A New Approach to Treasury Analysis & Liquidity Status Reporting

By Kristin Montgomery, Controller, Financial Reporting & Accounting Services Division, California Public Employees' Retirement System (CalPERS)

One of the primary components of treasury management is to ensure adequate liquidity to meet funding obligations. As pension funds across the US face increasing risks with uncertain market returns and changing demographics, the California Public Employees’ Retirement System (CalPERS, the nation’s largest public pension fund with more than $300bn  in assets) developed the Treasury Management Program (TMP) to mitigate uncertainty and provide relief to liquidity challenges. 

Part of the TMP, CalPERS’ Treasury Analysis and Liquidity Status Report is an innovative new report that helps stakeholders to understand the balance of risks and provides visibility over the financial soundness of CalPERS’ funds. The report provides a comprehensive six-month snapshot analysis of the liquidity coverage ratio (LCR) and cash flow forecast for the Public Employees’ Retirement Fund (PERF) — CalPERS' primary fund. The report is the first of its kind for CalPERS and is proving valuable in making enterprise-wide financial decisions, such as those regarding budgets and operational requirements. 

Background to the Treasury Analysis and Liquidity Status report

CalPERS created the report as part of the Treasury Management Program. The TMP was developed in response to the CalPERS Board of Administration (Board) Finance and Administration Committee request to identify a process to meet funding obligations and ensure promised pension and organisational payments are consistently met without interruption from financial or market events. In 2015, CalPERS Chief Financial Officer (CFO) presented the new Treasury Analysis and Liquidity Status report to comply with requirements set by the Board and in response to liquidity challenges, such as those that arose from the 2008 liquidity crisis. These requirements are outlined in the Treasury Management Policy, which governs treasury management principle and practice at CalPERS.

One strategic objective of the policy is to provide an integrated process for the oversight and management of enterprise cash and liquidity during normal, stressed, and crisis events. To meet this objective, CalPERS implemented a new Treasury Management Reserve Policy and developed a funding contingency plan in October 2015. The reserve policy allows CalPERS to establish and manage reserves to ensure the payment of member benefits and other obligations without interruption, while optimising the use of fund assets. The funding contingency plan defines the available asset and financial based options, the usage criteria, and the management protocols for a liquidity event. 

Constructing the report

To accurately capture and calculate the liquidity status of all funds, CalPERS needed to build a new in-house liquidity management framework with reporting capabilities. Production of the framework began in October 2015 and required a complete overhaul of the cash forecasting process. It also centralised the hub for capturing accounting information and investment data across multiple asset classes. A key feature is the system’s ability to generate liquidity status reports for seven CalPERS’ funds in normal, stressed, and crisis environments. In addition to details regarding the current liquidity health of each fund, the framework also produces forecasted liquidity coverage ratios (LCR) for the next 30, 60, and 90 days. 

The development and implementation of the framework was successfully completed in March 2016 and effectively provides a financial control that ensures CalPERS member benefits are consistently covered without interruption from financial or market events. In addition, the framework helps safeguard CalPERS against future market events that could potentially require the sale of long-term valued assets. 

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Details of the report

Each Treasury Analysis and Liquidity Status Report contains a description of the fund’s characteristics, formulas and funding sources.

The first section of the report contains graphical representations of actual month-end LCRs in normal, stressed, and crisis environments. This section manages risk by indicating whether the fund is operating at inadequate or at excessive levels of liquidity. Overall liquidity health for each month is determined by the LCR position against a pre-determined threshold. 

CalPERS followed Basel III LCR standards to validate overall liquidity health in normal, stressed, and crisis environments. LCRs are calculated by dividing total cash, assets convertible to cash, and incoming cash by total outgoing cash uses and contingent cash uses.

The funding sources in each fund are grouped into three levels based on their liquidity and order of redemption. Level I sources consist of cash and cash equivalents and Level III sources include the sale of public assets. Certain funds have access to a borrowing component and those assets are grouped into Level II. 

The stress and crisis events used in the LCR calculations were determined by analysing 17 historical market and financial events and selecting the events that had the greatest impact on CalPERS assets. The 2008 global liquidity crisis and 1987 stock market crash, also known as ‘Black Monday’, were selected as scenarios for stressed environments. Stressed environment LCRs are calculated assuming starting assets are stressed by the percentage actually experienced over 30 days during September 2008 and five days in 1987. The assets are further reduced by a transactional liquidity percentage equal to the estimated percentage of the assets that could be liquidated during a 30-day period. The crisis environment assumes a five-business-day market lockdown similar to what occurred after September 11, 2001 and the LCR calculations use only the cash available 10 days prior to the funding of member benefits.

The second section of the report includes actual versus estimated investment and non-investment cash flow activity. The cash forecasting analysis measures the accuracy of cash forecasts for funds with business activities that can result in a material impact to the enterprise liquidity. Variances, outliers, and causes of monthly fluctuations for each graph are explained throughout the report. The Treasury Analysis and Liquidity Status Report provides assurance to the Board that CalPERS has adequate liquidity levels to meet its monthly obligations and will be presented on an ongoing semi-annual basis. To see more details of the report, please visit goo.gl/e3dZSC

Stakeholder response

In March 2016, CalPERS presented its first report to the Board after a five-month collaborative effort between the CalPERS Financial Office and CalPERS Investment Office. In August 2016, a second report was presented to the Board after receiving positive feedback on the first. The second report was also expanded to include reporting for six additional funds administered by CalPERS. 

The new report has been a significant success, and provides far greater transparency than we had in the past about the overall liquidity health of the organisation to our members, stakeholders, and the Board. The reports also provide the Board with visual assurance that the policy and plan is being enforced and the payment of member benefits and enterprise obligations can be made without interruption regardless of financial markets and environmental conditions.