The umbrella structure of an overlay cash pool can offer corporates with internationally-diverse operations another dimension to their liquidity management. But it can be time-consuming to implement, and regulatory restrictions on banks could limit their incentive to provide the service. What do treasuries need to know about the arrangement?

Keeping control of liquidity can be a massive challenge at a multinational corporation (MNC) with diverse entities and numerous bank accounts across countries and currencies. Overlay cash pooling is one way such companies can keep close control of their cash, while also deriving cost benefits. Recent advances in technology and multi-bank capabilities have been key growth drivers.

An overlay cash pool is the top layer of a cash pooling structure in which liquidity is concentrated. Liquidity and interest can be offset through this top layer, which operates as an umbrella-type structure above a network of underlying regional and local accounts or account pools, which can be with the same bank as the overlay pool or with different, local banks. “The aim is to have one top-layer per group, and then under this you have a network of other structures. This serves as the treasury ‘cockpit’, allowing you to connect to any other accounts you like in the structure below, more or less anywhere around the globe,” says Paula Da Silva, Head of Working Capital Management at SEB.

The exact structure used depends on a corporate’s overall strategy, its treasury structure, its tax and legal structure, the accounting rules and policies in the jurisdictions in which it operates, and its business objectives – for example, whether it intends to concentrate its cash for investment purposes, or to pay down debt. Overlay cash pools, just like regional cash pools, can take the form of zero- or target-balancing (where funds are physically moved to or from operating accounts in order to achieve a single net cash position in a centralised account), or notional pooling (where there is no physical movement of funds). Multi-bank overlay structures must be pooled on a physical basis, whereas single bank structures can be operated on a physical or notional basis. Funds from local currency accounts in the pool can be transferred to the overlay bank, and subsequently converted into a single currency using the bank’s automated FX rate engine – this can save treasuries time and money in eliminating the need to carry out FX transactions on its positions. Alternatively, with multicurrency pools, cash remains in the original currency and is not physically moved; instead, the overlay bank notionally calculates all the balances in the pool in to a single base currency for the purposes of interest calculation.

Hybrid multi-bank overlay structures are also possible, whereby funds move from one bank to another, before participating in a notional structure. This eliminates the FX stage of the process, thus saving time and reducing costs. With multi-bank structures, transfers of cash can be made in two different ways: via a ‘push’, wherein the local bank pushes remaining balances up to the overlay bank; or via a ‘pull’, wherein the overlay bank executes the transaction to sweep from, or credit to, the local bank. Both the ‘push’ and ‘pull’ methods are usually executed at a pre-defined time every day.

However, overlay pooling, at least on a physical basis, differs from local and regional cash pooling in that the sweeping or funding of balances between the various local banks and the overlay-providing bank can sometimes require manual transfers, as a result of currency controls or jurisdiction controls, as is the case in Brazil, Russia and South Africa, for example. Overlay structures also carry the risk that the final end-of-day balance after the clearing cut-off may be missed. Furthermore, the transfer of back- and future-value days is not possible with overlay structures. Later on we will see some of the other challenges of the practice.

Hybrid multi-bank overlay structures are also possible, whereby funds move from one bank to another, before participating in a notional structure. This eliminates the FX stage of the process, thus saving time and reducing costs.

Despite these limitations, for corporates of a certain size and geographical diversity there are several key benefits of the method.

Interest optimisation

The principal advantage of overlay cash pooling is the visibility and control it provides to enable interest optimisation. As the structure allows corporates to use a single bank to draw down funds into a central location, the more efficient use of cash helps offset a corporate’s liquidity positions, enabling it to then either enhance the interest a corporate receives or alternatively to reduce the cost of its debt.

In addition to this optimisation of interest, overlaying also helps a corporate mitigate some of the risks that come with having entity accounts spread across countries and currencies. “Overlay cash pooling is a powerful risk management tool. Treasuries can better manage currency and geographical risk, as well as their internal risk, by only allowing a controlled, identified group of people to manage liquidity across all entity accounts,” explains Etienne Bernard, Head of Global Transaction Services Western Europe at RBS. It also provides greater visibility of a company’s overall cash position, allowing it to more efficiently manage its FX positions and facilitate improved reporting and reconciliation of these positions.

From a more strategic perspective, overlay structures enable corporates to retain their autonomy of funds, as cash is channelled through a single top-level entity, such as with an in-house bank-type model. Furthermore, overlay structures can provide tax benefits to corporates, if the cash is concentrated in a tax-efficient location.

The structure can also help with a company’s operating liquidity. “Overlay cash pooling can drive real efficiencies in terms of corporates’ working capital,” says Suzanne Janse van Rensburg, Regional Head of Liquidity and Investments, GTS EMEA at Bank of America Merrill Lynch. “It allows companies to segment their working capital from the excess balances to gain an enhanced yield.”

From a more strategic perspective, overlay structures enable corporates to retain their autonomy of funds, as cash is channelled through a single top-level entity, such as with an in-house bank-type model. Furthermore, overlay structures can provide tax benefits to corporates, if the cash is concentrated in a tax-efficient location. Beyond these key benefits, overlay cash pooling can also reduce the time treasury staff need to manually intervene in the administrative handling of accounts. However, the inherent scale and scope of overlay arrangements can also present significant challenges to the treasurer.

