Liquidity Management: is Europe the new Asia?

For many treasurers, Europe has historically been a benign environment for liquidity management. In contrast with regions such as Asia or Latin America, consistent regulation and unrestricted movement of funds has made for comparatively straightforward liquidity management. However, a variety of recent and forthcoming changes, including Brexit, bank ring fencing and the second Payment Services Directive (PSD2), will make Europe far more demanding over the next few years. Nevertheless, as Adnan Ahmed, Regional Head of Liquidity for Europe, Global Liquidity and Cash Management, explains, these changes are considerable opportunities for those treasuries that act now to ensure that their businesses, banks, systems, infrastructure and processes are agile.

Brexit

Brexit represents one of the greatest challenges for European liquidity management because of continuing uncertainty over the form it will ultimately take: ‘hard’, ‘soft’ or somewhere in between. At present there is no sense of linear progression to a predictable outcome, which makes planning future liquidity structures near impossible, especially in the context of rules relating to cross border transfer payments in Euros.

For example, there may be implications for treasuries regarding the creation of intercompany positions and the movement of funds in relation to their corporate tax positions. At present, whether or not the bank account is resident or non- resident is largely immaterial and the movement of funds is straightforward. This may no longer be the case post-Brexit.

The tax implications for a particular liquidity structure, or the consequences of an entity moving funds to another entity, or to the same entity in another jurisdiction, remain unknown.

Some more advanced corporate and other client treasuries are already undertaking considerable scenario scoping to devise strategies that have the flexibility to cover the broadest possible array of Brexit outcomes. Much depends on the size, complexity and location of operations. For instance, a corporate that is mostly European-focused with minimal UK operations, but with a UK-based liquidity structure, may have more at stake in terms of Brexit outcomes than one with mostly UK-based operations.

A key consideration in Brexit preparations is that a treasury’s banking partners will be able to support the broadest range of possible contingencies if changes of bank account domicile and/or ownership are needed. Those banking partners will therefore need to be able demonstrate both network range as well as depth, plus a consultative relationship approach to devising the optimal post-Brexit liquidity strategy and structures. Furthermore, they must also be able to offer the necessary tools for corporate treasuries to have maximum visibility and mobility of their liquidity both within Europe, as well as globally.

There is one very important upside to the very considerable demands of post-Brexit liquidity preparations. Many of the other changes due to affect the European liquidity landscape over the next few years are much more definite in their outcome than Brexit. Therefore, developing processes, systems and structures that are sufficiently flexible to cope with the broad range of post-Brexit outcomes will also implicitly deliver a more general competitive edge that will be of value in tackling these other challenges.

Ring fencing

As from January 2019, major UK banks have to ring fence core retail banking from investment banking. This represents a fundamental change that affects large corporates’ liquidity management. Historically, UK banks have used the funding raised from small/mid-sized business and retail customers to fund their loan books, with large corporates being major consumers of this loan capacity. After ring fencing, that pool of deposits may no longer be available to fund this lending.

This has two significant implications: the cost of large corporates’ borrowing will increase, but so will the value of their deposits, possibly quite considerably. These pricing implications are already becoming apparent in the market place and this trend is likely to become more pronounced as January 2019 approaches.

As regards deposit rates, an important distinction is whether large corporate deposits are being placed with a ring fenced or non ring fenced banking entity and the credit rating of that entity[1]. A non ring fenced entity may be perceived as higher risk and have a lower credit rating and so will have to pay higher rates to attract deposits. However, it may be content to do this if it can deploy the resulting deposits at a better return. Therefore corporates’ treasury investment policies will need re-examining to determine what is or is not acceptable in terms of risk/reward when choosing whether to place deposits with ring fenced or non ring fenced bank entities, or a mixture of both.

The ring fencing rules are likely to drive some notable shifts in banks’ liquidity positions and therefore the rates they are prepared to pay to attract deposits. Some that were previously flush with liquidity may have to compete aggressively in the corporate deposit market to retain it and vice versa. One area likely to see appreciable change is the large corporate Euro deposit market. Previously many banks have avoided accepting Euro deposits because of the negative credit interest rates involved. However, post ring fencing, some banks may feel they are nevertheless worth attracting as it may now be possible to use the Euro deposits as a source of funding and redeploy them profitably.

From a practical perspective, this fluid situation will place a premium upon the ability to (re)deploy surplus liquidity without incurring a large additional manual workload for treasury.

Therefore, tools that provide a single automated interface where liquidity investment/divestment can be accomplished across on/off balance sheet instruments and ring fenced or non ring fenced entities adds appreciable value.

 Regulation and agility

The Second Payment Services Directive (PSD2), which largely took effect from January 13th 2018 [2], should deliver further opportunities for corporate treasuries to enhance their liquidity management agility in Europe. By opening up banking client data (subject to client authorisation) it will be possible for non- bank third party providers to offer additional services. In many respects this mimics the situation with mobile phone networks, where only a few companies actually own physical networks, but multiple virtual network operators still leverage these to provide their own separate services.

