Basel III: The Start of a New Era in Corporate Cash Management?

A corporate panel discussion hosted by Citi and moderated by TMI

One of the most significant and far-reaching regulatory developments over the past decade has been the introduction of Basel III. Basel III is a regulatory framework that aims to increase resilience in the banking system by strengthening banks’ capital requirements, reducing market liquidity risk, and improving the ability of banks to weather sustained periods of market stress. Banks are now in the process of implementing the new requirements, with an end date of 2019 for most banks, although some are set to complete their implementation before this date. The impact of Basel III is not restricted to banks, however, as their clients will also be affected by changes in their banks’ operating model, capital and liquidity requirements.

In this feature, inspired by a seminar hosted by Citi in association with the Dutch Association of Corporate Treasurers (DACT) in November 2015, senior treasurers from three leading corporations with treasury centres in the Netherlands discuss the impact that Basel III has had on their treasury activities to date, and how they envisage that these may be affected in the future.

Sanders, TMI - How do you manage your operational flows today, and how has this been affected by your banks’ need to comply with Basel III and the liquidity coverage ratio (LCR) so far?

Janssen, Mars We have a multi-currency notional pool (MCNP) with Citi across around 25 currencies globally. Physical accounts zero balance into header accounts which are then included in the MCNP, which operates on a ‘follow the sun’ basis. As Mars is a US-headquartered company, the MCNP header account is linked into our US cash pool so that funds are available to our headquarters. Our MCNP has proved a highly convenient way of using excess liquidity to fund the business without having to exchange foreign currency balances. We reduce local foreign currency exposures by short-term lending to group companies in their home currency, and centralise exposures at our headquarters where they can be managed at a group level.

de Vos, Nielsen
So far, Basel III has not had an impact on the way that we manage our operational flows; however, we are now hearing more about the potential implications from banks and the wider market, although this is not always consistent.

Rust, VimpelCom We have a decentralised business organisation, where local treasuries have a relatively high degree of autonomy, particularly as they are located in countries with challenging regulatory characteristics. It is not possible to use cross-border pooling to upstream cash to our headquarters in most countries in which we operate. Instead, we upstream our cash using dividends and intercompany loans, with the aim of minimising our local operational cash buffer. We have a notional pool at our headquarters in the Netherlands to manage operational flows more efficiently among multiple legal entities. So far, Basel III hasn’t had an impact on our notional cash pool and our house bank has assured us that they will continue offering the product to VimpelCom.

Raptis, Citi
We are in the middle of industry-wide adoption of Basel III, in particular the LCR; there are implications for both banks and their corporate clients as banks change the way they fund their balance sheets and their operating model. Some notional pooling structures are likely to be affected, as pooling providers may find it difficult to net pooling balances, and their capital costs will increase. For example, notional pooling structures that do not have full documentation in place between participating entities will need to be formalised with intercompany guarantees etc. Certain models that capture non-LCR friendly balances may also need to be repriced.

Cunningham, Citi One of the challenges for treasurers is that regulations are pulling in different directions: under Basel III, for example, it is easier to maintain notional pooling where accounts are held by a single entity; however, new tax rules such as Base Erosion and Profit Shifting (BEPS) encourage the use of notional structures. In this situation, it is difficult to determine how best to ‘future proof’ treasury.

In the event that new bank liquidity obligations result in changes to existing methods for managing operational flows, what alternatives are you planning?

Janssen, Mars
Despite the ‘noise’ in the market, our understanding is that Basel III will not impact on our MCNP, and as such, we don’t have a defined ‘plan B’. We have engaged with Citi to discuss the potential future environment and the implications for our MCNP, and as accounts are held by a single entity, we are unlikely to experience an impact in the short term. If necessary, we could revert to swapping foreign currencies back to our functional currencies of EUR and USD as we did before implementing the MCNP, but the onus is really on the banks to propose alternatives to MCNP in situations where these are no longer feasible.[[[PAGE]]]

de Vos, Nielsen Our situation is more complicated as local entities participate in our MCNP. From the discussions we have had so far with our banks, it appears likely that we can maintain our MCNP, but the cost may be higher due to the capital implications for the bank. What is important, however, is not to look at the cost of individual products and services, but to review the whole bank wallet, as well as comparing solutions that are available from different banks.

Rust, VimpelCom
In a worst case scenario, if our notional pool is no longer available, we will most likely use a zero balancing solution instead: therefore, I don’t foresee that this issue will have a big impact on us. However, Basel III will affect us in terms of borrowing. Increasingly, we understand that banks’ ability and willingness to lend will depend on considerations such as the jurisdiction in which the lending bank is situated, whether the lending bank is a local or global, systemically important bank, the credit quality of the borrower and the wider corporate relationship with the bank. The latter will become more important as banks revise their business models under Basel III to focus on strategic rather than transactional relationships with clients.

Julia Rust mentions that Basel III is impacting on banks’ ability to lend, but what about the impact on corporate cash investment? Are you having to adjust your investment policy?

