Liquidity Management Techniques

1. Liquidity Management Techniques Pooling and Cash Concentration

2. Liquidity Management Having funds available to meet all known and unknown commitments • In the right currency • In the right place • At the right time Minimise cost of funds and debit interest Maximise use of surplus funds and interest earnings

3. Liquidity Management As always a balance between the costs and benefits of having liquidity and the costs and benefits of lacking liquidity

4. Liquidity Management How may a company improve liquidity? • External • Through borrowing • Through suppliers • Internal • Better practices on inventory, receivables short term investment • Better control of cash resources around the group

5. Liquidity Management • Focusing on maximising Internal liquidity utilising existing but wasted resources Pooling / Cash Concentration First: Notional Pooling

6. Notional Pooling • With Notional Pooling there is no actual movement of funds. • With Notional Pooling there is no co-mingling of funds • Credit balances are offset against debit balances and the net is used to work out the debit or credit interest paid or received • Also referred to as ‘interest offset pooling’

7. Notional PoolingPosition prior to pooling Average Balance Average Balance + 900,000 + 350,000 Average Balance Average Balance - 300,000 - 550,000 Credit interest at 4 % = 1,250,000 x .04 = 50,000 Debit interest at 6 % = 850,000 x .06 = 51,000 Net cost to group = - 1,000 But if notionally pooled Sub 1 Sub 2 Sub 3 Sub 4

8. Notional PoolingPosition if pooled Average Balance Average Balance + 900 + 350 Average Balance Average Balance - 300 - 550 Net position = + 400,000 So 400,000 x .04 = 16,000 an improvement of 17,000 Sub 1 Sub 2 Sub 4 Sub 3

9. Notional PoolingBenefits • Maximise interest earned • Minimise interest paid by As much as possible, for as long as possible, in one place

10. Notional PoolingTaking Advantage Tiered Interest Rate Structure 8 Interest 7 Rates 6 5 4 3 0 50 100 200 300 400 Balance in 000’s

11. Stepped versus Banded

12. Notional PoolingBenefits • Improves the balance sheet by offsetting surplus balances against group debt • Reduces and may eliminate short term borrowing (will probably still need credit lines as back up with limits on individual subs) • Reduces overall exposure to banks

13. Notional PoolingBenefits • May improve internal discipline and control • Do not have to move funds - reduce costs of transfers - reduce management time

14. Notional PoolingRequirements • Pooling agreement • Cross guarantees • Legal right of set off • Tax indemnity • Ability to link accounts for interest calculations. Obvious, but not every bank will have the capability • Interest apportionment • Board resolutions

15. Notional PoolingIssues • Bank charges • Resident non-resident issues • Tax issues (arms length) • May be treated as a form of lending with no transfer of funds ownership • Interest offered may be low / or charged high, so Treasury may wish to actively place funds or borrow

16. Notional PoolingActive Management Investment of 400,000 Sub 1 + 800 Sub 2 + 700 Sub 3 - 200 Sub 4 - 900 T + 400

17. Types of notional Pooling • Single currency, single country • Single currency, cross border • Multi-currency, single country • Multi-currency, cross border • What is possible? • What is offered? • What does it cost the bank?

18. How Banks Charge for Pooling • Interest rate spread • Reserve asset charge (cost recovery) • Set up fee • Management fee (monthly per account) • Interest apportionment fee • Account maintenance fees • Electronic reporting fee • Money movements, receipts/payments • FX if involved

19. PoolingDue diligence • Is pooling permitted? • Tax issues • Withholding tax – Res/non Res issues • Arms length rule • Is debit interest an allowable deduction? • Is thin capitalisation an issue? • Location?

20. Pooling Due diligence • How do laws of offset relate to • Multi entities? • Multi currencies? • Cross border aspects? • How does the bank cover? • Are cross–guarantees necessary? • Are Central Bank reserve ratios calculated gross or net?

21. Pooling Due Diligence • Impact on group of using one bank • Should all operational accounts be included in the pool? • Impact of cut-off times for movement in and out of pools • Value dating practices for cross border movements into and out of the pool.

22. Cash concentration Sometimes Notional Pooling is not possible or not wanted • Rules and regulations • Structure of banking industry • Legal issues Then we may have to cash concentrate i.e. physically move the funds to attain the same benefits.

23. Cash concentration Example of Zero Balance Cash concentration End of day 750 invested Sub 1 + 350 Sub 2 +500 Sub 3 +550 Sub 4 - 650 Concentration a/c

24. Cash Concentration • There are various forms of cash concentration • Zero balance, as illustrated • Target balance, to keep a specific amount in each account • Threshold, to move funds only when an account moves in excess of a figure • Collar, when a threshold is reached, funds are moved but a balance is left

25. Cash Concentration • All will depend on the costs involved versus the needs of the group elsewhere, the sums involved and the overall treasury objective

26. Cash Concentration Issues Drawbacks • Transfers may have to be done manually • Will involve transfer fees • Transfers to/from non resident ac’s may add to central bank reporting and to cost • Local rules and regulations may prohibit/complicate cross border movements

27. Cash ConcentrationUsing MT101 to concentrate Customer Instruction Advice Lead Bank MT101 MT103 MT101 MT103 Sending bank Credit customer concentration account Debit sending bank nostro SWIFT Network Debit customer ac Credit vostro ac

28. Liquidity ManagementInterest Enhancement • As mentioned earlier, sometimes rules and regulations make cash concentration and cash pooling difficult, uneconomic or illegal • Nonetheless, Banks have developed ways to enable companies to gain some benefit from their balances • The banks recognise that the balances they hold, even where blocked, are reflected on their balance sheet and therefore of value

29. Liquidity ManagementInterest Enhancement • Suppose that the bank will normally charge interest on deficits at LIBOR plus ½ and pay on surpluses at LIBID – ½ • To the extent that balances offset each other the bank will adjust these rates • E.g. Account No 1 has a surplus balance of GBP 100 and account No 2 a deficit of GBP 50.

30. Liquidity ManagementInterest Enhancement • There is an offset of 50% so • They would charge interest at, say, Libor plus1/4 • And pay interest at LIBID – 1/4