Overlay challenges

Complexities can arise from the geographical scope of the overlay – for example, differences in cut-off times, taxation and regulation between jurisdictions covered by the structure need to be considered. The structure can also lead to cash being trapped in countries where there are restrictions on the repatriation of cash.

In terms of regulation, corporates may find that as a result of Basel III, some banks could start cutting back somewhat on their overlay cash pooling offer.

“Basel III will impact the operational business of a lot of banks. As this regulation comes into play next year, we may start to see that some banks will step away from offering a global overlay without the underlying working capital business,” says BAML’s Janse van Rensburg.

“In an overlay structure where several banks are used for regional cash pooling and another bank is providing the overlay, the bank doing the global overlay would not be getting any of the benefit of the underlying fees business – and this would have an additional cost in terms of high quality liquid assets (HQLAs) required to be held against that piece of business by that bank. If the overlay bank has at least some of the regional operating business, its HQLA requirement would be 25%. However, with just the global overlay, the HQLA requirement is actually 40% – so it could potentially be more costly for a bank to provide a global overlay structure going forward in the Basel III world. Some banks may look to price that in, which could negate some of the benefit to a client of using the structure,” she explains.

“Overlay cash pool structures with physical movements can upset the management of local entities, if they don’t want to lose control of their credit balances. It can be quite a political thing for the treasury to implement.”

Marcus Hughes, Director of Business Development, Bottomline Technologies.

Company law in certain jurisdictions can also impact the use of overlay structures. Inter-company loans are forbidden or extremely complex in some countries, such as China, rendering zero-balancing overlay cash pooling virtually impossible, while some central banks impose balance sheet reporting requirements that do not allow companies to report offset onto their balance sheets.

The implementation of overlay structures can sometimes also lead to internal conflict within a company. “Overlay cash pool structures with physical movements can upset the management of local entities, if they don’t want to lose control of their credit balances. It can be quite a political thing for the treasury to implement,” says Marcus Hughes, Director of Business Development at Bottomline Technologies.

Overlay cash pooling tips

Setting up a structure of this nature can take time – six months is not unusual in some treasuries. “Preparing the documentation for an overlay cash pool is time-consuming,” says Bottomline’s Hughes. “If a treasury’s thinking of embarking on a project like this, they’ve really got to be prepared to free up a significant amount of time and human resources. They’re going to have to select the banks to include in the pool, and decide on the technology – be it bank or non-bank technology.”

RBS’s Bernard says there are a number of key factors corporates should consider before implementing an overlay structure. Firstly the corporate should ensure the bank providing the overlay structure has a broad enough geographical scope to cover the countries and currencies in which the company’s entities operate. Secondly, the corporate should enquire what level of reporting and support the bank can offer the treasury, as well as whether the reporting can be integrated into its existing ERP systems.

And finally the corporate must decide which entities it would like to include in the overlay structure: some entities may carry such small residual balances that they do not warrant including in an overlay structure. “With some accounts, it’s just not worth it, because if the amounts moved are really low, the transfer fees could be greater than the net benefit,” says Bottomline Technologies’ Hughes; other entities may operate in a regulatory environment where it is impossible, or at least prohibitively complicated and costly, to participate in an overlay cash pool.

Overlays in the future

Overlay cash pooling looks set to remain a fixture in the liquidity management setups of many corporates for some time to come. However, the structure may well evolve as the credit environment and the needs of corporates themselves change.

Bottomline Technologies’ Hughes believes that as liquidity becomes tighter and payments become increasingly real-time, banks’ charging structures on overlay cash pools could change radically. “In the future, as money can be moved faster, and as intra-day liquidity becomes more sought after, systems will be required to deal with the complexity of moving money between the accounts in a structure more quickly and calculating interest, not just overnight, but also intra-day,” he says. “At certain times of the day, particularly towards the end of the day, using money is going to become more expensive and is likely to be charged – by the hour, or even by the minute.”

Anna Maria Nyström, Head of Liquidity Products at SEB feels the structure could also be rolled out more efficiently to new territories as regulation evolves. “Overlay cash pooling structures will continue to be a very important feature for treasuries going forward, and the world is opening up and regulation is evolving, presenting new opportunities,” she says. “Bank solutions will have to support corporates in dealing with the time zone challenges in overlay structures to make sure that more of the world is covered in an efficient way. The services should then develop – we will see a greater number of currencies and geographies included in more advanced services as time goes by.”

She also believes the visibility offered by overlay solutions will become increasingly important. “Access to information and reporting through these solutions will be crucial – not only visualising balances, but also having more in-depth information during intra-day periods,” she explains.

But beyond being adapted for use in countries where they are not currently widespread, such as China, SEB’s da Silva says overlay arrangements could also be deployed for new types of cash flows.

“In the past overlay cash pools have typically only been used to channel traditional cash flows, especially in OECD countries. But we can do much more to include a wider range of activity in these structures. For instance, trade finance-based cash flows tend to stay outside overlay cash pool solutions – this is an area where we can look to create benefits for corporates in the future,” she says.

It now remains to be seen which path overlay structures will take. Will they be successfully expanded to new territories, and to new kinds of cash flows, such as trade finance? Or will regulation, such as Basel III, restrict the attractiveness to banks of offering the umbrella arrangement?