Janssen, Mars
For us, it is not Basel III and banks’ ability to accept deposits that is impacting our investment policy, but rather the negative interest rate environment. Preservation of capital is a key objective for us, which in the past we have been able to manage through an effective counterparty risk management policy. Today, however, we need to avoid erosion of value. Increasingly, therefore, we are trying to find ways to use dividend and intercompany lending to minimise balances in European currencies, and therefore reduce the impact of negative rates.

de Vos, Nielsen
Basel III does not impact substantially on our investment policy either as we tend to use surplus cash to pay down debt and return capital to our shareholders.

Rust, VimpelCom
We invest mostly in money market funds (MMFs) and short-term deposits. As a result of Basel III, short-term deposits are becoming less attractive for banks and we already start to experience this through low rates or inability to accept deposits over month end to preserve ratios for Basel III reporting. As an alternative, banks are starting to introduce new products that offer better yield and greater flexibility for customers, e.g., ‘evergreen’ deposits of varying sorts. These have no maturity date as such, but are callable at predefined tenors. We can hold these deposits as a cash-equivalent instrument on our balance sheet without requiring changes to our investment policy, while they also meet banks’ liquidity requirements.

Janssen, Mars
Banks are also introducing products such as 32 day deposits which offer a more attractive yield than deposits up to 30 days; consequently, although we are not formally revising our investment policy, we are reviewing whether or not to utilise these new products where they offer the opportunity to enhance our yield.

Raptis, Citi
In the current environment, there are two types of liability (client deposit) sought by financial institutions: deposits that are linked to transactional activity, and deposits with a contractual maturity significantly beyond 30 days. This is because banks need to demonstrate that they have liquid assets sufficient to survive a 30 day stress scenario. Deposits with a maturity beyond 30 days at the time of such an event could not be exited by clients, and are therefore worth more to the bank than shorter term deposits, which is reflected in what it is prepared to pay. With regards to the negative yielding currencies that Joris mentioned, treasurers need to take a broader view of liquidity, and make use of a variety of instruments including both pooling and cash investment. For example, by pooling cash effectively across the business, they can create debit positions in the negative yielding currencies that are offset by balances in higher yielding currencies, therefore not only eliminating negative rates by generating positive interest income at net zero positions. There are also opportunities to use trade instruments to boost the return on surplus cash, such as paying suppliers early under dynamic discounting programmes.

One of the points that Bob de Vos mentioned earlier was the importance of looking at bank relationships holistically, rather than individual products. To what extent is Basel III prompting a review in the way that bank relationships are managed, in particular moving from transactional to more strategic relationships?

Janssen, Mars
Building fewer and more strategic partnerships with partner banks has been a policy for many years at Mars, and we routinely review these relationships. Basel III has emphasised the importance of this approach, looking not only at silos of activity, such as cash management, financing etc. but the value of the relationship as a whole, both to us and our banks.

de Vos, Nielsen
We started on a programme to rationalise banking partners about seven years ago, but as we are an acquisitive business, this is an ongoing process; however, we are always looking to migrate accounts and banking activities to our preferred banks wherever possible.  

Rust, VimpelCom
As a result of an ambitious acquisition strategy in the past, VimpelCom currently has around 140 banking relationships worldwide, more than 1,000 accounts and $9bn of debt. Refinancing has been and will remain a key priority. To ensure that our partners are able to support us in the long term, we have to make this relationship mutually beneficial by allocating a fair share of the wallet to each of our relationship banks. We are building a systematic framework of our banking relationships as part of our treasury policy to identify all the activities, costs and credit commitment of each bank as a tool to rationalise our banking partners as far as possible, although this is not always feasible given our activities in regions such as Eurasia, and emerging countries such as Algeria, Pakistan and Bangladesh. Basel III definitely accelerates this process as banks are reviewing their business models and customer relationships too.

Janssen, Mars
It is not only Basel III that is impacting bank relationships, but also ‘know your customer’ (KYC) regulations. We have seen a notable change over the past few years in the amount of time and resource we need to put into providing documentation to banks to meet their KYC obligations. If you have a few, strategic bank relationships, KYC compliance is easier when setting up new accounts, defining pooling structures etc. but it is becoming a more important consideration.

de Vos, Nielsen
This is absolutely our experience too: providing KYC documentation is definitely becoming more onerous.

Rust, VimpelCom
The problem is that every country is developing its own rules, as well as banks adopting different policies and requiring different formats. The resource required to provide this information, and therefore treasury’s costs, are therefore increasing. We are aware that some software vendors are introducing tools to help standardise and streamline the KYC documentation process, which is a potentially interesting development, but governments and banks need to work together to avoid adding to the burden of doing business. At the moment, it is not always clear which are requirements, which are guidelines, and which are banks’ internal policies.[[[PAGE]]]

Janssen, Mars
Absolutely, as the cost of compliance increases, banks’ ability to conduct KYC efficiently is becoming an important differentiator.

Helen Sanders, TMI
Thanks to our panel for a very interesting discussion. For me, one of the most important observations is the importance of taking an integrated approach to liquidity, such as across both cash pooling and cash investment. Similarly, it is interesting to see how regulatory change, both Basel III but other regulations too such as KYC, are influencing the factors that contribute to successful bank relationships, and the criteria by which treasurers, as well as banks, measure the value of these relationships.

Thank you to all of our panellists, and to Citi for hosting this valuable session.