Cash & Liquidity Management

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What Matters Today #4: Creating a Sustainable Liquidity Strategy During this series of TMI articles, J.P. Morgan has explored some of the priorities for corporate treasurers that have emerged since the financial crisis. Many of these, such as risk management, the need for efficiency and the value of bank relationships, are not new but have been given greater priority as the markets have become constrained.

In this article, the focus is on another issue which, while a universal theme for treasury, has become far more compelling: liquidity management. While it has always been a priority for every treasurer, a new set of concerns has arisen, coupled with an increased focus from the CFO and the board. This article explores these concerns and how treasurers, in partnership with their banking partners, are responding.

What Matters Today

#4: Creating a Sustainable Liquidity Strategy

by Tristan Attenborough, Managing Director, Liquidity & Investment Products Executive, EMEA and Margaret Yao, Managing Director, Asia Pacific Head of Liquidity Management & Investment Products, J.P. Morgan Treasury & Securities Services

During this series of articles, J.P. Morgan has explored some of the priorities for corporate treasurers that have emerged since the financial crisis. Many of these, such as risk management, the need for efficiency and the value of bank relationships, are not new but have been given greater priority as the markets have become more constrained. In this article, we look at another issue which, while a universal theme for treasury, has become far more compelling: liquidity management. While it has always been a priority for every treasurer, a new set of concerns has arisen, coupled with an increased focus from the CFO and the board. Here we will explore these concerns  and how treasurers, in partnership with their banking partners, are responding.

Changes to the liquidity landscape

Before the crisis, corporations pushed the risk-return spectrum in search of higher yields with some serious consequences. In reaction, many organisations sought safe harbour in traditional, risk-free investments, became more focused on counterparty risk and on moving liquidity to well-capitalised banks. Capital preservation, risk management and ensuring access to liquidity and funding are the dominant themes, only re-emphasised by the debt crisis in Dubai.

Confidence amongst market participants in the interbank market is a major driver of credit availability.

Government and central bank intervention, both explicit and implicit, has changed the risk management picture considerably. Interest rate markets have become dislocated, with unprecedented low investment rates, while borrowing rates remain high. Some banks have changed their strategy or exited markets altogether, creating new banking risks for treasurers in addition to the repricing of credit. Weaknesses in the interest rate markets, contrasting with strong equity performance, create new questions for treasurers as to how cash should be invested.

In such a rapidly changing market environment, treasurers do not have the luxury of time to determine whether or not a liquidity strategy is proving sufficiently resilient to withstand market pressures. If the low interest rates we have witnessed in major currencies were reflected on both sides of the balance sheet there would be fewer problems, but the cost of funding remains high, even for those for whom funding is accessible. Confidence amongst market participants in the interbank market is a major driver of credit availability, and it is taking some time for confidence to return to pre-crisis levels. While the US dollar has shown a more rapid recovery than other currencies, events in the United Arab Emirates have skaken confidence. Inevitably, any change in market confidence, positive or negative, will continue to have an impact in terms of the availability and cost of credit.

Treasury responses to market challenges

The new market landscape creates a variety of new questions and issues for treasurers; for example, comparing the value that is gained from bank relationships, including providers of payments, banking services and investments, with the risks posed by these providers. Secondly, with low yields creating a drag on financial performance, except in the equity markets, how can conservatism in investment decisions be aligned with the need for competitive performance? In our discussions with clients, we are seeing a variety of clear trends in how treasurers are responding to the new market environment:

Simplifying banking relationships. With these myriad challenges, treasurers are keen to simplify their business as far as possible, and reducing the total number of bank providers and accounts where it makes sense to do so is one way to find efficiencies and increase cash visibility. Treasurers are making a clear choice for providers with whom they are familiar and have long-standing relationships. Rationalising banking partners is a major step towards enhancing cash and liquidity management, including identifying where cash is located and how much control treasury has over this cash. This is difficult for companies operating in regions such as Asia, Latin America and Africa though, where currency and regulatory restrictions exist, as well as greater variance in banking capabilities. However, bank partner consolidation (where it can be achieved) can establish greater cash control by enabling  the treasurer to aggregate cash and optimise the use of liquidity  for internal funding, investment optimisation and debt reduction.

Defining investment priorities. Treasurers are re-evaluating investment policies to be more explicit about the relative priorities of yield, liquidity, credit and operational risk. In the case of counterparty risk, risk management has become more proactive, evidenced by less reliance on credit ratings in favour of more internal evaluation and the desire for greater visibility over investments, such as the assets held in a money market fund. In operational risk terms, if an investment strategy which appears ideal on paper requires new resources, systems or reporting overheads, it may not be feasible in practice. As a consequence of this re-evaluation, treasurers are selecting vanilla investment products such as deposits with highly-graded banks, AAA-rated money market funds and repos based on government debt.

Focusing on core competencies. Treasurers are refocusing their efforts on their core competencies, a trend which extends across the business landscape, with more willingness to outsource non-core activities. Treasurers are also reviewing their providers of core services, such as technology, outsourcing services, etc., to ensure that they are in a position to provide continuity of service.

These trends are comparable across all regions, although there are some differences in more highly-regulated markets such as in parts of Asia. Many treasurers have focused on increasing the resilience of the finance function and transparency over cash flow. This is particularly important in an environment where issues that may be taken for granted in Europe and North America, such as daily visibility over bank account balances, may be more difficult to achieve. We are seeing corporate clients focusing not only on cash management, but taking a more holistic approach to working capital management. The foundation for this is working with a bank provider who can help accelerate collections, make payments and enhance the cash conversion cycle, but also help integrate other cash flow sources from non-traditional areas such as the procurement or supply chain offices. The banking partner should also be able to support the company’s funding and investment needs, both in-country and cross-border.

From an investment perspective, most treasurers focus on bank deposits, particularly as many countries in Asia have deposit insurance schemes. Therefore, the concept of counterparty risk differs from other parts of the world, with more of a focus on bank concentration and avoiding excessive reliance on a single banking partner.

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