• <
  • >

What is Hybrid Cash Pooling?

Answers the questions about the hybrid cash pooling. How does it actually work? Also, what is the major legal and regulatory surrounding this form of pooling? Published on Treasury Today Magazine on December 2010 issue.

What is hybrid cash pooling and how does it actually work? Also, what are the major lega l and regul atory restrictions surrounding this form of pooling?

Mustafa Kilic, Treasury Manager, lndesit Company International, responded :

 Hybrid cash pooling is a system that uses two or more distinct cash balancing engines to maintain credit and debit positions of various accounts in the book of the service provider bank.

The system offsets credit balances in one currency against debit balances in another currency. It is a cross-currency interest system managed per account on a daily basis. However, unlike physical cash pooling, this does not require the physical conversion of currencies and movement of funds once the balances are concent rated in the header accounts. The funds remain in the name of the different legal entities, thus eliminating inter-company loans and the associated administratrative burden. In contrast, while not requiring the physical movement of funds, cross-currency notional cash pooling between different legal entities requires the signing of a set-off agreement.

The foundation of hybrid cash pooling is that treasurers are continuously seeking a better platform to strategically manage the entire cash management process, in order to increase the intrinsic value of the business. However, it is not feasible to have one approach for all coun tries when it comes to cash and treasury management, due to different jurisdictions in each country. Hybrid solutions have been specifically built to meet the needs of operat ions in challenging markets. Such a solution offers the following benefits:

  • Creates efficient ways to consolidate liquidity with better geographic coverage.
  • Eliminates local borrowing needs while reducing corporate guarantees for local credit lines.
  • Brings economies of scale in financing conditions with incremental income statement improvements.
  • Enhances control and visibility of cash balance.
  • Treasury  can overdraw in its currency of choice.
  • Maintains local bank accounts to serve local needs.
  • Eliminatesinter-company loans while creating a new funding vehicle.
  • Reduces or eliminates FX and swap transactions to offset the debit positions of the accounts.
  • Redu ces number and cost of operational transactions.
  • No additional hardware/software on user side.

There are certain requirements to be considered before hybrid cash pooling can take place. The currencies involved must be freely convertible; legal entities must be allowed to open local and foreign currency bank accounts outside its country; and a financial institution is required to provide the service. However, there is no need for the treasury to buy any additional hardware or software.

However, hybrid pooling is restricted or prohibited in certain countries; some entities may not be allowed to partic ipate in the agreements; and the physical movement of funds between accounts may sometimes be required.

 Carl Mantel, Director, Treasury and Financial Risk Management at PwC, r esponded :

Hybrid cash pooling is a combination of both notional and physical cash pooling (concentration, zero balancing) with the aim to pool different currencies and markets in which a multinational company has its operations. Although hybrid cash pooling is not an entirely new concept, it has increasingly attracted the interest of multinationals of varying sizes during recent years. This results in part from the improved capabilities and service offerings of international cash management banks, which include automatic sweeping arrangements and more transparent 'cross currency notional pooling' offerings.

There are different ways in which hybrid cash pools can operate and a lot depends on an organisation's size, structure and the jurisdiction in which its business units operate. For example, whilst some corporates may opt to set up a zero balancing structure on a country by county basis and then add an overlay (cross currency) notional pooling structure on top, others may prefer to implement a cross border zero balancing structure whereby balances are swept on a business unit basis and then notionally pooled in the ultimate pooling location.

Depending on the envisaged hybrid cash pooling structure and the level at which the physical flow of funds takes place (ie domestic vs. cross-border), different types of tax, legal and regulatory aspects need to be assessed prior to signing any cash pooling arrangement with the cash pool bank(s). Some of the major aspects a treasurer needs to take into consideration are the following:

  • In any cash pool structure, the model should be feasible from an overall tax perspective, with limited interest withholding tax (WHT) exposure. The evaluation of a suitab le jurisdiction to locate the cash pool leader (eg Belgium, Netherlands, and Switzerland) is crucial, as is the analysis of the jurisdiction of the business units participating in the cash pooling arrangement (double tax treaties). Whilst in a notional pooling environment there is no co-mingling of funds, physical poo ling triggers an intercompany relation.
  • Transfer pricing aspects need to be addressed. Not only do interest rates have to be in line with the arm's length principle, but the overall benefit of the cash pooling arrangement also has to be allocated between the participants. Relevant transfer pricing guidelines need to be reviewed periodically in order to ensure that any changes in circumstance are identified and appropriately considered. In addition, thin capitalisation and earning stripping rules, which limit the level of debt and interest payments at the level of each participant, have to be constantly monitored in order to avoid any additiona l tax consequences in the participants' jurisdictions.

Whilst in Europe most countries allow corporates to be included in a cash pooling scheme, there are still many regions (Africa, Asia, Latin America) that have central bank regulations and currency restrictions in place precluding companies from opening accounts abroad and participating in a multi-currency cash pool.

An important factor to consider in a notional multi-currency cash pool setup is the aspect of 'cross guarantees.' Banks typically require cash pool participants to jointly sign several liabilities for overdraft posit ions on any participat ing account, or require a guarantee from the parent company. Furthermore, central bank reporting requirements still exist in numerous countries with respect, inter alia, to cross-border transactions and foreign bank accounts. However, cash pooling banks are very often able to assist in this respect. Needless to say, these guarantees might also need to be appropriately remunerated from a transfer pricing perspective.

Given the above and in order to avoid surprises, it is crucial that treasurers establishing hybrid cash pooling structures consult with their tax department and/or their tax advisor to identify relevant tax issues as well as legal and regulatory constraints with regard to both the cash poo l participants' jurisdictions and the potential cash pool leader's location.

Download the article and share your comments at the link attached