Corporate liquidity managers are under more pressure than ever before, and not just those who wish to borrow. In fact, nowadays, treasurers grappling with how to manage excess liquidity face a host of challenges, not least of which are divergences in monetary policies and regulatory approaches.
Low interest rates mean companies hoping to earn a substantial return on excess cash can no longer rely on leaving it in overnight deposits. Indeed, with some central banks taking their rates into negative territory, bank deposits might actually cost a company money. In addition, the impact of financial regulations, such as Basel III, on banks' treatment of different kinds of corporate deposits further complicates the question of what to do with excess liquidity. The combined effect of these major—and, to a large extent, global—forces has overturned many of the old rules for corporate treasurers, forcing them to seek a new approach.
Yet there are new strategies and solutions that may assist treasurers in their quest to optimize their company's liquidity management even in these pressurized times. To start with, the current challenges call for a more collaborative relationship between banks and corporates than merely that of customer and provider.
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Corporates will genuinely benefit from understanding banks' pain points under the current regulatory regime, as this will allow them to make better-informed choices. Banks, meanwhile, must be proactive with strategic advice when it comes to corporates' liquidity management. They may advise customers on everything from optimizing cash flow visibility to making more creative and better-informed investment choices. Banks should offer their corporate customers one-stop platforms that combine all available investment and liquidity products, including on- and off-balance-sheet, as well as active and passive options. And in these times that call for nimbleness, bank platforms should enable companies to easily compare, simulate, and swap between different types of deposits and investments.
Global Forces Squeeze Banks
The U.S. Federal Reserve raised the federal funds rate in December 2016, and again in March 2017, in an effort to stay ahead of inflation. The rate jumped from near zero to 0.75%–1%. However, the increasing rates make the United States an anomaly amongst rich nations. Many central banks in the developed world are expected to continue to lower their rates. Indeed, the European Central Bank and the central banks of Denmark, Hungary, Sweden, Switzerland, and Japan have all taken their overnight rates into negative territory.
The intention behind negative rates is to encourage banks to lend to businesses so that they spend their money rather than placing their funds in bank deposits, thus benefiting the real economy. An immediate effect is that these banks now incur costs when depositing money overnight. And it is inevitable that such costs will eventually be passed on to their business customers. Indeed, in Europe, a number of major banks have already initiated a pass-through of negative interest rates, affecting U.S. companies' European subsidiaries and business associates.
These low or negative interest rates mean that corporate treasurers have to hunt more widely for a good place to park their short-term excess liquidity. Not only has the current interest rate environment taken away the option of putting money on overnight deposit—as was standard practice for decades—it may also have a knock-on effect on other traditional investment options such as money market funds and sovereign bonds. It is not surprising, then, that the majority of firms globally are hoarding excess cash.
Macroeconomics is just one driver impacting corporate liquidity. Equally significant are the banking regulations introduced in the wake of the financial crisis to ensure that banks are able to weather future storms while keeping their customers' money safe. The effect has been to change banks' behavior toward different types of corporate deposits, and these changes are puzzling to anyone who fails to understand the nature of the underlying pressures on banks.
Basel III places constraints on banks' liquidity by requiring them to hold a prescribed proportion of high-quality liquid assets, or HQLAs. HQLAs are assets that can be turned into cash within a day without losing value; thus, they ensure that funds continue to be available for withdrawal in the event of a run on the bank. Currently, banks in the U.S. must hold HQLAs equivalent to 100 percent of the value of their total projected net cash outflows during a 30-day-long "stress event." In the EU that ratio is only 80 percent. By 2019, however, EU banks will also be required to hold 100 percent of these investments in HQLAs.
The immediate consequence of this requirement is that banks now prefer some types of customer deposits over others. Obliged to discriminate following the regulator's classification, banks are welcoming operating cash. They are far less interested in receiving businesses' deposits of non-operating cash, as those deposits oblige the banks to increase the HQLA assets they're holding, to protect against the non-operating cash being withdrawn in times of stress.
Treasurers Turn to Automation Technologies
The market forces and pressures on banks raise the question of what businesses should be doing with their less-favored cash, as well as the question of how they can best deploy the favored kind. The first step in answering both of these questions is to review the level of visibility into its cash flows that the company or group has, and the accuracy of its cash forecasting. This may seem obvious, but it invariably proves beneficial by giving decision-makers a better view of all their options.
A treasurer who is able to predict precisely when and where excess cash—whether operating or non-operating—will appear, and how long it can be dispensed with, will not feel the need to hoard it or put it on short-term deposit at a low (or negative) rate of return. Instead, the treasurer will be able move excess cash to another part of the business where it is needed, confident that the company will be able to recover the funds when required. Precisely anticipating short-term borrowing needs could enable the company to self-finance, rather than borrowing externally and paying fees and interest. Alternatively, the treasurer could confidently place the cash in a longer-term deposit than is traditional—for 30, 60, or even 90 days—earning a better rate of return than the company could get on cash that it needed to have available immediately.
