Sweeping/ Zero Balance Account (ZBA)
About ZBA
Zero balance accounts (ZBA), also known as sweeping, is an arrangement whereby banks transfer (sweep) funds from a number of (operating) accounts to a designated header or master account at the close of business every day.
ZBA is sometimes called physical pooling to distinguish it from notional pooling. In ZBA, the bank moves funds between bank accounts, resulting in the sub accounts having zero balance and the net bank balance (or deficit) being concentrated to the master account. There are intercompany balances created between the master and sub accounts holders (assuming they belong to different legal entities). In notional pooling, there is no physical movement of funds.
ZBA can be conceived as outsourcing daily intercompany loans to a bank. Most TMS have the capability to do the same thing, but banks have two significant advantages. First, banks can execute the sweep as part of their end-of-day closing process, thus ensuring that all booked funds are swept (some banks also cover back valuations). Second, banks normally run 24/7 systems and processes that can handle different times zones to meet the requirement for true end-of-day sweeping, whereas this can be difficult for most corporates (although SaaS TMS solutions mitigate this on the technical level).
How it works?
ZBA is normally two way. This means that both credit and debit (where permitted by regulation) balances can be swept, i.e. overdrafts in sub accounts will be covered by an end-of-day sweep from the master account.
There are many variants of ZBA to meet different treasury requirements.
- One way sweeping generally means that only credit balances are swept to the master account
- One way sweeping typically means that funds are not returned to the sub account the following morning
- Target balance sweeping leaves a small balance in the sub account (and in two-way sweeping can sweep more than the overdraft amount to the sub account); the target balance is set by the corporate
- Reverse sweep option means that funds swept to the master account at end-of-day will be returned to the sub account the following morning, so that the operating entity has funds for its daily operations. This is an alternative to having intra-day overdrafts set up on the sub accounts for their payments needs during the day. One challenge of reverse sweep is across time zones where if the reverse sweep happens against the sun (e.g. from Europe to Asia, or Asia to Australia), the funds are not returned to the sub account for their start of day
- Some countries (such as China) tax intercompany loans and loan interest, making it important to minimise the number of sweeps and amounts to those necessary to cover debit positions; banks provide multilateral sweep optimisation for this purpose (sweeps can be between any ZBA participant depending on their balances, not just to and from the master account)
The role of banks in ZBA
ZBA can be executed most efficiently with a single bank, where the bank can offer true end-of-day sweeping between branches (although this may only be offered to selected customers).
Sweeping between different banks is also common but cannot achieve true end-of-day sweeping. This means that the sub account may not be zero balanced at end-of-day. Sweeping between different banks is executed using standard market infrastructure, typically SWIFT MT942 intraday statements to determine the balance to be swept and MT101 payment instructions to execute the sweep. This must happen before the currency's cut off time, which is why accounts may not be perfectly zero balanced.
A second cross bank sweeping method is for the bank holding the master account to open nostro accounts with the bank holding the sub accounts. This can enable later cutoff and thus more complete sweeping.
To maximise sweep effectiveness and reduce costs, some corporates do two stage sweeping, first sweeping multiple accounts to one master onshore and then making a single cross-border sweep to a regional or global master account. This can be effective because cross-border sweep fees may be more expensive than domestic sweeps, and performing domestic concentration first can also reduce duplicity of intercompany loans.
Cross-currency ZBA has been tried in the past using automated FX solutions, but pricing was never cost effective. Most corporates who want to pool multiple currencies use notional pooling rather than ZBA. Often, ZBAs are used to pool funds by currency, resulting in one master account per currency, which is then pooled using a single entity multi-currency notional pool.
Banks offer internal credit limits (set by the ZBA master with respect to the ZBA sub accounts) to facilitate internal control within their corporate clients. Since most groups will not allow their subsidiaries to go bankrupt, such limits serve more as warning signals than absolute limits. Robust cash flow forecasting is a better way to manage subsidiary cash balances.
Banks also offer interest calculation services to calculate daily interest ladders on ZBA generated intercompany balances. All TMS and most ERP systems can also calculate interest ladders, but some corporates prefer the bank service. The bank itself is not charging and paying interest to sub accounts (since they are zero balanced), but simply providing an interest calculation service based on the corporate's intercompany balances (which the bank knows from running the ZBA). Some banks are also able to automate the settlement of interest.
One implication of the fact that ZBA results in intercompany balances is that corporates must make the appropriate accounting entries every day, credit bank and debit intercompany for positive balances, for example. Most corporates automate these entries based on daily bank statements from their bank, typically in SWIFT MT940 or ISO20022 camt formats. Since no funds are transferred in a notional pool, notional pooling does not require daily accounting entries.
