Published: September 01, 2009
The next few years look set to usher in major changes in the way in which corporations manage their global liquidity. While some of the factors likely to drive these changes have been present for a while, the economic environment plus recent developments in regulation and technology will have a significant impact too. Swee Siong Lee, Global Head of Liquidity Management, Transaction Banking at Standard Chartered, examines how treasuries may need to revise their global liquidity management strategies in the light of these developments.
In the current credit-constrained environment, corporations are understandably focusing harder than ever on maximising the efficient usage of their own internal liquidity. Accomplishing that against a static backdrop is challenging enough, but looking ahead there are several likely changes to the liquidity management environment – both positive and negative – that will also need to be considered and accommodated.
Exchange control regulations pose a major challenge to corporates’ global liquidity management strategies, by restricting either the extent to which corporates can sweep funds centrally, or to which they can notionally pool balances residing in multiple locations. Recent years have seen a gradual relaxation of these regulations in many markets, including some of the fastest growing such as China, Thailand and Korea. In general, regulators in these countries have become increasingly aware of, and comfortable with, the range of liquidity management techniques used by the most sophisticated multinationals. In addition, corporate treasuries have typically been relatively conservative in how they operate within existing regulatory constraints, which has further helped to foster more relaxed regulation. The net effect has been that optimising global liquidity has gradually become less onerous from a regulatory perspective.
Exchange control regulations pose a major challenge to corporates' global liquidity management strategies.
However, there are limits to this benign scenario. More tightly regulated jurisdictions will still remain cautious about an activity that in their eyes has the potential to compromise their national interests in the form of tax and monetary policies. The economic downturn is only likely to increase this caution; like corporates, governments need cash, and reduced economic activity will be reducing their domestic tax take. Therefore losing potential tax revenues to multinationals’ global liquidity strategies is undesirable, both financially and politically.
On that note, the timing of a recently re-proposed piece of US legislation – the Stop Tax Haven Abuse Act – is probably not coincidental. Many of the key elements of this bill of 2 March relate to an entity referred to as an ‘offshore secrecy jurisdiction’, with both Singapore and Hong Kong defined as such. Other proposed US legislation seeks to limit the deferral of tax payments through the practice of keeping taxable income offshore.
These pieces of proposed legislation are broadly drafted, but indicate the resolve of the new US administration to reduce significantly tax revenue leakage from US individuals and corporations. If passed, there is growing concern that in their final form they may hamper the competitiveness of US multinational corporations operating internationally. From a global liquidity management perspective this could represent a significant stumbling block (in terms of economic benefit) to US headquartered companies setting up Asia Pacific treasury operations and cash pools in two of the most important Asian financial centres. [[[PAGE]]]
Whether or not the proposed US legislation is a harbinger of a flurry of similar legislation from other countries remains to be seen. Nevertheless, even if only a few key jurisdictions follow suit, the environment in which global liquidity management solutions operate will become appreciably tougher.
Suitably qualified banks have an important role to play in alleviating this situation. Those that have their own strong local network in more tightly-regulated markets are well-positioned to offer support, as they will have the advantage of close contact with regulators in those jurisdictions. On the one hand, this means they are likely to have early insight into regulatory trends and probable future changes. On the other, their regulatory contact allows them to predict more accurately what will be practically acceptable in terms of liquidity management structures. The net result is that they are able to deliver valuable regulatory insights to corporations (re)designing their global liquidity management strategies.
Global liquidity management should benefit from the investment certain banks are making in infrastructure and technology. However, recent events unfortunately mean that some previously prominent cash management banks will be too capital-constrained to do this. Fortunately the few banks capable of such investment are building global liquidity management platforms that can (within tax and regulatory limits) provide cross-border and cross-currency solutions.
The key differentiator for international banks will be how effective thier solutions are utilising liquidity trapped in highly regulated markets.