The requirement under PSD2 for banks to publish an application programming interface (API) that third party providers can use to deliver their services has important implications beyond those services. One of the most striking of these is the reduction in implementation timelines for new services. These are likely to decline significantly under PSD2 from perhaps years to just months or even weeks, and apply across a number of areas including data management/mining and payments.

This is a major opportunity for corporate treasuries to become technologically far more agile than they are today. Switching to the best provider of a particular service or product need no longer be a painful and protracted process, which also means that providers can no longer rely on inertia as a client retention technique. Nevertheless, if treasuries are to extract the maximum benefit from this, they may need to revisit their investment policy more frequently, and their own internal technology and processes will also need to be sufficiently flexible. Suitably qualified banks can assist clients in reviewing the entire scope of their investment policy, including re- examining counterparty risk policies, permissible investments and yield objectives. These banks can also help in reviewing internal treasury technology and processes and implementing any necessary changes, especially if the bank can offer in- country certified specialists in enterprise resource planning (ERP) systems and/or SWIFT.

In addition, depending on their choice of banking partner, treasuries may also have access to a new aid to liquidity agility and flexibility, in the form of next generation virtual accounts. Historically, virtual accounts have been used as a means of improving accounts receivable reconciliation by giving each customer their own specific virtual account to which they make remittances. However, some leading banks have reinvented them to include an important element of self service, whereby clients can open/close virtual accounts as they require for individual corporate entities, potentially in differing currencies. All the liquidity in the individual next generation virtual accounts is centrally visible and controllable via the single physical account that heads each group of next generation virtual accounts. By also automatically concentrating liquidity from each group of virtual accounts into this physical account, rapid and efficient liquidity mobilisation is far easier to achieve than if using multiple physical accounts. They are therefore a valuable tool for treasuries looking for an extra agility edge to cope with a rapidly changing European liquidity management environment.

2023: all change

It appears likely that by 2023 the process of managing liquidity in Europe will have changed radically. In addition to the regulatory changes outlined above, there will also be broader shifts to accommodate. There are already signs of a growth cycle developing in the Eurozone [3], so treasuries may well find themselves with considerably more surplus Euro liquidity to manage by 2023. It is also not unreasonable to assume that there will be greater political certainty regarding the final outcome of Brexit. At the same time, there is likely to be a far greater range of third party technology and service providers for treasurers to choose from by then, as well far lower barriers to switching among them.

This opportunity to move quickly and relatively painlessly among these providers is also likely to be applicable to banking relationships as well. In the past, changing banking partner might have taken perhaps three years because of the lengthy implementation times. As technology develops, these timelines may fall dramatically, making more frequent reviews of banking relationships feasible.

Despite some recent examples of protectionism, globalisation is still likely to remain a major theme in 2023, with businesses growing faster beyond their historical geographic boundaries. The internet has already had a major influence here in terms of both speed of expansion, but also the size range of entities expanding globally, with smaller companies now able to leverage the internet to establish a global presence with relative ease.

Even if just some of these changes have come about by 2023, it seems reasonable to suppose that the business environment in Europe will be more benign than it is today. However, this does not also imply that the liquidity management environment will be any more benign. In fact, partly due to the factors already mentioned, it is likely to be even more volatile and challenging. Furthermore, despite new technological advances, corporate treasuries will also have to find ways of optimising liquidity for the new business environment. Inertia is not a strategy, so to maximise any potential benefits, treasuries now need to be preparing for change by ensuring that they have the right partners to help them develop and maintain the requisite agility to cope in increasingly changeable conditions.

Conclusion: network and relationship

There is the possibility of a more benign European business environment emerging over the next five years. Nevertheless, the number of changes affecting liquidity management are likely to see the region morph from one that was once almost ‘set and forget’ from a liquidity management perspective, into something altogether more volatile. This necessitates a fundamental transformation in the way corporate treasuries approach European liquidity management.

As mentioned above, agility and flexibility are vital if treasuries are to succeed in the new environment, but points of certainty and stability are essential in helping to achieve this in terms of future proofing. Core banking relationships are a good example of this. If a transaction bank can provide comprehensive network coverage across the UK and Europe, as well as globally, then the effort required for liquidity management activities such as opening/closing bank accounts in response to external changes will be materially reduced. If that same bank also offers solutions such as next generation virtual accounts, then treasury’s workload drops by a further order of magnitude. 

Analogous to this network stability is relationship stability in the context of consultancy. Most corporate treasuries simply do not have the resources to research the consequences of every possible factor that might affect their liquidity management activities. However, a major network bank that works with numerous global corporations is able to share that collective perspective and insight to deliver a consultative relationship that supports treasury in achieving the agility and flexibility it needs. 

 Notes
^{1 Unlike small/mid-sized businesses and retail customers, the ring fencing rules do not specify whether large corporate deposits should be inside or outside a ring fence: https://blogs.treasurers.org/what-do-treasurers-need-to-know-about-bank-ring-fencing/}