Notional Cash Pooling: Examining Complexities

A few weeks ago we talked about physical cash pooling and the role it plays in cash management. This week, we’re going to take a look at the second kind of pooling. Notional cash pooling, a useful tool for optimizing interest and improving visibility, but one that comes with its own set of complexities.

With notional pooling, no money changes accounts. Instead, each participant maintains its own accounts, with the bank creating a “notional position”, or a sum of the account balances of all the participants. This consolidates the participant balances into a master account with a notional (or “virtual”) balance on which interest is paid/charged – eliminating the bid/ask spread of multiple account/bank relationships.

Since no money is transferred between accounts in a notional pool, there are no transfer fees to consider. Instead, the bank will charge a “management fee” for using their system to calculate the net balance of the Pool.

Note: In notional pooling schemes that allow the usage of the net cash position of all participating entities and accounts (sometimes called Dutch Notional Pooling) you have to negotiate the bid/ask rate including the spread for the FCY operations (e.g. calculating USD to EUR) that the bank applies to provide the net position to the central treasury.

Read more: Physical Cash Pooling: The Ins and Outs

Advantages of notional cash pooling

Offsetting of debt and credit positions

Since debt and credit positions are offset, there are lower interest expenses.

Reduced FX transactions

One of the key advantages of notional pooling comes from its effects on multicurrency transactions. A notional pool can be created from cross currency accounts brought to a common base, and then used to offset credits and debits, without the need for FX transactions by the organization itself. This can help reduce complex FX situations that can cause serious problems for companies with smaller treasury departments.

Things to consider with notional cash pooling

Regulation

Notional cash pooling creates tax issues in locations like Germany and the US, though banks sometimes provide offset arrangement for branches/sales offices of the same company – assuming they are not separate legal entities.

Meanwhile, Dodd-Frank and Basel III are tightening requirements on allowing banks to report net balances rather than gross balances. Due to this, some banks may need to have cross guarantees between participants, lest deficit balances from the pools participants count as assets on the bank’s balance sheet. Since the bank can’t earn interest on these assets (they’re notional after all), they may be seen as non-performing loans unless the bank has the right to offset.

Management fees from the bank may outweigh the interest savings

Notional cash pooling is complex to set up and manage. Some banks may only be willing to accommodate notional pooling for customers with large potentials; however, for some the management fees may offset any advantages from their interest savings.

Complications with external accounts

Providers also offer the choice to include external bank accounts in Notional Pooling Structures. Should you go for such a solution you must also consider fees for sending/receiving MT940/MT942 at least for the account holding bank. When you start using accounts outside your region, it is very likely that because of local operating hours the calculation of balances will not happen within the same day. This means that balances available to the central treasury can have value on D+1.

FX and Currencies

While there are definite advantages to using notional cash pooling across multiple currency accounts, doing so requires that all currencies are brought to a common base. This may make the process more problematic and cost-effective on the bank’s side. Banks may want to be compensated for the risk this creates, increasing their expenses, or offsetting with adjustments in the interest charged/paid.

Commitments of participating entities

In interest enhancement schemes it is relatively easy to break off participation in a notional cash pool, as no actual co-mingling of cash occurs.

In schemes where the balances of the participating entities are provided as a net position to the central treasury, it is necessary to check local regulations and insolvency laws to see if participation of entities is legally doable. If it is positively decided, a cancellation period normally applies.

Alternatives

Perhaps one of the best reasons that notional cash pooling is falling out of style is that many of the benefits simply aren’t needed in an era of Treasury Management Systems (TMSs). For example, a centralized treasury management system gives the same ability to calculate a notional amount, and instead of performing a notional conversion and eating the increased interest rates, you could use short-dated swaps. This can be handled in-company, giving better transparency over FX and interest rates.

Notional cash pooling seems elegant, with its notional accounts and clear separation of funds, but it’s not without complexity. Regulatory issues are increasing the controls required by banks, and in turn increasing their cost – sometimes to the point where notional pooling may no longer be an effective solution for treasuries to use or banks to offer.  As with all things in treasury, the devil is in the details and understanding the contexts that each company is dealing with will be crucial to getting the most out of this tool.

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