A Forward-Looking Approach to Cash Management

An interview with Matt Jones, Managing Director, Cash Management Group, BlackRock

Basel III has been discussed extensively since the Accord was first unveiled in 2010 as a response to the global financial crisis of 2008-9. It is only now, in 2015, however, that the impact of some of the key features of the new regulations, such as the liquidity coverage ratio (LCR), are becoming tangible for corporate treasury practitioners involved in day-to-day cash management. In this interview, Matt Jones, Managing Director in BlackRock’s Cash Management Group, talks to editor Helen Sanders about how corporate treasurers should be preparing for Basel III and other regulatory changes.

Why should treasurers prioritise Basel III now given that the LCR, for example, will be introduced gradually over the next four years?

Treasury practitioners and other finance professionals involved in the management of their firm’s balance sheet cash will increasingly feel the impact of Basel III over the coming months and years, if not already. This has probably already started to materialise in their dealings with larger international banks who will be the first to comply with new balance sheet requirements. For example, some major banks have for some time been highlighting the impact of the LCR, a key element of Basel III, with their clients, and explaining how receptive they may be for certain types of cash, such as operating and non-operating balances. The LCR will take effect in 2015 with a gradual increase in the required ratio each year until 2019.

What impact will LCR have on corporate investments?

Currently, bank deposit products are the most common liquidity investment instruments in use by corporate treasurers. However some types of deposit, such as non-operating cash, will be less attractive to banks in the future. This may lead to lower rates offered, or less flexible features around term maturity products. Alternatively, banks may charge clients to hold balances or stop accepting deposits altogether.

The LCR will take effect in 2015 with a gradual increase in the required ratio each year until 2019.

Another challenge arising from Basel III for corporations is that under the Net Stable Funding Ratio (NSFR) requirements, banks will be pushed to seek longer-term deposits to meet their funding obligations; while, conversely, corporate treasurers prefer shorter-term deposits to meet their working capital and liquidity management needs. Consequently, many treasurers may need to find alternative or supplementary investment products and instruments to meet their liquidity and security requirements, and consider a wide range of cash investment options in the marketplace.

Will all companies be affected?

Basel III is an industry-wide regulation and, as such, all companies need to consider its implications. However, a significant effect of Basel III is that banks will increasingly take a holistic view of the profitability of their client relationships, so their appetite to take on the deposits of a particular client will be influenced by the value of other activities that they undertake with them. Many companies have multiple relationships of varying depths in their banking group, and each bank may have a different appetite for cash deposits, depending on the profitability they expect to derive from the client. There is also  a fundamental difference in how banks will differentiate between customers in the financial and non-financial sectors. For example, hedge funds and private equity firms are already finding that their deposits are less attractive to banks than non-financials or industrial firms given that financial sector firms provide less attractive deposits to banks under the LCR framework.

What should treasurers be doing now in preparation?

Treasurers need to keep up to date, not only with the changes that will result from Basel III, but also other regulations that will impact the availability of other types of short-term investments. For example, changes to the SEC rules for money market funds (MMFs) in the United States will impact how investors use MMFs, with new products beginning to emerge as we approach the SEC’s 2016 final implementation date for changes to the Rule 2a-7 regulations governing MMFs. In Europe, new proposals have recently been released for MMFs offered within the European Union that, when finalised, may also have a significant impact to the international MMF industry.  A notable, and likely, impact of MMF reform in the U.S. and Europe is that the supply/demand dynamics within the short-term fixed income markets may be exacerbated. 

Government securities, including U.S. treasuries and German bunds, will continue to be highly sought after by a wide range of institutional investors, including banks and MMFs. As these new regulations continue to impact the availability of short-term investment options, it will be important for treasury practitioners to continue discussions around liquidity management with both their banking and asset managers, while being mindful of the constraints and opportunities that their company’s Investment Policy Statement provides. For example, some companies that currently invest in prime MMFs in the US could decide that the new products and instruments that emerge in response to new regulatory requirements will meet their cash investing needs, but may need to adjust their investment policy documents to reflect them as permissible investments.

Finally, while yield may have been a lower priority than principal stability and liquidity for many corporate investors during the aftermath of the crisis, the prolonged period of low interest rates means that yield is now emerging as a more frequently expressed concern, although still not to the detriment of security and liquidity.  With these extensive shifts in regulation and markets, greater demand for higher yielding cash investments, and the desire to maintain the benefits of safety and liquidity, corporate treasurers may need to review their investment policy documents and consider incorporating different types of instruments that they may not have considered in the past.[[[PAGE]]]

Do corporate treasury departments have the expertise in-house to invest in, and manage new instruments?

In many cases, yes, and today many corporations take a very sophisticated approach to managing cash, including tracking various risk indicators using transparency tools and other reporting that have become features of the cash marketplace. Not all treasury departments are large or complex enough to require specialist investment resourcing, while others have the right expertise, but lack time. These companies have typically relied on their asset managers and banks for advice, or invested in products such as prime MMFs that effectively outsource investment decision-making to the fund manager. As the new cash investing landscape emerges, treasurers may need to review the resources within the department to determine whether additional resourcing and skill sets are required.

What new instruments do you expect to emerge as a result of the regulatory and market changes that you have described?

This is an area of huge focus for asset managers and banks at this stage, and although  new products will certainly emerge, and are emerging, we are still relatively early in the cycle.  However, as mentioned previously, treasurers need to consider today whether their investment policy is sufficiently flexible to support the different permutations that are likely to emerge. Treasury practitioners will need to maintain an active dialogue with their asset manager and bank partners to understand and assess the new products that are offered to them.

In addition to newly emerging products that will be prompted by regulation, corporate investors should also be looking at instruments that are already well-established, but that they may not have considered in the past. For example, in the asset management space, separately-managed accounts (SMAs), short duration mutual funds and exchange traded funds (ETFs) may offer particular opportunities, although there may need to be both investment policy guidelines and operational changes to support their use for balance sheet cash investment purposes.

Reliable cash flow forecasting will be essential for every treasury department in the future, both from a financing and an investment perspective

One of the requirements that is often discussed is the need for enhanced cash flow forecasting to support a more segmented approach to cash investment. Would you agree?

Absolutely, we have seen treasurers prioritise this for some time, and reliable cash flow forecasting will be essential for every treasury department in the future, both from a financing and an investment perspective. In particular, treasurers need to be in a position to segment their cash into working capital, core and strategic cash (or primary, secondary and tertiary) as a basis for maximising the use they source from their cash.

Some treasurers will be working with asset managers for the first time as they supplement their deposits with other investment instruments. What should they be looking for in an asset manager?

There are a number of large, well-established asset managers operating today that offer extensive choices for cash investors, combined with considerable depth in portfolio management, trading and risk management resourcing and experience. Treasurers need to develop relationships with their asset manager partners and ensure that they provide the levels of partnership, servicing and transparency that are consistent with the specific needs of their business. Importantly, building effective long-term relationships is key. Treasurers should be comfortable with the individuals and organisations they deal with, in addition to being comfortable with the products and services they offer.

Basel III, together with other regulatory and market changes, will have a profound effect on all market participants. Treasurers therefore need to be prepared and keep communicating, in order to avoid surprises and ensure that they can continue to manage their cash in line with the company’s risk appetite and liquidity requirements.