obligations thereunder. As such, the central treasury must not be qualified as (or deemed to operate as) a financial institution for the purposes of Belgian law. Numerous major banks and other financial institutions administer cash pools in this manner (i.e., as a central treasury) in Belgium.
Exemplars and Insights
The successful implementation of cash pooling agreements can be illustrated through several real-world examples and case studies. By exploring how companies have navigated this process, we can gain valuable insights into the practical aspects of cash pooling.
Company A: A Multinational Corporation
A large multinational corporation operating in various jurisdictions across Europe and Asia implemented a cash management solution utilizing notional cash pooling. The group’s treasury team worked closely with external legal advisors to ensure that the legal structure of the pooling arrangement complied with the different regulations and maximized the synergies of their cash positions. The treasury team was heavily involved in the design phase of the project, outlining the strategic goals and assessing the potential impact of the solution on the cash flow of the entire group.
Company B: A Manufacturing Group
A manufacturing conglomerate with operational facilities in multiple countries sought to optimize its cash position and minimize idle cash reserves. The treasury department conducted a thorough analysis of cash flow patterns before designing a cash management system that involved physical cash pooling. The pooling structure consolidated the organization’s cash balances into a single, centralized pool under the control of the corporate treasurer. The implementation of the cash pooling agreement resulted in significant savings for the group in terms of interest expense and utilization of excess cash for investments.
Key Takeaways and Lessons Learned
The successful implementation of cash pooling agreements requires careful planning and consideration of each group’s unique circumstances. Some of the key takeaways and lessons learned from the examples above include:
- Strategic Alignment: Treasury must work closely with the organization’s strategy to ensure that the cash management structure aligns with its short- and long-term goals and objectives.
- Legal Considerations: Compliance with local laws and regulations is a critical factor in the implementation of cash pooling. Consultations with legal and regulatory experts are highly recommended.
- Clear Documentation: Clearly documented policies and procedures are essential for ensuring the effectiveness of the cash pool and facilitating its day-to-day operations.
- Regular Review: Consistent evaluations of the cash pooling arrangement will help verify its effectiveness and identify areas for improvement.
Emerging Issues in Cash Pooling
New Fintech Solutions: Digital Platforms and Enhanced Cash Liquidity Management
The world of cash pooling is expanding, with advances in technology and the introduction of fintech players introducing new possibilities that add efficiency to these arrangements. Just as retailers find new ways to attract customers into brick-and-mortar locations, it is an obvious step for banks and financial service providers to attract and retain those deposits.
The opening of cash pooling to a wider group of participants (through the establishment of bank neutral accounts and other similar arrangements) has further reshaped the cash pooling landscape, allowing any participant – whether it is an independent company required to comply with local IS standards , or a bank providing a cash pool in jurisdictions where a bank-neutral account is not an option – to take advantage of opportunities to consolidate currencies and reduce overall interest costs. Indeed, as banks are increasingly using online platforms such as Payment Service Providers (PSPs), further opportunities arise for smaller players.
More recently, advances in communication technology have made it possible to develop digital solutions for cash pooling, such as MNC payments, a solution introduced in France by The NedBank, which grants a banking certificate or letter stating that the signer has an account with MNC.
Although there are a few potential downsides associated with the use of cash pools, these risks are outweighed by commercial benefits. Cash pooling is here to stay.