Notional pooling is the treasurer’s best tool for balance management. Lack of regulatory clarity provides a cover for banks who would be happy to see pooling end, because it eliminates net interest margin (NIM) on pooled accounts. Basel III regulates the right of offset for both single currency and cross currency in details designed to cover interbank transactions. What is needed is a push by treasurers to get consistent regulatory treatment of pooling.

The issues with notional pooling

Notional pooling is the most elegant tool available to treasurers for intercompany balance management. Other cash pooling techniques like sweeping and zero balance accounts (ZBA) create intercompany balances, which bring a host of regulatory and fiscal and accounting challenges.

Notional pooling causes no substantive problems for corporates—other than misunderstanding.

First, critics claim that notional pooling is not tax-effective, citing cases like ConocoPhilips where the Norwegian tax authorities successfully claimed that ConocoPhilips’ Norwegian subsidiaries were not receiving enough interest for funding other group companies through the pool. Apart from the fact that the case is widely disputed, this concern is missing the point. The case was not about notional pooling but rather about base erosion and profit sharing (BEPS). No alternative solution would have enabled ConocoPhilips to achieve the tax result it was seeking.

When advisers say that notional pooling is not tax effective, treasurers need to ask what solution would be better. Notional pooling will always be at least as effective as intercompany loans (including sweeping, IHB, etc.), and the operational and cost benefits of notional pooling make it preferable to alternatives.

Second, critics insist that notional pooling does not work for accounting, claiming that IAS 32 does not allow netting of pool balances on consolidation. This rule has been around for a decade, and has been resolved long ago by competent notional pool providers—normally by offering a service to periodically physically offset the pool (typically monthly or quarterly). This problem does not exist under FAS/US GAAP.

Third, people worry that notional pooling is or will be too difficult for banks to offer. For banks to offer notional pooling cost effectively, they require a regulatory right of offset, and for multicurrency notional pools (MCNPs) the right of offset across currencies. Banks have to satisfy regulators that they have a solid right of offset to support a zero or minimized capital allocation. These are very common and critical practices in banking operations, primarily in interbank and financial institution (FI) businesses. And, because the FI business volumes are much larger than corporate business volumes, these offsets are extensively regulated. This sets a clear precedent for the offset required for notional pooling.  

The main problems cited for banks’ perspective with notional pooling are:

• Basel III and especially liquidity coverage ratio (LCR) rules will not allow banks to offset pool balances, and
• Banks may not be able to report net balances under IAS 32.

There have been a series of articles by bankers or citing bankers claiming that Basel III will kill notional pooling. They claim that statements such as “netting of loans and deposits is not allowed” make notional pooling impossible. Yet this line clearly does not mean current accounts, which is what we include in notional pooling. And, as cited above, the concepts of offset (which they more often call netting) and haircuts for cross-currency offset are dealt with at length by the regulators— and that is all we need for functioning notional pooling.

The right of offset is used extensively in, and is a critical enabler for, financial markets. Bank regulations cover the right of offset extensively in other contexts: “netting agreements… will be recognized… if the agreements are legally enforceable in each relevant jurisdiction upon the occurrence of an event of default and regardless of whether the counterparty is insolvent or bankrupt.”  

Likewise, cross-currency offset is extremely common in interbank derivative and collateral trading, and there are reams of detailed documentation from regulators on how to measure offset currency risk. Simply put, the bank has to use its VaR (or equivalent) methodology to calculate a ‘haircut’ that will cover the currency risk, and the haircut amount attracts a capital charge. This is why MCNPs do not have a zero capital weight though the capital weight will be very small if not negligible.

As for whether the bank will be able to offset pool balances in their financial reporting because of IAS 32—this is a pseudo-problem that has been resolved long ago.

In summary, the banks’ so-called challenges with notional pooling are illusory. In business sectors like derivatives and securities as well as interbank liquidity management, banks have managed to get clear regulations that allow them to offset assets and liabilities across currencies. As usual, the problem has been failure to get the corporate voice heard in the financial community.

David Blair is a managing director at Acarate Consulting. He formerly served as vice-president treasury at Huawei and group treasurer at Nokia.