Staying liquid in challenging times

These are trying times for treasurers. Corporates in the UK, US and EU have for some time now felt the knock-on effect of the pressure of post-crisis regulation on banks, which has limited funding and left many without the required capital for growth or expansion.

However, corporates with excess cash face increasing difficulties of their own, mainly due to two factors: the impact of low and negative interest rates, and the increasing constraints put on their choices to deposit or invest money by banking regulation. For corporates whose business involves international trade this is multiplied in impact by the number of countries, currencies and jurisdictions in which they operate.

A diverging rate environment

Gone are the days when treasurers could simply place excess cash on overnight deposit and be assured of a quick and significant profit.

While the US Federal Reserve may be committed to increasing Federal Fund rates in their efforts to stay ahead of inflation (hiking rates from near zero in December 2016 to 1.25% in June, the third consecutive quarterly increase), in this respect, the US  is an anomaly among rich nations. Many central banks continue to lower their rates, squeezing profits on deposited cash. In fact, the European Central Bank and the central banks of Denmark, Hungary, Sweden, Switzerland and Japan – have all now taken their overnight rates into negative territory. 

The underlying intention of taking rates into negative territory is to encourage banks to lend to businesses (rather than deposit funds with them), thus benefitting the real economy. However, the immediate impact is that banks now incur costs when depositing money overnight.  Eventually, these costs have to be passed on to banks’ business customers.

With a number of major banks having already initiated pass-through of negative interest rates, efficient liquidity management has been catapulted up the corporate agenda.

Regulation’s insidious impact

Even more far-reaching for corporate liquidity management  ̶  as well as more insidious  ̶  is likely to be the impact of forthcoming changes to banking regulation.

Basel III imposes on banks a requirement to keep a sufficient quantity of ‘high quality liquid assets’ (HQLAs)  ̶  assets which can readily be turned into cash within a single day  ̶  to offset those which may be withdrawn from the bank in case of a 30-day stress event. The current ‘Liquidity Coverage Ratio’ is 70% in the EU and 90% in the US  ̶  yet this will rise to 100% next year in the US, and in 2019 in the EU.

One direct consequence is an increasing preference on the part of banks for operational cash   ̶   flowing from in the ongoing, day-to-day, operations of a business   ̶   rather than non-operational corporate deposits, as regulators consider the latter to have a 100% ‘outflow factor’. Corporates have never had to make such a distinction before, and this is just one of many ways in which they must become both more flexible and more pro-active in their choice of investments. In fact, treasurers may find they have to deploy portfolio management techniques even to manage their operating cash and current accounts.

Practical solutions

Accurate cash flow forecasting, analysis and planning are even more crucial for companies involved in international trade, given the complexities and scale of operating cross-border. Fortunately, technology is already providing tools here, delivering something approaching near real-time visibility of all cash flows across countries, currencies, and business divisions. Future advances should bring even closer approximation to real-time, together with integration of data streams, customisation of packages, and, most importantly of all, richer data flows and analysis which will be even more selective and sensitive to a business’ individual needs.

Additionally, centralised global control over payments and receivables can bring benefits, allowing consolidation of a group’s liquidity and its strategic deployment where it is most needed; for example to self-finance rather than paying interest charges for short-term borrowing, or where it can earn most interest. A chief financial officer or group treasurer may also choose to concentrate all cash cross-currency into a base currency and a single account, with automation reducing the connected operational burden and execution risk. Cash sweeping services which automatically move surplus balances, including across borders, to where they are required, are now widely available from banking providers.

Where this is not appropriate  ̶  subsidiary companies may wish to maintain autonomy in their daily cash management, for instance  ̶  notional pooling may be an alternative, by netting off balances virtually across a group. This can optimise interest and reduce funding costs overall, without any cash moving physically. However, it is subject to varying regulations and  ̶  depending on circumstances  ̶  may be less advantageous now than it once was, due for example to the way regulators may classify debit balances as Risk Weighted Assets, reducing the profitability of such structures for banks under the Basel III Liquidity Leverage ratio  ̶  as previously discussed.

Hedging your bets

Another important topic for those trading is the smooth management of cross-border payments and minimising losses by reason of fluctuating foreign exchange rates. When it comes to payments, corporates involved in cross-border trade have a greater and a considerably more complex task on their hands than many others to manage payments using a multiplicity of currencies, payment systems and business practices.

Just as it provides greater visibility for cash flows in general, technology can help here too. It can for example provide platforms that carry out seamless payment processing in multiple currencies and integrate the data collected from these into the company’s other systems. Additionally, corporates may want to use foreign currency hedging to mitigate the effects of large currency fluctuations, for example by using automated rolling collars, locking in liquidity and avoiding volatility particularly in emerging market currency rates.

A new approach

When it comes to investing surplus cash, all corporates can benefit from a periodic review of the way they are managing liquidity. This might involve taking a step back and engaging in a ‘scenario-building’ exercise to decide whether in fact it might be a time for redeploying excess cash by entering new markets or embarking on a merger or acquisition strategy.

Where it is decided to invest money, all product types, old and new, should be considered. Once tried-and-tested investment vehicles may no longer meet new requirements, whereas options never before considered may now appeal more, once the combined effects of banking regulation and monetary policy have been taken into account. If the future of treasury in general is nimble, flexible and proactive, it is even more so in the multi-party, multi-country, multi-currency world of global trade.