The term ‘trapped cash’ refers to money that is inaccessible. While that may sometimes be accurate, it normally refers to cash that, if concentrated, would suffer some loss of principal or leakage. More accurately, therefore, the cash is more likely hampered than completely blocked. Trapped cash can also include cash that is required to support financial activity (such as rent deposits, credit card risk collateral). There are only a few places in the world where foreign currency is in such short supply, where cash simply cannot be moved at all.
In the short term, trapped cash need not be a problem. Many companies are happy to invest capital into a new country, and to allow local cash balances to build up over a period of time. As the business grows, it may use these balances to fund additional local acquisitions or provide services to the parent company.
In the past, for example, companies were happy to hold surplus funds in China. The level of investment being made into their Chinese businesses meant there was a reason to hold cash locally.
Restrictions can include:
- Limitations on the bank accounts used;
- Limitations on the use of zero-balance sweeping;
- Compulsory reserves for loans and deposits;
- Taxes on financial and banking transactions;
- Banning the use of local currency offshore accounts;
- Controls on currency convertibility and transferability;
- Heavy administrative and central bank reporting; and
- Withholding taxes on dividends, royalties, loan interest compensation, share transfer and capital repatriation.
Implications of trapped cash
- FX risk: Many of the countries where cash can get trapped are emerging markets where the currency continually devalues. Holding cash in these countries can result in a loss of value when the balances get revalued into the functional currency of the parent company.
- Credit/counterparty risk: Many countries operating restrictions and capital controls on the movements of local and foreign currencies have financial institutions with poor credit ratings. Large local cash balances may consequently be exposed to counterparty risk in addition to overall business risk from operating in that country.
- Financial reporting: Some companies may need to limit the level of gross debt. Trapped cash prevents gross debt being reduced and may affect covenants or credit ratings.
- Business valuation: Buyers may discount the value of the trapped cash and this may affect the price they are willing to pay for the business.
- Fraud: Concentrating liquidity in central locations reduces the opportunity for employees to misappropriate corporate funds. Large local cash balances, especially if known to be inaccessible to an overseas parent company, may be a tempting target for fraudulent activity.
Tackling trapped cash
Given the renewed importance of available liquidity, treasurers are continuing to look for techniques to reduce trapped cash, not only for liquidity management purposes, but also to reduce foreign currency and sovereign risk.
- Business model and strategy: Do you want/need to operate in the respective country? If yes, only for local consumption or also for export? Does the business model still fit under the current circumstances?
- Capital structure: Is it right for the entity? Is it conducive to avoiding trapping cash? Beware using intercompany loans, as in some countries you may not be able to hedge the loan.
Basic system flexibility and efficacy:
- Dividend distributions can be used to minimise trapped cash;
- Settlement of liabilities (intercompany liabilities, third-party liabilities, etc) to ensure trapped cash is minimised by not having unnecessary cash;
- FX sourcing: partner with several banks as they will have different accesses to required currencies; and
- Safeguard financial assets: carefully consider how to invest cash.
Regular communication with:
- Subsidiaries worldwide;
- Range of banks to understand available options;
- Fellow peers to keep up to date; and
- Key stakeholders to ensure general knowledge, ie regulation change, increased levels of risk – also in the area of business continuity.
Dealing with trapped cash
Safeguarding assets by regularly reviewing:
- All counterparties holding cash;
- Decision to hold cash in local versus hard currency, with full awareness of any restrictions of holding cash in hard currency; and
- Other local investment opportunities beyond cash, for example, real estate.
Thinking outside the box:
- Review the business configuration: imports vs local production, local or offshore sourcing of materials, etc;
- Investment instruments: could you hold gold? Consider options that would not apply normally;
- Payments-on-behalf-of: could your local entity pay on behalf of an offshore entity?
- Capital injections or (intercompany) loans might sound counterintuitive, but might be the right thing to do – if key issue is FX liquidity without risking business continuity; and
- Housekeeping and controls: ensure regular payment of foreign liabilities when FX is available rather than waiting for the ‘right’ forex rate.
Regular communication with:
- Country subsidiaries to ensure full understanding of the situation;
- Banks to fully gauge the market and the options available;
- Peers to keep up to date on what others do; and
- Key stakeholders.