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Treasury Insights

Centralize Cash for Optimal Global Liquidity

If your company has multiple subsidiaries, you may want to consider revamping your liquidity strategy to consolidate your cash. Here are two options to consider—notional pooling and physical cash concentration.
Adrian Perez, Executive Director and Senior Liquidity Advisor, Commercial Banking
September 24, 2015

Continued global expansion by multinational corporations, as well as a complex and dynamic regulatory environment, has prompted businesses to implement new—or re-examine their current—liquidity management practices. In particular, businesses with multiple subsidiaries require a liquidity strategy that maximizes available cash while providing three main benefits:

  1. Visibility over cash positions, which allows for the efficient management of funding and investment needs
  2. Access to—and control over—cash flows and balances
  3. Opportunities to leverage tactics to reduce external funding and optimize yields on balances, depending on the amount, currency, and location
Centralize Cash Global Liquidity

And while your ideal liquidity structure must align with, among other factors, your company’s legal structure, culture (e.g. centralized vs. decentralized treasury) and strategic plans, most businesses with multiple subsidiaries can optimize global liquidity by adopting a structure that consolidates all available funds in a central location, notionally or physically.

Why Consolidated Cash Works

Why consolidate cash? The primary advantage is that it allows a company’s subsidiaries to borrow from one another to cover temporary deficits, which reduces borrowing costs on short-term debt.

For example, consider a company with two subsidiaries: a profitable East Coast subsidiary, which ended the day with a surplus of $1,000, and a fledgling West Coast subsidiary, which ran a deficit of $600. If the subsidiaries’ finances were kept completely separate, the West Coast office would be forced to cover its shortfall through external financing. Meanwhile, the East Coast would invest its surplus. Since the interest rate charged on external borrowings is much higher than the rate earned on deposits, on a consolidated basis, the parent company would unnecessarily be paying interest or overdraft charges, despite having a net surplus of $400. If the subsidiaries’ balances were instead consolidated, the company could use its internal funds, eliminating the need for external financing and saving considerably on interest expense.

Structure Matters

A solid liquidity strategy can do more than utilize a consolidated account to simply distribute cash to cover shortfalls and earn higher returns on excess balances. A consolidated account should be managed in a way that provides subsidiaries with ready access, while maintaining visibility and tight control over the flow of funds and ensuring a high level of transparency. A successful liquidity strategy will reflect the company’s organizational structure and the relative independence of its subsidiaries, rather than interfering with their day-to-day operations.

Here are a couple of options to consider, when it comes to structure.

Physical Pooling

The most straightforward strategy for consolidating cash flow, “physical pooling,” or physical cash concentration, results in a central account that holds surplus cash on behalf of the entire structure. At the end of each day, the participating subsidiaries “sweep” their excess cash into the central account. If a subsidiary runs a deficit, the central account will ensure that the subsidiary receives the required funds to cover the shortfall. The movement of funds across the respective legal entities is then reconciled from an accounting perspective as daily intercompany loans. 

For a company with centralized operational control, physical cash concentration has many advantages—the system of deposits and intercompany loans is highly transparent and relatively easy to control. Plus, automated controls can be put into place to track the intercompany loan positions, further improving transparency and efficiency. The structure also maximizes the company’s flexibility when investing the surplus balances that accumulate in the central account.

 

 

 

Centralize Cash Global Liquidity

 

 

 

But physical cash concentration can have its drawbacks. Transferring cash between subsidiaries may be much cheaper than borrowing from the bank, but it’s not entirely free, and the administrative costs of managing the structure should also be taken into consideration. Moreover, foreign currencies cannot be combined in a single account—they must be converted into a common currency or held in separate accounts, and some nations employ strict currency controls that can make the movement of funds difficult. The tax implications on intercompany loans can also vary greatly between jurisdictions, so companies should consult with their tax and legal advisors about the potential impact of any liquidity structure under consideration.

Physically consolidating accounts may also present difficulties for independently operated subsidiaries, especially if they are not wholly owned by the parent company. For example, if the East Coast subsidiary were a joint venture, its junior partner might object to a structure that shares balances with a wholly owned West Coast division.

Notional Pooling

Notional pooling is an alternative to physically moving cash balances. It’s designed to solve many of the issues facing traditional consolidation. Instead of transferring funds into a single consolidated account, the subsidiaries keep their operating cash in their own accounts. For purposes of calculating interest, however, the bank refers to a “notional” position that combines the separate accounts of each subsidiary into one net balance.

The greatest advantage of notional pooling is the elimination of intercompany loans; each participant keeps its own account and will not see the daily inflows or outflows from a central account. Additionally, in the case of a multicurrency notional pool, another key advantage is the ability to operate with multiple currencies, as participating subsidiaries have the ability to combine their various currency positions without having to convert those balances to a common currency for the sake of consolidation.

 

 

 

Centralize Cash Global Liquidity

 

 

 

That said, notional pooling does come with challenges and restrictions. Despite retaining a great deal of autonomy, subsidiaries must agree to jointly share liability for all incurred debts, which could be a sticking point for highly independent or jointly owned organizations, and some countries simply don’t allow it. Notional pooling is also not available in all jurisdictions (notably in the US) and typically comes under heavy scrutiny by regulators and tax authorities.

Choosing the Right Liquidity Strategy

The advantages of pooling operating cash are straightforward, but designing a cash pooling structure that optimizes global liquidity requires innumerable decisions about organizational autonomy, along with financial and accounting impact. The necessity of tight control over liquidity and yield optimization must be balanced with the costs and resources involved. And ultimately, multinational firms must weigh a variety of tax and regulatory considerations when considering implementing a liquidity structure.

 

Related Services

Liquidity Management

International Banking

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