Cash Management in a Credit Crisis:
A case study
by Helen Sanders, Editor
Every treasurer has been forced to review how they manage their cash and liquidity since the crisis first struck. In this case study, we use a real-life example of a global insurance company and explore how treasury has dealt with the changing marketplace.
Cash management background
As an insurance company, the firm has substantial operational cash flow together with fiduciary money owed to insurance carriers. With such high cash balances managed by the company but owed to third parties, the financial and reputational risk of counterparty default is huge. Cash management and short-term investment is a priority for treasury, and principle preservation is the primary investment objective.
With many of the banks experiencing a downgrade in credit rating, treasury is increasingly finding that it needs to spread its bank exposure risk. This is easy to do for short-term investment activity such as deposits, but it becomes more difficult when it comes to cash management. Corporates need to make decisions about the banks they want to work with based on those that are most likely to be around in the future. Like many other firms, the company has needed to focus carefully on where to place the company’s cash. Even in situations when a national government has stepped in to support a bank, and not every bank can be bailed out, it could easily take three to four months to retrieve the cash, creating potentially serious liquidity problems, FX risk and a loss of return over this period. A company in this position may have to borrow to cover the liquidity gap or lose out on business investment opportunities.
Treasury has considered government securities as investment vehicles; however, these are typically only issued in three currencies which normally create the fewest difficulties. It uses money market funds (MMFs) in Latin America, Europe and the United States. It is important to be familiar with the investment portfolio in each fund, so treasury receives regular updates on fund assets and reviews both individual holdings and asset classes to ensure that there is nothing of concern and that decisions comply with internal investment policies.
Corporates need to make decisions about the banks they want to work with based on those that are most likely to be around in the future.
Challenges remain in Latin America and Asia, where there are fewer repositories for local currencies. Treasury is looking at money market funds in Asia in recognition of the benefits of a diversified, high quality investment product, but this involves seeking regulatory approval to place client money in these funds. The same issues apply to Middle East and Africa, and treasury is working to address these needs as well.
Implementing notional cash pooling
Cash pooling has been a significant way in which the company has leveraged its group cash position both before and during the current crisis. The company has had in-country cash pools in place for a number of years across Europe. In the US, treasury has established a daily sweeping structure, allowing for centralised investment activity of US cash balances.
Outside the US, the situation has been more decentralised, with some countries maintaining local autonomy, resulting in external borrowings and trapped cash in-country. One of treasury’s objectives is to repatriate funds more effectively and gain greater control over the global cash position. To achieve this, the company has implemented a multi-currency global notional pooling arrangement. An important element of this is the ability to allow self funding, provide cash visibility, and centralise the management of surplus cash. The pool is now functional in 50 countries across 25 currencies. Furthermore, as central banks remove some of their countries’ fiscal constraints, further countries may be added in the future in either their functional or non-functional currencies.
One of treasury's objectives is to repatriate funds more effectively and gain greater control over the global cash position.
This structure was not easy to implement, and initially, business units were worried that they would lose autonomy over their financial management, but these concerns have not been justified. Local finance departments still manage their day-to-day bank relationships and cash management, but have access to cash internally at a known benchmark rate based on a recognised market index, rather than having the uncertainty of trying to borrow externally. Business units which are net investors benefit from market-based overnight returns, and cash remains within their own accounts. As people came to understand the structure more fully, they also recognised the time savings which allowed them to concentrate more on their core business. Treasury uses their bank’s system for payments. For example, a depositor will put in a credit advice for the amount it wishes to deposit, to which an overnight return is applied on receipt by treasury. The system then treats the credit as an overnight rolling deposit and applies interest accordingly. When cash is required, the business unit can make a payment request which is processed by treasury and treated effectively as an overdraft position when the account balance goes negative.