Notional pooling has been an effective liquidity management tool for many multinational corporations, despite some countries outlawing the practice. But where it is legal, the ability to offset on the bank’s books the cash poor position of a subsidiary in one country with the cash rich position of another has resulted in significant cost savings and eliminated the need for costly intercompany loans.
Unlike physical pooling, notional pooling does not involve moving the actual money around the globe. Rather, the company maintains multiple accounts in multiple countries with the same bank, allowing it to offset overdrafts with cash-plus positions, avoiding unnecessary fees and complicated transactions. While intercompany loans are not required, most jurisdictions require cross guarantees to ensure the right of offset. The overall objective is to reduce the interest rate cost to the company resulting from overdraft positions.
Basel III threatens all that, particularly in Europe. That’s because of Basel III’s liquidity coverage ratio (LCR) and capital requirements. According to a recent report from Treasury Alliance Group, “while periodic demonstrations of offset may satisfy the accounting standards, national regulators facing enforcing Basel compliance are more likely to look at the actual accounts.” As such, they “may require that banks use gross amounts in calculating and reporting liquidity ratios.”
This means banks will have to keep extra liquidity on the balance sheets to offset the “plus” accounts. Meanwhile, on the overdraft, regulators may well require the banks to hold regulatory capital. “Formal credit lines supporting the overdrafts may soften the blow,” the report noted, “but will not entirely remove the need for additional capital even if they’re never used.” The upshot is a possible significant cost increase in running the pool, though Treasury Alliance Group is quick to note that this has not happened to date.
“What I see is that the new legislation under Basel III is creating a lot of uncertainty as to how interpret the rules,” said Greet van der Steen, managing director of clients and products in the U.S. for Bank Mendes Gans (BMG), a leading notional pooling bank. “We are still talking to the regulators about what it means exactly. Basel III doesn’t say A or B with regard to pooling. We have to understand how to interpret the rules.”
In addition, notional pooling doesn’t always mean the same thing to all clients. For some, it means no FX and no swaps within a multicurrency, multi-entity structure. For others it’s single entity, multicurrency, or even single currency. The rules would apply differently in either situation, according to van der Steen. Regulators have not gone into a lot of details. But she does not see the new rules as the death knell for notional pooling, and instead believes they will provide new opportunities.
Every bank may have issues with different aspects of Basel III. Certainly, the rules would require additional capital. However, different banks offer different products with different execution. In many cases, notional pooling means that funds sit within the branches. But a bank like BMG doesn’t have any branches. “Certainly the rules have led to much more discussions with clients about the product. Discussions about the leverage ratio (LR) are mixed up with the discussions about the liquidity coverage ratio (LCR). So for corporates, the information might be confusing as well. We share what we know with our customers. We try to be open and transparent as possible,” van der Steen said.
Corporates confirm that it still unclear how the wind will blow on notional pooling and whether the impact will go beyond Europe. “I hear it’s a bigger issue in Europe than anywhere else,” said the assistant treasurer of a multinational manufacturer. “There doesn’t seem to be any issue with in-country pooling. We’re looking at putting a USD notional pool in Singapore through a large U.S. bank and there doesn’t seem to be any issue with that.”
But the assistant treasurer added that there remains a lot of confusion in the market as to how the new rules, which will be effective 2018, will impact the notional pooling structure.