Cruise control

Feature | 19 October 2016
Cruise Control

Cash might be king, but corporate treasury has got a good deal tougher in this low interest rate and capital cover hungry environment. Lisa Rossi sets out the new cash management landscape

Treasurers face the perennial problem of maintaining a balance between ensuring sufficient liquidity for day-to-day operations and getting a decent return on excess cash. But in today's post-crisis financial landscape, both macroeconomic factors such as interest rates and the indirect effect of financial regulation significantly impact corporate liquidity management.

Having sufficient liquidity to keep operations running smoothly at all times is essential for any business. They need cash to fund daily operations, cash for regular payments such as payroll and overheads, and cash for predictable deadlines such as payments to suppliers. Then there is the wild card - the cash that may or may not be needed to cover unforeseen circumstances. Unfortunately, one knows neither whether or when these will occur, nor how much will be required.

The unknown unknowns

Businesses can go a long way to reducing their exposure to these "unknown unknowns" by using information and planning tools to improve the predictability of their cash flows. Technology is improving treasurers' views of a business' global cash flows in leaps and bounds, and bringing them closer to a real-time perspective.

While these capabilities are increasingly taken for granted, what they allow is the accurate prediction of short-term liquidity issues in a group's own finances, and also spotting irregularities in customers' or suppliers' transaction patterns that may identify problems early on and allow remedial action. The more accurate and detailed the data, and the better the customised analyses of that data in treasurers' hands, the faster and the more appropriately they are able to react to, and even to predict, external events impacting liquidity. At the same time, greater and better quality information allows them to make full use of all group resources by pooling, lending or moving cash between group companies to bridge temporary liquidity gaps.

Of course, the impact of unpredictable events will never be eliminated entirely. All the old imponderables are still in place, and spare liquidity will always be needed as a buffer against a wide range of unforeseen circumstances, from geopolitical volatility to supply chain and working capital risks. And while good visibility will allow this to be fine-tuned to a minimum, some liquidity will always have to be available at short-term notice.

Hence, liquidity management will always need to strike a balance between having sufficient spare cash to ensure the business does not judder to a temporary halt, and losing interest that could have been earned on idle cash kept back for contingencies.

Chasing returns

There is nothing new about this basic dilemma. What is new in our post-crisis financial landscape, however, is the fact that leaving cash on deposit may cost rather than earn the company money. Suddenly treasurers face having a bank decline
to give a return on cash, because it is the wrong kind of corporate cash (non-operational rather than operational). They find themselves in the position of having to scour all available options to find investments with a positive, let alone attractive, yield.

Negative interest rates, along with the effects of financial regulation, have combined with geopolitical volatility and economic uncertainty to subvert old rules and turn the habits on which treasurers have relied for decades completely upside down. No longer can treasurers simply leave cash on their current account without a thought.

Cost of deposits

Whether or not you believe that the negative base rates introduced by a number of central banks - including the European Central Bank and the central banks of Denmark, Sweden, Switzerland and Japan - are likely to succeed in their macroeconomic goals of increasing lending and stimulating economies, they have undoubtedly had an immediate impact. As a result, commercial banks must now pay for their deposits with those banks. While most of those paying banks were initially hesitant to pass on these costs to their customers, this is now starting to happen.

Regulation costs

Financial regulation is another major factor that has changed the overall landscape for corporates, by skewing banks' appetites for different kinds of corporate cash. Basel III, for instance, requires banks to hold a prescribed ratio of High Quality Liquid Assets (HQLAs) - assets that can be converted into cash in a day with minimal loss - to offset those assets that the regulator assumes will be quickly drawn out in case of a 30-day stress event. This ratio is 70% in the European Union and 90% in the US. So where does this leave the impact on corporates? Banks now tend to prefer corporate operating cash (which has a low outflow factor) over non-operating or investment cash (which has a high one). Yields for banks' customers will therefore be considerably more favourable on the former than on the latter.

A further example is the effect of the Markets in Financial Instruments Directive II (MiFID II). Coming into force in January 2018, MiFID II will increase banks' system costs, which will likely filter through to customers.