Equally, the corporate, sometimes with the help of their banks, will have to manage any withholding tax arising on interest on the intercompany balances resulting from ZBA arrangements. As with intercompany interest, some banks can also calculate the corporate’s withholding tax obligations.
ZBA compared
ZBA is a balance management tool. A ZBA results in an intercompany balance between the sub account and header account.
Comparing ZBA to intercompany loans, one can say that ZBA is outsourcing intercompany loans to a bank. Because ZBA is automated, it normally operates daily whereas intercompany loans are typically monthly.
Regulations
ZBA results in intercompany balances, on which interest must be paid to mitigate transfer pricing and BEPS risks. As such the result of ZBA is legally and fiscally the same as intercompany loans.
Many developing countries do not allow or severely restrict intercompany loans, though some offer work-arounds. Some examples include:
- China does not allow intercompany loans but allows 'entrustment loans' mediated (off balance sheet) by banks for a small fee
- India limits intercompany loans (called inter corporate deposits in the companies act) between related parties with common directors
- Vietnam does not allow intercompany loans at all.
Many developing countries have exchange control rules that make cross-border intercompany loans difficult or impossible. This will make cross-border ZBA very difficult though in many cases domestic ZBA will work.
Where registration is required, the proper approvals must be in place before transferring funds to ensure that the intercompany balance can be repaid at maturity. Cross-border intercompany loans and intercompany balances that are not properly registered may be deemed capital, which makes repayment extremely difficult.
Tax
The primary tax consideration for intercompany loans and therefore ZBA is withholding tax on interest. This applies mostly to cross-border intercompany loans. Some countries levy withholding tax on domestic interest payments. China used to levy a business tax on interest and has now made domestic interest liable to value added tax (VAT); China also has withholding tax on cross-border interest (and dividends).
Withholding tax is often waived or lowered for bank loans, which can make them more cost effective than intercompany balances if the withholding tax is not recoverable. This is one reason why many corporates prefer notional pooling.
The interest rate on intercompany balances resulting from ZBA must be set at arm's length rates, and the pricing documented to avoid transfer pricing problems from tax authorities. New rules on BEPS have increased the importance of setting tax acceptable pricing and documenting this accordingly.
Thin capitalisation rules can limit the deductibility of interest for tax purposes. In many countries, interest deductibility is limited to specified debt to equity ratios. Many corporates use the internal credit limits within ZBA services to ensure that they remain tax effective.
Implementation
Given all the different styles of ZBA, implementation will require a thorough analysis of the underlying needs as well as the different bank offerings. For example, cash concentration to aggregate credit balances is much simpler than two way sweeping to cover subsidiaries' funding needs.
The mix of countries to be included will heavily impact the requirements. In general, developing markets are more difficult whereas Europe being financially open and benefitting from a single currency and consistent market infrastructures such as PSD2 and Target is easy.
ZBA implementations are often accompanied by cash management RfPs, implying a move of operating accounts and a large project. Using multi bank sweeping can simplify this considerably at the cost of leaving one-quarter to half one day's collections as float in the operating accounts. This implies that corporates who like target balancing need not move all their accounts to one bank.
The driving reason to move accounts for a ZBA is to achieve 100% true end-of-day zero balancing, which can only be done with one bank. (And more specifically within one treasury book, if the bank is not to lose out in their own cash management.)
Cross-border sweeping in regulated markets can require approval, and depending on the economic climate this can take time.
ZBA documentation is normally rather simple since the bank is merely providing a service and not taking limited (i.e. intra-day only) balance sheet exposure and risk in case of arrangements involving multiple legal entities.
ZBA usually requires daylight overdrafts / intra-day credit limits. These can be handled in the normal way, like any other bank credit facility, although since they are cover by the ZBA master the bank normally handles them transparently through their internal inter branch limit processes. If the corporate requires overdraft for then ZBA as a whole, this will be implemented as an overdraft limit for the pool master itself.
Analysis of the payment and collections trends of the operating accounts that are going to be zero balanced is critical to ensure that sufficient intra-day credit limits are put in place; otherwise, there is a risk that operating accounts are not sufficiently funded to make payments, creating extra effort and cost to monitor balances and make urgent funding transfers.
Holidays are another key consideration for cross-border sweeps. If the header country is on holiday, yet the operating account in a different country is working, the operating account may use up intraday credit lines while making payments during the day, and then go in to unauthorized overdraft due to no sweep from the header on holiday at end of day. Some banks are able to offer holiday sweep processing, typically on a selected basis due to the balance sheet cost to the bank
