Assaulted by the bombardment of new financial regulations capital, liquidity, due diligence banks and corporate treasurers have barely begun to ponder the impact of Basel III and new accounting norms on an esoteric, but useful, liquidity management technique known as notional pooling. It allows corporations to improve their interest income or reduce interest charges across a number of accounts by asking the bank to offset the balances against each other and apply an interest rate to the net balance. Unlike physical cash pooling, in which cash from participating accounts is swept into a header account, notional pooling does not involve the physical movement of cash. As such, notional pooling has some advantages over cash pooling. For one thing, it can be carried out in some jurisdictions that do not permit cash pooling. For another, it enables subsidiaries to maintain control over their cash balances and avoids the co-mingling of funds. Notional pooling does not result in inter-company loans and might be less expensive than physical pooling. However, it does have some drawbacks. In some cases it is necessary to establish a legal right of offset, such that if one of the subsidiaries in the notional pool goes bankrupt, the shortfall will be covered by other participants. To achieve this right of offset, participants within the pool might be required to sign cross guarantees, which some might be unwilling to do. Even if companies are willing to agree to these terms, some countries do not allow notional pooling, such as India and Brazil. In other jurisdictions this is a popular technique. Research published by JPMorgan Asset Management in 2011 found that 43% of respondents use notional pooling, either on its own or in combination with zero or target balancing both of which are forms of physical cash pooling. For European respondents, the figure was more than 50% and two thirds of those treasurers cited retaining local treasury control/transparency for subsidiaries as a main driver. Notional pooling has become more attractive in recent years in 2010, JPMorgans research found that this structure was used on its own or in combination with zero balancing by only 37% of respondents. However, regulatory considerations could have a substantial impact on the way in which notional pooling can be used. Basel III bite The arrival of Basel III is likely to place further pressure on the viability of notional pooling. Under Basel III, liquidity ratios for banks do not necessarily allow outstanding balances within a notional pool to be netted, which means that ratios might have to be calculated based on the gross value of the balances. Such an outcome would mean that banks have to carry more liquidity on their balance sheet to cover the notional pool. Its still up in the air as to whether the effects of the Basel III capital requirements will affect notional pooling, and whether or not banks will continue to offer this product, says David Kelin, partner at treasury consultancy Zanders. It could potentially end up costing banks more to provide notional pooling under Basel III the question is whether it will still be worthwhile offering it then.
The issues relating to notional pooling are not new. Bas Rebel, senior director treasury advisory at PwC, says that under accounting standard IAS 32 (Financial Instruments: Presentation), released in 2005, positions cannot be netted unless the company has a legal right of offset and can demonstrate on a periodic basis that an offset has taken place.
The banks and corporates found an acceptable workaround to continue notional pooling, says Rebel.
This workaround involves periodically sweeping cash into one account and then back again a few seconds later to demonstrate that netting has taken place.
Rebel says that despite the legal issues associated with this interpretation, banks have continued to offer notional pooling and have been reluctant to adjust their pricing for commercial reasons.
However, Rebel adds that under Basel III the way in which offsetting is allowed is worded in a similar way to in IAS 32, which is likely to resurrect the issue and that the outcome is likely to be different today because banks have become more comfortable with adjusting pricing in the current economic climate.
As a result, Rebel believes that when Basel III comes into effect banks will price notional pooling out of reach.
Another possibility is that banks might become more selective about offering notional pooling and might only offer this solution to certain types of client.
If notional pooling does become more expensive, the companies already using this solution might find they need to rethink their cash-management structures. In some cases companies might be able to adopt physical cash pooling instead, although cash pooling is not permitted in all jurisdictions.
For companies using notional pooling this issue will need to be addressed at some point. However, Rebel says while there is some awareness among banks of this issue, corporate awareness is limited not least because treasurers have their hands full with more pressing regulatory concerns in the form of Sepa compliance.
|Bas Rebel, senior director treasury advisory at PwC|