Growth Entails Owning Your Cash Position

Treasury must reassess structures, processes and its choice of banks to optimise cash

by Fiona Deroo, Head of North America Liquidity and Investments, Bank of America Merrill Lynch

According to the Bank of America Merrill Lynch 2015 CFO Outlook survey, CFOs are confident about the US economy and anticipate growth in their sales, workforce and companies in 2015. For treasury, this return of confidence and related growth necessitates a renewed focus on visibility, control and optimisation of cash. To that end, the fluid geopolitical and macro-economic outlook, and the evolving implications of banking regulations, require treasury to reassess its structures, processes and people.

Account structures, global cash concentration and liquidity structures, including end-to-end working capital solutions, are at the heart of treasury’s functions. Before embarking on any growth initiative, it’s important to take a fresh look at all treasury operations to identify gaps, reduce risk and costs, and enhance synergies across the organisation.

Leveraging a global overlay bank

For treasurers managing liquidity globally, gaining visibility into global cash positions is key: the provision of solutions to achieve these goals is the critical function of a transaction bank. Corporates that operate internationally usually work with multiple banks, either through necessity (because their core bank does not operate in a certain geography) or by design (to reduce counterparty risk or to maintain bank relationships in order to have access to credit).

Working with multiple banks can reduce visibility and control of funds due to lack of systems synergies and multiple platforms. To overcome these challenges, a global overlay bank is often used to deliver a single, comprehensive view of liquidity while facilitating greater control.

Centralised control of liquidity gives treasury strategic flexibility in relation to investments, counterparty risk management, debt repayment and foreign exchange (FX). As a result, it can respond rapidly to changing market conditions or deploy liquidity in support of business needs.

While overlay structures are invaluable to corporates that work with multiple banks, they should not remain static. They can only fulfil their objectives if they are regularly updated to reflect changing operational requirements and market realities. Many companies amended their overlay structures during the financial crisis to address counterparty, country- or FX-specific risk. However, since bank and country ratings have continued to change, ongoing reassessment is necessary.

Treasury must also regularly review its payments and receipts structures, which play a critical role in achieving visibility of global liquidity. An efficient payables and receivables structure should reflect the company’s broader working capital strategy. Corporates should seek advice from their banks about how emerging trends such as payment-on-behalf-of (POBO) structures can be used to achieve their liquidity objectives. An overlay bank can also offer electronic payables or new mobile solutions, for example, to minimise manual and paper-based processes and maximise automation and straight-through processing to improve efficiency.

Automating liquidity structures

The effectiveness of corporates’ cash concentration improved dramatically in the past decade as the importance of cash to the organisation increased. However, many companies continue to have pockets of liquidity in entities or countries outside their cash concentration structures. This cash may be left in country accounts for legitimate reasons, such as to make a tax payment in future months. However, there is no reason why cash cannot be put to effective use in the months before it is required to pay a tax bill.

Effective cash concentration requires automation to eliminate manual movement of funds, improve efficiency, reduce paperwork and create opportunities to aggregate cash more effectively – not least by maximising cut-off times in various country accounts. The resulting benefit is the potential for a corporate to increase yield on these funds. Automation also gives treasury greater flexibility to alter its concentration or pooling structures if the market environment changes rapidly.[[[PAGE]]]

Companies also need to consider where their cash is concentrated. Concentration – either by physical cash sweeping or notional pooling – typically occurs at various levels throughout the organisation, such as nationally, regionally or globally. However, many companies’ structures have sub-optimal concentration points. By reassessing existing concentration structures, liquidity management can be improved dramatically.

Liquidity management is complex and reworking structures is a daunting task given the documentation involved. However, companies do not have to embark on wholesale change to improve liquidity management. Instead, treasury can simply perform an audit to verify that recent regulatory and tax changes are taken into consideration. For example, in recent years rules relating to movement of China’s renminbi have been reformed while a free trade zone has been created in Shanghai, making it easier to include that country’s cash in a regional pool. Corporates can also use an audit as an opportunity to determine whether they can leverage notional pooling arrangements in countries where liquidity is trapped because of currency restrictions.

