Cross border Liquidity Management
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Centralising cash is one of the key priorities for treasury when managing liquidity. Concentrating cash in one location improves control and maximises the efficiency of a company’s liquidity. Treasury is better able to manage cash across a group of entities more effectively, offset surplus and deficit balances and reduce spreads paid to banks, resulting in savings for the organisation.
Liquidity management in this context refers to techniques such as sweeping/cash concentration, notional pooling, and interest optimisation. For some treasurers, liquidity management could also refer to investing the company’s excess cash.
Cash pooling can be done domestically, within the same or across-different banks, as well as across multiple markets, subject to local regulations. Companies with multi-location and multi-currency cash balances would typically prefer to concentrate and pool cash across regions and / or globally. The end goal for treasury is to obtain full visibility of their cash globally, and to be able to control their cash seamlessly and efficiently from a single location.
Generally, cross-border cash pooling is more complicated than domestic cash pooling as:
Market regulations on cross-border flows are often more onerous than on domestic flows,
Tax on cross-border flows can be more complex and costly,
Execution of cross-border payments is more difficult and costly, especially when it’s involving multiple-banks and
Multiple currencies, with respective restrictions, may be involved.
This article will discuss how each cross-border liquidity management solution works, and key considerations for treasury in this respect.
ZBA / Sweeping
Sweeping and Zero Balance Account is a popular tool for both domestic and cross-border liquidity management. Sweeping generates intercompany balances, rather than bank balances, and this has significant tax consequences especially for companies with cash across markets. However, with the more sophisticated tools recently adopted by banks, management and reporting of such inter-company balances with its associated interest yield can usually be automated.
The table below provides an overview of the requirements and considerations for domestic and cross-border sweep.
Requires intercompany loan agreements as well as bank sweep agreements
Requires intercompany loan agreements as well as bank sweep agreements
Most markets do not have domestic withholding tax for intercompany loan (1)
Most markets have withholding tax on cross-border interest payments for intercompany loan
Domestic payments are simpler, cheaper and have later cut-off timings for processing, when being executed within the same bank or financial institution.
Cross-border payments can potentially be more complicated due to the specific country and currency restrictions, are more costly to process and have earlier cut-off timings for processing when involving multiple banks.
1In China, VAT and stamp duty on intercompany loans apply.
From a tax perspective, domestic intercompany balances in most markets are not applicable for withholding tax and do not have complex income tax implications, especially where the entities are in a tax group. A ZBA becomes more complex in a cross-border scenario. Cross-border intercompany balances are, however, subject to withholding tax in many markets, and can have material income tax implications, including transfer pricing and BEPS (Base Erosion and Profit Sharing) as well as thin capitalisation issues, leading to non-deductibility of interest expenses.
Operationally, domestic sweeps is simpler, more efficient, and cheaper than cross-border sweeps. An important consideration in sweeping is whether the sweep is between branches of the same bank or between unrelated banks. Domestic sweeps within the same bank typically occur as part of the bank’s end-of-day closing process, and the sweep captures all funds and creates true zero balancing. In some cases, late or back-valued funds may not swept, however, these are normally compensated as funds are either back-valued, or interest is compensated.
Domestic sweeps between unrelated banks may not achieve 100% sweep effectiveness as the sweep will have to be processed through domestic clearing first, and before the clearing cut-off time. As a result, some last minute payments may be missed. Nonetheless, sweep effectiveness of domestic sweeps is generally high.
Cross border sweeping between different banks often has to occur before the local cut-off time so that the sweep flows can be executed through the clearing system, which means achieving a true end of day zero balance may not be possible. Nonetheless, cross-border sweeping is common and generally cost effective. Many international banks offer true end of day cross-border sweeping between their own branches.
Cross-border sweeping between unrelated banks are subject to less flexible cut-off times and have higher transaction costs. In scenarios where payments are cleared late in the day, sweep effectiveness can be as low as 50%. This means that the actual end-of-day balance of the account being swept may be as much as half of the daily collections.
Notional pooling is an arrangement whereby no funds are physically transferred, and notional pooling results in bank balances. Since there is no physical movement or commingling of funds, therefore the original beneficial ownership structure of balances is maintained.
Notional pooling comes in different forms:
Multi-entity, multi-currency notional pool
Single entity, multi-currency notional pool
Multi-entity, single-currency notional pool
Single entity, single currency notional pool
Operating entities typically need to hold bank accounts for their local currency in local markets to benefit from local low-value clearing, as well as to facilitate local collections. Companies can benefit from cost savings by making payments to local vendors in local currency, as opposed to making a cross-border payment to an offshore account.
