Regional Pooling in Central Europe - An Opportunity
Foreign investment in Central Europe has been on the rise for a number of years. The 1 May 2004 accession of 10 European countries to the European Union, and their adoption of the European legislative framework, has prompted many corporates to explore how to optimize their management in the region. Most limitations have been lifted on currency convertibility, on foreign currency holdings, on local currency accounts by non-resident entities and on import and export payments irrespective of the currency. As a next step in streamlining their treasury operations in the region, corporates are increasingly looking to optimise their flow and liquidity management through centralisation and the implementation of regional cash management structures. This article focuses on the commonly available options and points out some pitfalls and areas for consideration.
Relatively new concepts in liquidity management such as cash pooling, and especially cross-border and cross-currency cash pooling, are not yet commonplace as the legal and fiscal framework in Central Europe is rapidly changing and does not necessarily cover these structures.
Equally important, the existence of local currencies, and the implied foreign exchange transactions to off-set credit and debit balances across currencies, still constitute a barrier to implementing in Central Europe cross-border cash pooling structures that are as efficient as in the eurozone.
Both notional cross-border cash pooling and cross-border cash concentration (also referred to as zero-balancing) solutions are available in (most countries) in the region. When looking at cross-border cash pooling possibilities, several questions have to be looked into.
In cross-border zero-balancing, issues that have to be considered include:
The above considerations call for sound fiscal and legal advice before proceeding with the implementation. The complexity of these issues, in combination with the different local currencies, contributes to the limited success so far of cross-border zero-balancing within the region. However, there is a growing demand for such structures, mostly initiated by large international companies that have implemented similar structures in western Europe. Mostly, these corporates tend to zero-balance the local currency balances on a daily or periodic basis to their western European treasury centre.
Cross-border notional pooling on the contrary is much easier to implement. Genuine cross-border notional pooling yields exactly the same interest results as cross-border zero-balancing, which is not the case for cross-border interest enhancement systems that are offered by some banks. Cross-border notional pooling does not imply cross-border transactions, does not result in inter-company loans and the embedded administration and does not pose any fiscal or legal issues that have to be complied with. Moreover, it is usually less expensive compared to cross-border zero-balancing. The only issues a corporate has to consider when implementing a cross-border notional cash pooling structure are related to the cost of capital (on debit balances) and reserve requirements (on credit balances), if any. In most cases, these can be negotiated with the bank involved.
As cross-border notional cash pooling is easier to implement and to administer, this technique, which is offered by a number of major European Corporate banks, is currently more popular in the region.
1. Cross-border notional pooling structure
In the above example, the company has a centralised European treasury centre. The western European operating companies each have a local euro account for their day-to-day payments and collections. Similarly, the Central European operating companies each have a local currency account collections receipts as they do not need a euro account locally.
The European treasury centre manages the cross-border cross-currency notional cash pooling structure:
As all euro and foreign currency balances are fully compensated, both in western and in Central Europe, the group maximizes the interest result. There is no need for frequent (local) foreign exchange transactions and the notional pool structure avoids all inter-company administration and remuneration and implied withholding tax, double taxation and thin capitalisation issues.
2. Cross-border zero-balancing structure in euro
This Group has centralised its western European liquidity management but leaves foreign exchange management decentralised. The Central European operating companies have a local currency account for their day-to-day payments and collections and a local euro account. Excess liquidity is periodically transferred to the local euro account and liquidity shortfalls are funded out of the local euro account (both implying a foreign currency transaction). The local euro accounts as well as the euro accounts of the western European operating companies are daily zero-balanced to the master euro current account of the European treasury centre.
Advantages
This structure enables the group to centralise both its liquidity management and its euro credit facility. The foreign currency position is reduced and the Central European operating companies have no more need for a local currency credit facility.
3. Cross-currency cash pool on top of a cross-border zero-balancing structure
In this example, the group has a fully centralised treasury. The local operating companies, both in western and in Central Europe have an account in local currency for their day-to-day payments and collections. The balances in each country are daily zero-balanced to the master account in the same currency of the treasury centre. Finally, a notional cross-currency pool is positioned on top, including all euro and foreign currency accounts.
Full centralisation at the treasury centre of all euro and foreign currency liquidity of all operating companies of the group and of all credit facilities. Each operating company is assigned intra-day limits to enable the execution of payments. The treasury centre manages the foreign currency position through forward hedging operations.
At some point in the future, all Central European accession countries will introduce the euro as their home currency. However, this transition will hardly affect the above cash pooling structures as they can be seamlessly adapted to fully fledged euro cash pooling structures. Even a phased introduction of the euro in the respective accession states is no issue at all.
In the first example, the local cross-currency in each country will be discontinued upon the euro introduction. The local euro accounts are integrated in the cross-border notional euro pool. In the second structure, the periodic local foreign exchange transactions disappear. The local currency accounts will be closed and the euro accounts continue to be zero-balanced to the master euro account of the treasury centre. In the last case, the local currency accounts of the Central European operating companies will be converted to euro. The latter are cross-border zero-balanced to the master euro account of the treasury centre. The master foreign currency accounts of the treasury centre can be closed and the cross-currency pool is stopped.
The choice of the right cash pooling structure largely depends on the company policy, whereby the following key questions will drive the decision process:
As one of the largest banking institutions in Central Europe, the KBC group has a proven track record in providing regional liquidity management and corporate e-banking solutions and is well positioned to assist corporates in implementing customised cash management solutions that meet their requirement.