Those with a good overview of their cash flows and reliable forecasting have better choices. Treasurers have many technology options that can help provide this visibility. With an ever-rising level of sophisticated automation, tech tools can give treasurers a truly global view of all their cash flows, providing information in nearly real time and integrating numerous data streams to create detailed and customized cash flow analyses. Additionally, centralizing control of cash management may enable companies to deploy group resources more effectively and strategically, and to manage foreign currency exposures more proactively across all operations.
Technology can also enable treasurers to automate cross-currency cash concentration, consolidating liquidity across currencies into one chosen account and base currency. Where physical pooling is either impractical or inappropriate, notional pooling may be an alternative that would allow the group to benefit from many of the perks of concentration without, for example, forfeiting the autonomy of subsidiary operations.
Those involved in cross-border operations will constantly be on the lookout for ways to optimize foreign exchange flows in cross-currency payments and collections. Technology can help here, as well. For example, treasurers may wish to hedge foreign exchange rates with an automated tool such as a rolling collar, to lock in liquidity and mitigate the volatility associated with emerging-market currencies.
Redeploy … or Invest Anew?
Using advances in automation to move money around nimbly and proactively is part of the answer to today's treasury challenges. However, technology is not the sole solution. Sometimes it is good for a company to take a step back and gain a clearer view of where the overall business is going. One approach is scenario planning, developing detailed visions of potential future cash flows based on the possible consequences of alternative decisions.
Cash management scenario planning can help a treasurer determine where the company's cash can bring the most benefit. One option, for instance, might be redeploying longer-term investments to grow the business, enter new markets, or improve efficiencies through capital spending.
In addition, many corporate treasurers are now revising their companies' investment policies to optimize their cash investments in a financial landscape that has been subject to major change. For example, due to the interest rate environment, treasury teams today may be considering longer-term investments for their operating cash than the 30-day term deposits they have traditionally used. Many companies are opting for 60- or even 90-day terms. But investment policies may need revision to allow for these longer-term investments of corporate cash.
As always, treasurers looking to balance their company's need and appetite for yield, principal protection, maturity, and risk diversification must consider the entire gamut of investment choices. Old types of investment that once fell out of fashion might gain new currency due to changed circumstances. Meanwhile, new investment options will increasingly be developed to cater to changing needs, and to allow for more favorable treatment of corporate cash under evolving regulatory requirements.
Corporate treasuries may choose to start shifting their cash reserves into mutual funds and money market funds, or even an agency reverse repo which involves investing cash with third-party banks against securities as collateral, allowing the yield to be determined by specific risk preferences. Call deposits present another option; they involve making an investment for an unspecified term with a fixed call period—producing a variable yield tied to a market reference rate—while term deposits have a fixed term and a fixed (or floating) yield.
Rather than relying on old certainties, treasury teams need to seek out individualized solutions that meet their specific liquidity needs, and they need to exploit the opportunities presented by their particular regulatory, macroeconomic, market, and investment product mix.
In order to make such decisions, treasurers should first assess their objectives in terms of yield, maturity, principal protection, and risk diversification. Then they should turn to their banking provider, which should be able to offer a one-stop platform for accessing a range of liquidity and investment products. Doing so will allow the treasurers to plan and test changes to their portfolios, assessing the impact on key metrics.
Thriving in a Radically Changed World
Managing liquidity efficiently is about far more than avoiding losses on unattractive deposits. Treasurers need to keep abreast of economic developments such as changes in central bank interest rates and bond market fluctuations. They also need to stay up-to-date on the latest banking regulations. And they need to tailor their individual toolbox to their company's fluctuating liquidity requirements.
The treasurer needs to have a revised strategy that takes into account the new environment, for which he or she may need to get buy-in from the CFO or board. In addition, the treasurer needs to be prepared to act tactically on a day-to-day basis, regularly reviewing the current strategy, the company's cash flows, and the available investment products—effectively using portfolio management techniques to manage the current account.
The financial world we inhabit has gone through a radical transformation over the past decade, and much of the previously accepted wisdom has been turned on its head. Corporate treasurers today must try to understand the interconnected banking, regulatory, and monetary policy drivers shaping their cash-investment choices. Rather than relying on old certainties, they need to seek out individualized solutions meeting their specific liquidity needs, and exploit the opportunities presented by their particular regulatory, macroeconomic, market, and investment product mix. That way, it is indeed still possible to optimize a group's liquidity management.
Seth Brener is a director and head of Corporate Cash Management Sales, Americas, Global Transaction Banking, at Deutsche Bank. Before joining Deutsche Bank, Brener spent 14 years at Chase Manhattan, where he held positions in operations, client service, and sales.
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