Cash Management - The Mirage of One Country, One Bank, One Account

The introduction of the euro five years ago created a greenhouse for new global liquidity practices. Although many companies have adopted new regional treasury management practices, most companies, including many large organizations, continue to manage cash in Europe in discrete, country specific positions. A recent survey performed by PricewaterhouseCoopers disclosed that only slightly more than 30 per cent of all companies concentrate cash in Europe on a daily basis. Among those companies with revenues of $2bn or less, only 15 per cent have centralized the cash of their European entities.

Conceptually, the global treasurer’s problem is simple to fix – concentrate all the cash in one country with one bank and in one account. When cash has been gathered in this fashion, a corporate treasurer is prepared to manage cash efficiently and with optimal results. Yet, in some respects, the goal of one country, one bank, and one account is a mirage.

One Country

Beginning with the hard news, a corporation must re-position the cash of its subsidiaries and divisions in one country to make effective use of its working capital. Though some believe that merely re-positioning cash in one bank throughout various countries might work, there is one important hurdle. The recent consolidation of global banks and the creation of a common currency for Europe have not obviated the fact that each EU state retains its own central bank, which imposes capital requirements on banks regardless of whether they operate across these jurisdictional lines.

Imagine, for example, that Cash Rich, Inc. has €10m in the Paris branch of the United Bank of Europe but an overdraft of €7m in a Frankfurt account of the same bank. In a perfect world, the United Bank of Europe would simply pay interest on the net position of €3m. But the bank is unlikely to do so because it must set aside capital against the entire overdraft of €7m. Every overdraft in Germany represents an asset for which the bank must maintain capital, and the existence of the €10m balance in Paris is irrelevant to the central bank of Germany. The United Bank of Europe must satisfy the capital requirements imposed by the central bank of each country. The corporation might think that it has offsetting cash positions, but for the purposes of bank capital requirements, they are not offset. Consequently, to have a meaningful cash pool, a company must concentrate all of its cash, not just with a single bank, but also within a single country.

One Bank

Instinctively, a treasury manager might seek the support of a worldwide bank in an effort to behave as a more global treasury, a decision that might require a course correction for most companies. It is fairly typical of a global company to have at least as many banking relationships as the number of countries in which it does business. A simple litmus test of a company’s management of cash is the ratio of the number of its relationship banks to the number of countries in which it does business. If the ratio is less than one, the company has made progress toward global management. No one would seriously suggest that it makes sense to have more than one concentration bank for a region. The real question, however, is whether it makes sense to have more than one bank involved in the transfer of funds into the country chosen as the corporation’s central cash repository.

Option 1: Rely on Local Operating Banks and Local Financial Managers to Move Funds

It is very possible for a corporation to retain local operating banks in each country and instruct the local controllers to monitor in-country cash balances and then initiate the transfers to a central account in London, for example. This option is attractive because it is easy to implement and preserves the local banking relationships of the subsidiaries. Also, all of the operating services in which indigenous banks specialize continue to be available to the corporation.

A number of risks should be addressed before adopting this approach. First of all, the process is labour-intensive and not wholly reliable, as it requires day-to-day decisions by managers in multiple countries. And for the most part, the managers are likely to be controllers occupied with accounting rather than treasury objectives. Furthermore, the company may find itself vulnerable to the significant charges that banks often impose for cross-border transfers. Finally, someone on either the local or regional level needs to maintain reliable cash forecasts in order to determine when it is necessary to downstream funds to cover cash shortfalls.

Option 2: Rely on a Global Bank to Concentrate Funds

The alternative is to have a global or regional bank automatically sweep funds between local operating accounts in each country and concentration accounts in a central banking location, such as London, Amsterdam, Dublin or Frankfurt. If all of the in-country operating accounts are with a leading global bank, the local accounts can function as zero-balance accounts that are automatically drained or funded by one or more master accounts in a central location.

The major benefit of this arrangement is that cash can be moved on an automated basis, daily or weekly, and without intervention by a local controller. Idle pockets of cash in remote locations become a thing of the past. Furthermore, because the same bank will not only zero out the local accounts but also receive the funds at the other end (such as London), it will be inclined to forego or reduce the heavy fees associated with cross-border transfers.

A couple of factors cause some corporations to pause in the face of this option. First, banking is still, in many ways, a country-specific business because each country has its own customized clearing systems. Furthermore, over the course of the years, each subsidiary of a corporation establishes an allegiance to its local banks. A mid-western company that recently re-structured its European banking relationships was surprised by the level of local co-operation. When the finance managers from the subsidiaries in France, Germany and the UK participated in the meetings with the banks vying for the corporation’s business, these European managers took the lead in selecting a mutually acceptable bank without any feverish attempts to save their favoured local banks. The corporate treasury manager from the US took a backseat and observed as the European staff did their part to select a common European banking network.

One Account

Assuming that a company concentrates all of its cash with one bank in one country, it faces one final challenge: to treat the accumulated cash as a single cash position for the purpose of investing and borrowing. The tactic could be simple. If the funds for a region, such as Europe, are concentrated into a single master account, then a central treasury manager can manage the cash of that region as a single position. Certainly that is the common practice when a company manages the cash of various business units within the States. Outside of the US, however, this arrangement does not work so easily. If all of the foreign subsidiaries of a US corporation were to concentrate their cash into a single account in the name of the US parent, calamitous tax consequences would be likely to follow in the form of “deemed dividends”.

Consequently, the corporation needs to make a choice between managing the cash of each subsidiary independently – which creates operational inefficiencies – or possibly adopting a technique for overcoming the deemed dividend problem. If the latter approach is desired, the common solution is notional pooling, a technique that enables a company to cover the requirements of a “cash-poor” subsidiary with the funds of a “cash-rich” subsidiary without mixing their funds in the same bank account. The bank effectively positions itself as the lender to the cash-poor subs and the borrower from the cash rich, and the tax risk is minimized. This avoids the deemed dividend problem, but it is also a legally complex solution and a more expensive banking service.

The justification for notional pooling appears in the amounts of cash available and the degree to which there are offsetting cash positions-surpluses and deficits. The financial and tax circumstances of each corporation will dictate whether pooling is the best, and maybe only, alternative that the company enjoys. It is safe to say, however, that the funds available for concentration must measure at least a small multiple of €10m to justify notional pooling. Whether a company adopts zero balancing or notional pooling, each accomplishes the same objective – the creation of a single position that allows the company to treat its cash if it were in a single bank account. The issues raised here represent the basic and, in some ways, most challenging concepts facing the company that wants to create a global treasury. When positioning cash on a worldwide basis, companies should also consider in-country payment options, foreign exchange management, netting of inter-company payments, and the best location for a regional or global treasury staff, along with the other issues discussed above.

Copyright 2005 by the Association for Financial Professionals (AFP). Reproduction of this material is prohibited without prior permission by AFP. All rights reserved in all countries