Post-financial crisis, notional pooling was one of the tools that received increased interest as companies looked to optimize their internal cash sources.
However, higher bank equity requirements and demands of the liquidity coverage ratio under Basel III have raised questions on the future of the product.
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Benoit Desserre, |
Notional pooling differs from physical cash pooling in that the funds are not moved between the various locations where a company is based. It has been preferred by large companies as it creates a single funding pool while allowing each organization to retain its own cash position. Notional pooling also removes the expense of conducting FX transactions, and the need to conduct inter-company loans.
The requirements under Basel III mean outstanding balances within a pool will be netted, leaving the ratios to be calculated on the gross balances. Because of this, banks will need liquidity to cover the pool. Overdraft balances, which see greater scrutiny under Basel III, also require an increase in regulatory capital being held by the banks.
The rising costs have forced a number of banks to reconsider offering the product, and raised questions on its viability as a cash-management tool. However, rather than seeing the death of notional pooling, the banks committed to the product are likely to reassess their criteria.
Benoit Desserre, global head of payments and cash management at Société Générale, explains the product's challenges.
“Under previous rules, notional pooling was profitable from the first cent," he says. "But in the future, to continue offering the product, banks will need to meet the new regulatory requirements, like allocating a minimum of equity and applying leverage ratio. They will need to be able to put a lot of equity into something which in the past cost nothing.”
Notional pooling could be seen as being a victim of its success, being implemented for a greater number of companies than it was potentially suitable for, by banks without the full capabilities to manage it.
“Notional pooling is very niche,” says Desserre. “Not many banks can offer it as it is a very technical product. And the customers that are large enough to need it and have good enough treasury functions to support it are rare.”
The product requires considerable legal and tax resources relating to each jurisdiction it is implemented.
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Suzanne Janse van |
Suzanne Janse van Rensburg, regional head of liquidity, GTS EMEA, at Bank of America Merrill Lynch (BAML), says: “Pooling is a complex product offering. Banks need to apply a high level of due diligence to ensure it is the right solution for a client and that it meets a client's objectives, but also make sure that it fits within the bank's parameters.”
Mark Smith, head of global liquidity, GTS, at BAML, adds: “The notional-pooling proposition needs to be strong and future-proofed. There needs to be a stringent legal and account framework underpinning the offering to ensure it meets the necessary requirements and to deal with complexities.”
The banks that continue to use notional pooling are also likely to apply stricter rules on which companies they will offer the product to.
“By the time the Basel rules are implemented in 2018, I would be surprised if there are not some important changes from the banks on who they offer it to – either with them being more picky, more restrictive or more expensive,” says SocGén's Desserre.
In particular, banks are likely to move towards their best credit-rated clients, and the ones with the most sophisticated treasury structures.
Whatever the reason for the withdrawal, the corporate that had been used to the notional pool will be faced with finding an alternative.
BAML's Janse van Rensburg says: “If notional pooling is no longer a viable solution for a corporate, whether this is a provider or a company-driven solution, this can be challenging for a corporate.
"It is important for them to work with their banking providers to assess suitable alternatives to ensure they can continue to meet their liquidity management objectives. This may involve considering other providers or pooling product alternatives.”
In some circumstances, corporate treasurers will choose to issue a request for proposal, but might still realize they cannot find another bank that will be willing to provide them with the service.
One alternative is to shift from notional to physical pooling, such as cash concentration, when money is physically relocated to one account. This gives greater oversight over cash and enough control to allow the identification of excess cash for use in investment.
Some corporates are already organically making this switch away in response to pricing changes.
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Thomas Schickler, HSBC |
Thomas Schickler, global head of product management, global payments and cash management, HSBC, says: “Notional pooling and cash concentration can both serve a client's need to self-fund. Increasingly, we are observing a slight bias towards cash concentration as the need to increase the frequency of settlement of notional pool positions has increased the costs to manage the pool.”
The treasurers themselves need to be prepared for the additional workload such a complex structure creates.
Schickler adds: “Whether a customer chooses notional pooling or cash concentration, there are extensive internal documentation and operational considerations. For the former, a client will need to manage a set of cross-guarantees, as well as take measures to ensure that short positions in the pool are settled on a periodic basis.”
Although notional pooling faces a substantial increase in cost, and increasing restrictions, it still remains an essential part of cash management for a number of corporate treasurers.
Therefore, banks might be willing to take the financial hit on continuing to offer the service, even if for a reduced number of customers.
Desserre says: “It is possible the banks will not pass on the higher cost to the corporate. If they have a profitable relationship, they may not want to jeopardize it by increasing the price.”