INTM503150 - Cash pooling: UK company as long term depositor in the cash pool

Consider firstly a UK company with material deposits in the cash pool, a large proportion of which have been there for a period of over 12 months (called hereafter the “structural deposit”). The question to ask in this situation is whether, in an arm’s length situation, a company treasurer would leave this structural deposit in the cash pool, only earning a short-term rate, when one key responsibility of the company treasurer (aside from the considerations of liquidity and security), is to maximise the return on excess cash.

Factors to consider are as follows:

  • The functions, assets, and risks of the UK company. For example, if it is a limited risk service provider remunerated on a cost plus basis, it would likely have no requirement to hold material cash deposits at arm’s length.
  • Does it also have debt which is incurring a higher finance charge than the interest being received on the deposit? If so, at arm’s length any excess funds not required for working capital/imminent future expenditure would likely have been used to pay down the more expensive debt, as long as the terms and conditions of the debt did not preclude this option. If the company’s debt is intra-group, are those terms and conditions on an arm’s length basis, i.e. does any obstacle which stands in the way of pay down amount to an uncommercial restriction?
  • Is the UK acquisitive, or does the company have, for example, pension deficits which may require cash funding in the future with little notice given? This may to some extent warrant holding cash on short term deposits. Can such immediate need be evidenced?
  • Are there debts or contingent liabilities which would require immediate settlement?
  • Is the UK shortly due to pay a dividend up to its parent company? Can this be evidenced?
  • Does the UK need a strong balance sheet, for pension levy purposes, supplier relationships etc.?
  • The reasons for holding cash are further diluted if the cash pool participant can borrow from the cash pool with no notice, has no limit on the amounts to be borrowed and the interest rate for borrowing is low.

To the extent that the facts and circumstances do not justify the cash balance being held on short term deposit (and taking into consideration the information available to the depositor during the period for which the sum is held as a short term deposit), it may be appropriate to impute additional interest income to the UK depositor, taking into account:

  • The length of time the deposit has been held.
  • The credit rating of the cash pool header – quite often the comparator transaction given (the comparable uncontrolled price or “CUP”) is the short deposit rate that the depositor would receive from a local bank, and groups demonstrate that the rate applied to deposits in the cash pool arrangement is more generous than these external CUPs.
    However, the comparator bank would normally be at least an A or BBB rated financial institution, with perceived low liquidity and credit default risk. For many of these arrangements, the cash pool header may actually have a non-investment grade credit rating, which would increase the risk, and hence reward, that a depositor would need to be given. Thus an adjustment to the CUP to account for this difference in credit rating between the third party bank being used as a CUP and the cash pool header ought to be considered. It should also be noted that as the term increases, it is likely that the credit rating of the cash pool header will have a proportionately larger effect on the rate required by the depositor, due to increased risk. In considering the rating, the existence of implicit support or passive association between the group parent and the cash pool header may be a relevant consideration.

  • The presence of any cross-guarantee is a factor that is rarely considered when pricing the return that should be given to the depositors. To the extent that deposits are left long term on the cash pool, they are providing principal sums which can be relied on by the cash pool header as a source for repayment of any borrowing by another legal entity. Accordingly, there may be some merit, when trying to find an appropriate CUP to use, to consider not only an adjusted CUP to account for the credit default risk of the cash pool header, but also add on an additional margin, which would reflect the arm’s length price that the UK company depositing funds would charge each “structural” borrower (or the cash pool header, if a standard borrowing rate is charged across all borrowers) for providing a guarantee for their borrowings. In reality, this would likely be based on some aggregated estimate of the credit risk of the borrowers.

    It is recognised that there will likely be many participants, and cash is fungible, so one would not easily be able to “track/apportion/identify” the risks that, say, a depositor was taking when becoming a cross-guarantor. Nevertheless there may be specific facts and circumstances of the cash pool in question which highlight this as a high risk area. For example, if the borrowing/lending is concentrated in a handful of entities with little fluctuation.

  • Consider the functions, assets and risks of the cash pooling arrangements as a whole. Where long term deposits are made, the depositors are providing a significant asset to the arrangement, and may also be taking on significant risk by doing so. Accordingly, as a secondary method to CUP, one could use a profit split methodology to split the cash pooling benefit among the participants. It would be reasonable to assume that this method would also result in increasing the return given to the depositors.