While the maintenance of separate balances and ability to view cash as a single position clearly has its advantage, it imposes considerably greater due diligence and contractual documentation overheads than cash concentration. Matters such as right of set off and cross guarantees or indemnities must be thoroughly addressed in order to achieve balance optimisation that the notional pool is expected to deliver. Notional pooling is also permitted in fewer jurisdictions than cash concentration.
Since notional pooling can only be set up in one branch of a bank, cross-border notional pooling arrangements either use offshore accounts for participants outside the pool location or cross-border sweeps into the pool location – what is commonly called an overlay.
In this scenario, the company has a Treasury Centre in Singapore, and operating entities in Hong Kong and Indonesia. It is looking to set up a notional pool in Singapore.
With the notional pool overlay, both the Hong Kong and Indonesia entities will open an offshore USD account each in Singapore. These entities sweep the balance of its onshore USD account in their respective markets into the offshore USD account in Singapore.
The overlay arrangement might be:
Singapore Treasury Centre has USD account in pool in Singapore
Hong Kong entity has a USD operating account in Hong Kong (which is an onshore account) and sweeps the balance of its USD account in Hong Kong daily to its USD pool account in Singapore (which is an offshore account)
Indonesia entity has a USD operating account in Indonesia (which is an onshore account) and sweeps the balance of its USD account in Indonesia daily to its USD pool account in Singapore (which is an offshore account)
An advantage of the overlay arrangement is that the operating entity can continue to use its local onshore bank account. Many companies typically hold currencies in their location of origin wherever possible to avoid sweeping, reduce redundant bank accounts, and enjoy the latest possible bank processing cut off times, thereby optimising efficiency.
A disadvantage of the overlay arrangement for foreign currencies is that a cross-border sweep is required and consequently an extra bank account is required. Furthermore, if the onshore operating account is not with the same bank as the pooling bank, then the cross-border sweep is between unrelated banks and the cut-off time will be mid-afternoon, instead of at true end-of-day. This could result in substantial balances being left in the operating account and therefore cash is not pooled efficiently.
Where currencies are notionally pooled domestically across multiple entities (in multi-entity single currency pools), a designated account in each currency pool can be swept to a central multi-currency pool to achieve the desired single global balance.
From a currency perspective, this functions similar to an IHB (In-House Bank) with a multi-currency notional pool overlay. IHB results in one bank account per currency for the whole group, so there will be substantially less bank accounts in an IHB.
A growing number of treasurers leverage liquidity between entities via Balance Sharing arrangement. Balances are shared between notional pooling participants within the same or multiple currencies, essentially allowing an account to make payment beyond its own balance, without the need to set up intraday or overdraft limit agreements.
The benefits accrue to both local entities and to the Treasury Centre. Treasurer could enhance control when balance sharing is applied together with notional pooling or within cash concentration arrangements. Entities that are short of cash can draw down on a shared balance to fund working capital needs and reduce the need for external borrowing. Treasury retains visibility over the net cash position and can take a more strategic approach to analysing and addressing working capital needs at a regional or group level.
Even though a ZBA or notional pooling is in place to address overnight balances (either by physically sweeping or by notional offset), corporates may still be constrained by intraday limits. In other words, corporates may have insufficient funds to cover payments. This is normally addressed by intraday or daylight overdraft limits provided by banks.
Comparatively, the balance sharing solution is more flexible as each account in a group can make payments up to the combined net credit balances of other companies in the group. In this way, balance sharing maximises intraday flexibility for corporate groups.
IHB (In-House Bank)
An IHB is typically a cross-border liquidity management arrangement, but it is possible to do IHB within one market. The most common and effective arrangement for IHB is that the IHB has one bank account per currency, in the location of the currency.
The IHB makes payments and receives collections in one bank account on-behalf-of operating entities, both domestic and offshore. In this way, IHB minimises the number of bank accounts, thereby reducing costs and risks.
Furthermore, the IHB and all the entities it serves can benefit from the lower costs associated with domestic clearing, and later cut-off times that come with using an onshore account.
Many IHBs use a notional overlay to sweep funds from local accounts into a multi-currency notional pool (subject to local regulations and exchange controls) in a financial centre that is located conveniently for the group or headquarters. This results in a single, global balance that is available for investments; the primary goal of balance management.
Variations to the IHB include similar arrangements to the in-country notional pools, described above, where the group prefers not to process payments and collections on-behalf-of local entities. In these variations, even though payments/collections on-behalf-of is core to the IHB concept, most of the operational and processing benefits of IHB can be enjoyed with such arrangements.
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