Liquidity Management Techniques Pooling and Cash Concentration

Liquidity Management Having funds available to meet all known and unknown commitments In the right currency In the right place At the right time Minimise cost of funds and debit interest Maximise use of surplus funds and interest earnings

Liquidity Management As always a balance between the costs and benefits of having liquidity and the costs and benefits of lacking liquidity

Liquidity Management How may a company improve liquidity? External Through borrowing Through suppliers Internal Better practices on inventory, receivables short term investment Better control of cash resources around the group

Liquidity Management Focusing on maximising Internal liquidity utilising existing but wasted resources Pooling / Cash Concentration First: Notional Pooling

Notional Pooling With Notional Pooling there is no actual movement of funds. With Notional Pooling there is no co-mingling of funds Credit balances are offset against debit balances and the net is used to work out the debit or credit interest paid or received Also referred to as ‘interest offset pooling’

Notional Pooling Position prior to pooling Average Balance Average Balance + 900,000 + 350,000 Average Balance Average Balance - 300,000 - 550,000 Credit interest at 4 % = 1,250,000 x .04 = 50,000 Debit interest at 6 % = 850,000 x .06 = 51,000 Net cost to group = - 1,000 But if notionally pooled Sub 1 Sub 2 Sub 3 Sub 4

Notional Pooling Position if pooled Average Balance Average Balance + 900 + 350 Average Balance Average Balance - 300 - 550 Net position = + 400,000 So 400,000 x .04 = 16,000 an improvement of 17,000 Sub 1 Sub 2 Sub 4 Sub 3

Notional Pooling Benefits Maximise interest earned Minimise interest paid by As much as possible, for as long as possible, in one place

Notional Pooling Taking Advantage Tiered Interest Rate Structure 8 Interest 7 Rates 6 5 4 3 0 50 100 200 300 400 Balance in 000’s

Stepped versus Banded Amount in GBP Interest Rate 1 to 250,000 0.10 0.20 500,001 to 1,000,000 0.50 Over 1,000,000 0.90 Company Balance Tier Interest rate Interest A 355,000 250,000 .001 250   105,000 .002 210 B 400,000 150,000 300 C Total 1,260 Pooled 1,005,000 .009 9,045 Benefit 7,785

Notional Pooling Benefits Improves the balance sheet by offsetting surplus balances against group debt Reduces and may eliminate short term borrowing (will probably still need credit lines as back up with limits on individual subs) Reduces overall exposure to banks

Notional Pooling Benefits May improve internal discipline and control Do not have to move funds - reduce costs of transfers - reduce management time

Notional Pooling Requirements Pooling agreement Cross guarantees Legal right of set off Tax indemnity Ability to link accounts for interest calculations. Obvious, but not every bank will have the capability Interest apportionment Board resolutions

Notional Pooling Issues Bank charges Resident non-resident issues Tax issues (arms length) May be treated as a form of lending with no transfer of funds ownership Interest offered may be low / or charged high, so Treasury may wish to actively place funds or borrow

Notional Pooling Active Management Investment of 400,000 Sub 1 + 800 Sub 2 + 700 Sub 3 - 200 Sub 4 - 900 T + 400

Types of notional Pooling Single currency, single country Single currency, cross border Multi-currency, single country Multi-currency, cross border What is possible? What is offered? What does it cost the bank?

How Banks Charge for Pooling Interest rate spread Reserve asset charge (cost recovery) Set up fee Management fee (monthly per account) Interest apportionment fee Account maintenance fees Electronic reporting fee Money movements, receipts/payments FX if involved

Pooling Due diligence Is pooling permitted? Tax issues Withholding tax – Res/non Res issues Arms length rule Is debit interest an allowable deduction? Is thin capitalisation an issue? Location?

Pooling Due diligence How do laws of offset relate to Multi entities? Multi currencies? Cross border aspects? How does the bank cover? Are cross–guarantees necessary? Are Central Bank reserve ratios calculated gross or net?

Pooling Due Diligence Impact on group of using one bank Should all operational accounts be included in the pool? Impact of cut-off times for movement in and out of pools Value dating practices for cross border movements into and out of the pool.

Cash concentration Sometimes Notional Pooling is not possible or not wanted Rules and regulations Structure of banking industry Legal issues Then we may have to cash concentrate i.e. physically move the funds to attain the same benefits.

Cash concentration Example of Zero Balance Cash concentration End of day 750 invested Sub 1 + 350 Sub 2 +500 Sub 3 +550 Sub 4 - 650 Concentration a/c

Cash Concentration There are various forms of cash concentration Zero balance, as illustrated Target balance, to keep a specific amount in each account Threshold, to move funds only when an account moves in excess of a figure Collar, when a threshold is reached, funds are moved but a balance is left

Cash Concentration All will depend on the costs involved versus the needs of the group elsewhere, the sums involved and the overall treasury objective

Cash Concentration Issues Drawbacks Transfers may have to be done manually Will involve transfer fees Transfers to/from non resident ac’s may add to central bank reporting and to cost Local rules and regulations may prohibit/complicate cross border movements

Cash Concentration Using MT101 to concentrate Customer Instruction Advice Lead Bank MT101 MT103 MT101 MT103 Sending bank Credit customer concentration account Debit sending bank nostro SWIFT Network Debit customer ac Credit vostro ac

Liquidity Management Interest Enhancement As mentioned earlier, sometimes rules and regulations make cash concentration and cash pooling difficult, uneconomic or illegal Nonetheless, Banks have developed ways to enable companies to gain some benefit from their balances The banks recognise that the balances they hold, even where blocked, are reflected on their balance sheet and therefore of value

Liquidity Management Interest Enhancement Suppose that the bank will normally charge interest on deficits at LIBOR plus ½ and pay on surpluses at LIBID – ½ To the extent that balances offset each other the bank will adjust these rates E.g. Account No 1 has a surplus balance of GBP 100 and account No 2 a deficit of GBP 50.

Liquidity Management Interest Enhancement There is an offset of 50% so They would charge interest at, say, Libor plus1/4 And pay interest at LIBID – 1/4