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Notional Pooling: That Other Day May Not Be Far Away PwC's Senior Director of Corporate Treasury Solutions asserts that the tone and direction of the IFRIC agenda decision should urge corporate clients who rely on notional pooling to now plan for the worst.

Notional Pooling: That Other Day May Not Be Far Away

by Bas Rebel, Senior Director of Corporate Treasury Solutions, PwC The Netherlands, Philippe Förster, Director, PwC Luxembourg and Claire Howells, PwC UK

Since our article on notional pooling in January 2016, 'Die Another Day', the debate has continued to accelerate. In that article, we highlighted the potential impact on some banks and uncertainty around timing to formulate an adequate response, however the tone and direction of the IFRIC agenda decision should urge corporate clients who rely on notional pooling to now plan for the worst.

What is the point?

There is mounting pressure by Basel III and CRD IV on the cost of notional pooling products due to capital requirement and liquidity coverage ratio calculations. The discussion partially gravitates around distortion of the level playing field in the transaction banking space as a result of some deviations in how Basel III is interpreted and implemented in different legislations. Closely related is our observation that banks have different opinions on the implications. Some have made alterations to their pooling products that, in their opinion, counter the impact of national regulation.

Another part of the discussion focuses on the preconditions of net representation of bank balances. Because Basel III took its language directly from decade-old accounting standards, the IFRIC agenda decision is pivotal for the viability of the various notional pooling products.

IFRIC new input

While the IFRIC paper technically does not prohibit notional pooling, it makes it practically and economically unviable for corporate clients. The inability to net present bank balances provides a clear guideline as to how the capital requirements and liquidity coverage ratios of banks have to be calculated and also how most banks would need to include these in their financial statements.

The IFRIC agenda decision discusses whether a particular cash pooling arrangement would meet the criteria for offsetting (and then net presentation). Their motivation to reject net presentation centres around the more fundamental question of whether bank balances even meet the criteria to be eligible for offsetting. The key argument is that because bank balances are fluctuating, it is impossible to determine in advance what will be settled. Consequently, if the amount to be settled cannot be defined, one is unable to demonstrate the intention to net settle.

The line of reasoning by IFRIC can be applied to most, if not all, notional pooling structures. Banks and corporates alike can no longer avoid gross representation and have to anticipate a material and potentially prohibitive impact on the cost and availability of notional pooling products.

Undoubtedly, as banks continue to offer notional pooling products to their clients, the break-even point at which notional pooling makes sense economically and operationally shifts upwards more rapidly than we may like. We urge corporate treasurers to build the business case for change and explore the alternatives now.

Unhappy bankers…

Given the sometimes subtle differences in how Basel III works out across legislations, opinions about the survival of notional pooling partially gravitate around the distortion of the level playing field in the transaction banking space. If this is the only argument, it seems highly unlikely that the grander scheme of Basel III would stand up for transaction bankers.

Another topic in the debate centres around the ability to net present bank balances in the notional pool. In this context, you need to understand that Basel III took its language and definitions for the calculation of the capital requirement and liquidity coverage ratio derived from IFRS. IAS32 defines two simple preconditions for net representation:

  • Having the legally enforceable right to offset balances under all circumstances; and
  • Demonstrating the intent to settle outstanding balances simultaneously or on a net basis.

There is, and always has been, diversity in practice. The debate amongst accountants on notional pooling and IAS32 has never been settled or put to rest.

Over time, auditors have become more rigid in their interpretation of IAS32. Until recently, the stepped up rigidity had little material impact on the popularity of notional pooling among corporate clients because it had no material impact on their cost of funding or bank fees. Bank covenants typically took the net instead of gross debt coverage ratio as triggers for funding cost adjustments or other loan renegotiation.

Given the historical popularity of notional pooling among their corporate clients, it is not a surprise that banks see the product as key to their transaction banking proposition and client retention. Product pricing and product cost leadership are key drivers that explain their management of notional pooling products.

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