January 18, 2024
Will interest rates continue to rise over the coming years, or will they hold steady or even decrease? That’s a question that’s been top of mind for CFOs as a new fiscal year begins for many organizations.
While rising interest rates over the past two years drew global attention to the need for more effective liquidity management, liquidity should be paramount for all corporates, regardless of economic conditions. As the Association of Financial Professionals (AFP) puts it, liquidity is “integral to the day-to-day life of an organization, as it informs critical decisions such as whether or not to invest in an expansion or new project, or whether or not a lender will grant your organization a loan.”
Treasurers need to know their company’s cash position to be able to react to any immediate needs and plan ahead for the future. This includes cash reserves, assets, investments, liabilities, spending, and billing, encompassing both short-term turnaround and the time needed for any longer-term liquidation of fixed assets such as property and equipment. Many organizations were caught unprepared when the pandemic hit, and did not have the wherewithal — the liquidity — to get through the extended disruption in access to funding.
Many corporations use cash pooling to increase the effectiveness of their liquidity management and gain the transparency into operations that the business and its shareholders or stakeholders require.
What Is Cash Pooling?
Cash pooling is one method any corporation with subsidiaries, or groups of linked companies, can use to optimize interest rates and thereby reduce costs. Cash pooling allows the organization to share surplus cash generated by one portion of the business with another group entity or entities that need funds — effectively balancing out money across the greater organization.
In physical cash pooling, funds are moved from one bank to another. They are physically consolidated in one location.
Notional cash pooling involves virtual balancing of bank account balances. While allowed in most European countries, notional cash pooling is not allowed in the United States.
In the US, account sweeping, also known as zero-balance accounts (ZBA), is more common. Banks transfer (sweep) funds at the close of business each day from the corporate’s various operating accounts to a designated master account.
The Challenges of Cash Pooling
Consolidation of cash in one place (whether physically or notionally), vs. having it spread across multiple, individual accounts, improves liquidity management and can increase interest yields while reducing the need for external funding.
However, managing cash pooling structures in a global, multibanking environment can quickly become challenging. Multiple currencies, banks, FX rates for international transactions, plus ever-evolving tax and regulatory requirements make management highly complex and time-consuming.
Tax and regulatory requirements are especially important to note. As previously mentioned, notional cash pooling is not an option in the US. In addition, some countries restrict notional cash pooling to wholly-owned subsidiaries, while others disallow accounts located in other countries.
Organizations need to ensure their cash pooling structures are set up and managed transparently, with all transactions documented to provide a clear audit trail if needed.
Preparing for the Future
In December, the European Central Bank (ECB) announced it was holding interest rates and expects inflation to decline over the course of 2024. And the U.S. Federal Reserve held rates steady, predicting the likelihood of future reductions. However, with global uncertainty, commodity prices that remain high, and a general slowdown in the economy, there’s no guarantee how long this period of stability will last.
Corporates can elect to create cash pooling structures in house, use those provided by banks (although only a handful offer global cash pooling), or use third-party pooling services offered by treasury management providers or treasury aggregators.
It pays to be prepared for any circumstance: if you don’t have the cash visibility and cash management tools you need in place now — or if your cash pooling setup isn’t optimized to meet your current and future business needs — it’s time to start looking at your options.
Fides strives to provide a true one-stop shop for corporate treasury and financial professionals, streamlining liquidity management and payments. That’s why we have been working to develop a cash pooling solution that will be released later this year. Fides Cash Pooling will complement our existing offerings, making it easy for treasurers to centrally access all the information needed for more efficient operations and harmonized reporting. We’ll be sharing more details in the coming weeks!
Contact us to find out how Fides can help with your liquidity management needs.
