Pooling Arrangement Seen as Solution for Trapped Cash
Understanding the proportion of cash that resides outside an issuer’s cash pooling network provides an insight into trapped cash, according to Fitch Ratings. The credit rating agency (CRA) says that cash situated in a pooling arrangement offers a quick pre-arranged channel for redistributing cash around a group.
These balances are considered freely and readily accessible for immediate parent liquidity requirements and can be offset against debt in net debt metrics. Normally, cash located in joint ventures and emerging market subsidiaries are not part of an issuer’s cash pooling network. Consequently, these cash balances may not be readily available in a liquidity shock scenario should urgent repatriation of funds to the parent be required.
“Typically, cash balances domiciled outside a company’s cash pooling network of subsidiaries may be considered trapped from a group liquidity perspective,” said Anil Jhangiani, director in Fitch’s European corporate finance team. “Europe, Middle East and Africa [EMEA] corporates with cash-rich subsidiaries may face costly withholding tax and even capital controls in a number of emerging markets where cash pooling is not feasible.”
The CRA says that benefits to corporates of cash pooling are widely accepted, notably facilitating inter-group liquidity, reducing negative carry and reducing the need for foreign exchange (FX) hedging through the sharing of multicurrency facilities. Cash pooling can often compensate external subsidiary funding requirements when local banking markets are under stress with parent companies channelling excess internal liquidity to weaker subsidiaries.
However, there are complex tax and varying jurisdictional issues to be taken into account when moving cash around a group structure. Typically these are addressed when a cash pool is implemented. Subsidiaries that belong to the group cash pooling network have therefore passed a series of tax and legal considerations. Fitch says that cash balances corresponding to subsidiaries not within a cash pooling arrangement can therefore be considered partially trapped, as they have likely been left out of the pooling arrangement due to detrimental tax and capital control rules.
Understanding the proportion of consolidated cash within a cash pooling network provides a proxy for freely and readily available cash. Taxation can become costly when considering repatriation of funds. However, most importantly from a group liquidity perspective, this can be a timely process.
Fitch concludes that as EMEA issuers increasingly focus growth on emerging markets, and cash accumulation at the subsidiary level increases, the greater the proportion of potentially trapped cash on balance sheet becomes. Furthermore, leakage of cash flow to local tax authorities upon repatriation becomes a consideration for those entities with large emerging market exposures.