A recent well-attended seminar held in the Netherlands and jointly organised by Orchard Finance Consultants and ABN AMRO invited guest speakers and panel members to share their interpretation of the impact that the Basel III capital adequacy regime is having on notional cash pooling, which has been used by many companies.
There are a number of summaries of what notional pooling consists of: this is the one offered by the UK’s Association of Corporate Treasurers (ACT):
“Notional pooling means companies can minimise their overdraft interest while retaining local autonomy. Bank account balances within a notional pool are offset against one another and interest is paid (or earned) on the net balance.”
The Orchard-ABN AMRO seminar was attended by key personnel from both groups, as well as various corporates, a law firm and De Nederlandsche Bank (DNB) – the Dutch Central Bank – with the aim of building bridges between the different market participants. Representatives from both banks explained their interpretation of Basel III’s impact on notional cash pooling, corporates provided insights into how their corporate treasury managed the uncertainty created by Basel III in their bank migration process and the session concluded with guest speakers forming a panel to discuss the topic with attendants.
Notional pooling is a cash management technique offered by banks, which is commonly used in a number of countries including the Netherlands due to its simplicity. Cash pooling is a common practice to ensure that the corporate group’s liquidity is visible, readily available and earns an adequate return. The main goal is to get full control of cash balances and to offset debit and credit balances of all accounts in the pool. Its main advantage is that it achieves an optimised interest income or expense as interest is charged or credited on the resulting net balance, reducing overall financing costs.
Notional cash pooling virtually offsets positive and negative positions of different accounts within a group without actually transferring cash, allowing the subsidiaries to remain autonomous in their daily cash management. However, the practice has come under pressure as the Basel III regulation starts to make its mark on the banking sector. This pooling technique is threatened by the stricter capital and liquidity requirements under Basel III, impacting the outstanding balances within a notional cash pool, implying that banks will have to carry more liquidity and capital on their balance sheet to cover the notional pool.
Various media have carried a range on different opinions on the future of notional pooling. A number of commentators believe that nothing will change and other, more pessimistic individuals suggest that the technique will cease to exist.
Discussions between the different stakeholders at the seminar provided new insights and confirmed that notional pooling is not going to disappear in the Netherlands. According to the DNB the legal interpretation of Basel III’s requirements will be strict, because the regime is implemented in the European Union (EU) through the Capital Requirements Regulation and Directive (CRR/CRD IV). Basel III states that credit and debit balances are not allowed to be offset; not even within a single entity cash management structure for the calculation of the leverage ratio. Moreover, under the liquidity ratio (LCR), banks cannot apply netting of the positions in a notional cash pool, as credit positions are seen as funds that can ‘run-off’ in a stress scenario.
This rigid interpretation can have a significant impact on the notional cash pooling offering of different banks, according to ABN AMRO’s experts. Whether banks will be able to support the specific needs of a corporate depends on the business profile of the individual bank. The different Basel III ratios are affected differently by the different products offered by banks and the (risk) profile of their corporate clients. This implies that those banks which, to a large extent, rely on cash management need to define additional measures to manage their liquidity and leverage ratios.
Other banks, which may have a more diversified portfolio, could take a more holistic view. These will offer a pooling product, taking into account other services as well. Moreover, some banks – such as those in North America – did not apply netting before Basel III and hence have not been feeling the burden now imposed. Also, for UK banks, the implementation of CRD IV and CRR is of lesser impact as these do not differ greatly from that already imposed by that country’s financial regulation – meaning that UK notional cash pooling practices were already in line with regulation in terms of documentation and offsetting.
According to company treasurers and others at the seminar, the impact of Basel III should definitely be an issue on the corporate agenda. The effect should not be underestimated and it can be a driver for change and efficiency. When corporates decide to change their cash management structure they should deliberately take into account the foreseen impact of Basel III and ask different banks about future scenarios.
It is widely expected that notional cash pooling is likely to increase in price – or will be more difficult to implement due to stricter requirements by banks over coming years – so corporates should be aware of developments in the market and need to consider their options. There are several possibilities such as a zero-balance cash pool, while a further alternative that is often referred to is a virtual account structure.
A call to action
In contrast to last year’s retreat by Royal Bank of Scotland (RBS), which decided to wind down its non-UK and Western Europe cash management services, regulation regarding notional pooling does not appear to call for immediate action as tightened regulation only comes into full force from the start of 2018. As a result, most treasurers have adopted a passive position.
However rather than waiting and being mesmerised by the headlines treasurers should adopt a more active stance – bearing in mind that banks are already anticipating and responding to the higher capital and liquidity targets.
As a result, costs have already started to move higher. Treasurers should reconsider their bank account structure now, as at some point in time between now and 2018 the resources to change that structure will become scarce on the banks’ side. Once that happens the corporate treasurer will find that the resource issues of the bank has become his or her issue as well – and solving issues normally comes at a cost.
*Femke Baum and Esther Goemans-Verkleij, both finance and corporate treasury consultants at Orchard Finance, also contributed to this report.