Such issues are among the new types of driver currently affecting treasurers' investment choices, causing them to revise old assumptions and in many cases seek alternatives to the traditional types of investment that served them well for a long time.

The new rules of investing

Despite the changed liquidity environment, treasurers must find homes for cash of varying provenance, labelled differently for regulatory purposes, and each with its own ideal term (for the duration of which the business can dispense with it). Treasurers will invest as they have always done, following their specific corporate risk, term and yield parameters (though these parameters may themselves have to be revised). However, they may well find themselves adopting a new approach akin to portfolio management, proactively anticipating flows and switching investments, as well as dedicating more time and effort to researching all alternatives available - both old and new.

All investment options must be sifted, and if need be adapted to suit the new circumstances.
This includes everything from term-, call- or rolling time deposits and money market funds, to for example an agency reverse repo. Getting creative with traditional products is part of the answer,
as is possibly swapping cash between subsidiaries, or into a currency that offers a better (or a positive) interest rate. The aim is to optimise balances locally, regionally and globally.
 

Expect the unexpected

Investing aside, there is of course a wide range of tools and techniques treasurers can deploy to manage their group's liquidity efficiently, and mitigate the effects of unforeseen events. Next to improving cash flow visibility and the accuracy of prediction, managing a group's payments and receivables centrally may afford corporates the greatest benefit, as this can give control over group companies' working capital and allow the group's treasurer to allocate cash resources where they are most needed, releasing them back as soon as they are no longer required. This demands flexibility and pro-activity, and is best done on the basis of good visibility. In addition to using excess cash to self-fund, or to aid inter-company lending, it can help achieve maximum returns and minimum costs on all balances.

For those engaged in cross-border trade, the picture is additionally complicated by foreign exchange considerations. Foreign exchange risk may be mitigated by concentrating cash into a fully automated single currency account from which all payments are made, with same day settlement of funds and full reporting transparency. A further option is hedging. Since traditional hedges such as forwards or cross-currency swaps can be costly for example in volatile emerging markets through the high cost of carry, given local interest rates, using collar-based, rolling short-term hedges with pre-set collar strikes at trade inception may prove useful. These can lock in all market parameters including liquidity and market levels, to a given maturity.

The treasury of tomorrow

While the fundamentals of corporate treasury management have not changed - treasurers have always had to weigh up their companies' short-term liquidity requirements against the desire to optimise yield on all balances - this has simply become more involved and demanding in the current climate of negative interest rates and regulatory pressure on banks.

The landscape is not about to change back to pre-crisis dimensions. Low interest rates seem set to stay across a number of geographical regions, at least for the short term. In the UK, the Bank of England (BoE) cut its base rate for the first time since 2009 in August 2016, halving it from 0.5% to 0.25%, in an effort to ensure stability of the UK's banking system after the June Brexit referendum.

Economic indicators have subsequently been stronger than expected, so that the BoE refrained from lowering the rate any further in September 2016, but it has nevertheless indicated it might make further cuts in the rate over coming months. In the US, there is the chance of a rate rise, with the Federal Reserve Board deciding to hold interest rates between 0.25% and 0.5% in its September 2016 meeting, but other factors may come into the balance including the forthcoming presidential election. Constantly updated and augmented, banking regulation is of course also here to stay and will continue to affect corporate liquidity through its impact on banks.

Eyes on the road

These are times for treasurers to look lively, react nimbly and pre-empt developments as best they can. In so doing, they may find that using technology to achieve optimal visibility and predictability of flows, and relying on their financial institutions' advisory and investment offerings to help them choose the best options for their portfolios can provide a springboard for success. Banks, on the other hand, should now be offering their corporate customers one-stop platforms that connect the many kinds of different investments and pull them into one place. These would include on- and off-balance sheet, active and passive options.

Support of this kind allows treasurers to simulate, plan, and tailor investments to meet their companies' specific needs, and helps them achieve optimal returns when managing their company's or group's liquidity.

Lisa Rossi is global head of liquidity and investment product development and UK head of institutional cash management at Deutsche Bank

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