Strategic Treasury

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Working Capital and Liquidity Management: Safety First Losses in the US sub-prime market have had a global impact on corporate liquidity, which has driven corporate treasuries to take measures ranging from squeezing internal liquidity to tighter risk management of banking relationships. These and other initiatives were discussed during the ongoing series of thought leadership forums organised for senior Asian corporate treasury personnel by Standard Chartered Bank’s Transaction Banking team.

This article discusses fundamental changes in the way in which corporations are managing their working capital and liquidity. In many cases, existing approaches to risk, investment (in terms of both cash and new ventures) and funding have had to change radically to cope with a new and uncertain banking world.

A range of topics were explored by the attendees, such as the drastic reduction and re-pricing of bank liquidity, the diversification of liquidity relationships in order to provide a broader banking structure, and the change in expectations regarding liquidity timelines. Additionally, the article reports upon many more issues that have been discussedd at the forum, including the minimisation of trapped cash and the problem of trapped capital (particularly for corporations active in Asia), the advisory role of banks in such situations, the liquidity implications of customer settlement, and bank liquidity risk in terms of surplus liquidity.

Working Capital and Liquidity Management: Safety first

by Transaction Banking, Standard Chartered Bank

Losses in the US sub-prime market have had a global impact on corporate liquidity, which has driven corporate treasuries to take measures ranging from squeezing internal liquidity to tighter risk management of banking relationships.These and other initiatives were discussed during the ongoing series of thought leadership forums organised for senior Asian corporate treasury personnel by Standard Chartered Bank’s Transaction Banking team.

The sub-prime debt crisis has obviously had a profound effect on economic activity, which in turn has fundamentally affected the way in which corporations are managing their working capital and liquidity. In many cases, existing approaches to risk, investment (in terms of both cash and new ventures) and funding have had to change radically to cope with a new and very uncertain world.

Bank liquidity

One of the most noticeable environmental changes for treasurers over the past eighteen months has been the drastic reduction and repricing of bank liquidity. One consequence of the government bailouts of certain global banks has been the pressure on those banks to concentrate their lending in their domestic markets. In addition to this liquidity drain, there has been the more general reduction in confidence among banks, which has seen many of them radically tighten their lending criteria. Sabre-rattling by some governments over increasing capital requirements has only added to this caution.

One potentially bright spot amid the current liquidity gloom is the role of local banks.

Therefore, despite lower base rates, actual refinancing rates have increased. This in itself is bad enough, but several forum participants remarked on a further complication, namely a change in the basis upon which banks are pricing liquidity to corporate clients. The traditional convention of a margin added to a benchmark rate (such as Libor) had the virtue of transparency as well as conveniently coinciding with the way in which hedging instruments (such as interest rate swaps) were based on market rates. However, banks are now moving from ‘benchmark plus’ pricing, to cost of funds based pricing, which is making it extremely difficult for treasuries to hedge their interest rate risks accurately.

Unfortunately, for treasurers to gain a better insight into banks’ cost of funds is not a trivial task. One forum attendee remarked that some anecdotal evidence for specific banks was available and others are also pressing for greater transparency, but more formal calculation remains complex. For instance, Basel II is a significant factor in determining a bank’s cost of funds but the resources required for treasury to reverse-engineer partner banks’ regulatory cost of capital could probably be deployed more profitably elsewhere.

Treasurers are taking various steps to protect their existing bank liquidity sources. A relatively common strategy is to increase the frequency of bank contact and also the level of disclosure. The key objective in this process is to enhance bank partners’ comfort factor. Another strategy is to pre-empt the possible withdrawal of unused credit lines by drawing on them even if not immediately required. The negative margin achieved after depositing this surplus cash is seen by some treasurers as a liquidity risk premium well worth paying.

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