Similarly, an audit of liquidity structures should check that legal entities created in recent years – as the company has expanded organically or through M&A, for example – are incorporated into appropriate pools. Redundant or high-risk entities exposed to volatile FX, for instance, should be considered for removal.

Monitoring geopolitical and macro-economic conditions

While CFOs are increasingly confident about the prospects for their companies and the broader economy, the geopolitical and global macro-economic environment remains volatile. Treasury should consider assessing the numerous short-term and long-term risks faced by the company – such as volatility in the Eurozone or escalating conflict in the Middle East – by constantly monitoring events and ensuring they have strategies to address the most likely scenarios.

Corporates need to overcome their reluctance to change forecasting practices

Short-term changes, such as the move by the European Central Bank in June 2014 to cut a key interest rate below zero, have significant implications for treasury management. Usually the aims of cash pooling are to maximise interest yield and minimise short-term working capital cost. Negative rates make the first objective challenging but the second remains valid: treasury should still seek to expand liquidity structures across Europe, where possible, to maximise self-financing by cash pooling.

On a longer-term basis, the increasingly strategic role played by treasury, which often provides risk assessment for the business in new markets, for example, means that it should look beyond current events to consider the business’ response to evolving trends. The growth in the size of the middle class in many emerging market countries, for instance, will increase demand for consumer products, healthcare and education. By understanding the challenges of entering such markets, treasury can take a proactive role in supporting operations.

Gathering reliable and accessible information about geopolitical and macro-economic conditions can be difficult. Treasury should seek support and insight from its banks so that it understands changes in the risk environment and the likely implications for treasury and the business.

Improving forecasting

While global cash concentration and liquidity structures have improved immeasurably in recent years, one closely linked discipline, forecasting, has been neglected.

Many multinational companies continue to forecast using spreadsheets, and, as a result, their forecasts often fail to include all parts of the business. Given the manual nature of spreadsheet forecasting, it is error-prone and time-consuming – forecasts are often redundant by the time they are completed. Such forecasts provide few opportunities to exploit available cash for investment purposes.

Effective concentration strategies can lead to better forecasts. Once treasury has visibility into working capital and liquidity, cash flow forecasting becomes more straightforward. Corporates need to overcome their reluctance to change forecasting practices – forecasting should not require significant investment. Indeed, companies may already have existing functionality in their enterprise resource planning system. Similarly, a company’s global overlay bank should offer proprietary forecasting models or offer templates and tools for forecasting.

Counterparty selection remains a priority

The banking sector continues to undergo significant change, not least because of new regulations being implemented and the different implications for banks depending on their size and location. Consequently, it is advisable for treasury to take a fresh look at counterparty selection, and confirm the list of acceptable investments and counterparties remains aligned with its investment policy.

In the US, the liquidity coverage ratio (LCR) under Basel III, which requires banks to hold high quality liquid assets (HQLA) to offset cash outflows in a liquidity crisis, will have divergent impacts on banks depending on their size. It will therefore affect pricing that different sized banks will be able to offer: smaller banks (below $50bn in assets) will have no HQLA requirements on deposits or liquidity facilities.

Treasury should consider assessing whether potentially higher rewards are commensurate with the additional risk of these smaller counterparties, which are subject to a lesser level of stability requirement under the new regulatory environment. It must also take into account the broader relationship it has with its banks, the services they provide and the level of commitment they show towards helping the company to achieve its strategic goals. Indeed, changes in bank regulations should prompt treasury to focus more intensely on the strength of its relationship with its banks.[[[PAGE]]]

While companies must be careful not to over-concentrate their treasury operations with one bank – contingency remains important – by having fewer strong banks, treasury can achieve greater visibility and control, while reducing risk and cost through managing fewer counterparties and reporting systems. Consolidated banking relationships not only offer simplified solutions, but also help a company achieve its goals by having a deep understanding of its business strategy.

Choosing the right bank to fulfill this role is essential. Corporates need to work with a bank that offers a global platform to achieve standardisation and efficiency. A bank should also offer best-in-class liquidity solutions, in order that cash is in the right place at the right time and can be used effectively. A broad range of investment options should also be available, so that yields can be enhanced where possible. Equally important is on-the-ground expertise, especially in emerging markets, which are a key area for corporate expansion and often more challenging to operate in.