Such global functionality will enable multinational companies to utilise their global liquidity more seamlessly. A case in point would be where an international bank is able to structure solutions that are pan-regional in nature. This is already commonplace for non-regulated markets; for example, the physical concentration of cash from Singapore and Hong Kong to the US. Therefore the key differentiator for international banks will be how effective their solutions are at utilising liquidity trapped in highly regulated markets.
Non-bank treasury technology providers also offer bank-neutral cash management modules which complement the banks’ liquidity management solutions. These do not provide balance and interest offsetting on a notional basis and have to rely on bank payment initiation to ‘sweep’ funds. However, they do provide robust cash visibility and in-house banking functionality to track internal lending or netting. Looking forward, expect banks to continue enhancing capabilities in the areas of cash visibility, reporting and forecasting. How these will match up against the existing offerings of the non-bank providers remains to be seen. Current market interest is focused on how neutral a bank-provided platform will be and how seamlessly it will be able to consolidate and present information from multiple sources. In the aftermath of the current financial crisis, when corporations reconsider the merits (or demerits) of a single global cash management bank, this may well be the main limitation of such bank-provided treasury management platforms.
In terms of regulatory capital, one of the most expensive products banks provide is an overdraft. Under current market conditions, where banks are under pressure to make the most efficient use of their available capital, this is likely to prompt many of them to review their policy of extending overdraft facilities to support notional pooling.
At present, corporates operating a notional pool in a jurisdiction such as Singapore or Hong Kong often use a structure that allows the global treasury account to draw down the net pool balance of all the individual entity accounts. From a corporate perspective, this has two main advantages:
Unfortunately, from a bank perspective this represents the worst of both worlds: a large overdraft line that is extremely expensive in regulatory capital terms is being provided – free of charge. As a result, banks are likely to be rethinking their support for these ‘net-zero’ notional pools. At the very least, they will be keen to ensure the legal enforceability of rights of set-off and cross guarantees so they are able to achieve balance sheet set-off for their own regulatory reporting and capital efficiency. This is not a trivial process and it becomes especially challenging when legal entities from multiple different jurisdictions are involved in the same notional pool.
It seems probable that banks will also be looking to cover the costs associated with notional pooling overdrafts. Apart from actually charging fees, another possibility would be to allow only partial offsets – in effect, applying a ‘haircut’. Under this model, a corporation might have a USD100m surplus but would only be allowed a debit offset on this of USD80m. It would then pay overdraft charges on any funds that it wished to draw above that level.
[[[PAGE]]]
The ‘Holy Grail’ of global liquidity management is nothing new. The concept is simple – corporations have multiple accounts in multiple currencies and multiple locations. Should they require liquidity in a specific market, they should be able to draw on a ‘facility amount’ in any currency up to the notional pool of all the balances in the group of accounts without paying any overdraft charges. In reality banks have been striving to provide such solutions in various limited forms. In view of the myriad regulatory, tax and bank regulatory capital changes mentioned earlier, one might assume that these would spell the complete demise of notional pooling. In practice that seems improbable. It is more likely that it will instead evolve into something more pragmatic that can accommodate these potential changes.
Having said that, and depending upon individual corporate circumstances, two alternative global liquidity management techniques are likely to gain popularity at the expense of notional pooling. The first is interest optimisation (sometimes referred to as notional aggregation). This takes a portfolio view of all the client credit balances held in multiple jurisdictions with a bank to provide an enhanced return (in comparison with the returns that would otherwise be achievable on the balances individually). In contrast with notional pooling, interest optimisation is tax, regulation and documentation friendly. It is also far easier to achieve on a cross-border, cross-currency basis than notional pooling.
For certain corporations that currently use notional pooling in unregulated locations for internal reasons (such as business units’ insistence on retaining control of their cash balances), physical pooling provides a logical alternative. From a treasury perspective, this is ideal; provided there are no regulatory obstacles, treasury actually gains direct control of the corporate cash, which allows for far more efficient usage. Many treasurers regret the fact that local entities’ control of their own cash results in unnecessary borrowing and/or poor investment return for the company as a whole. Therefore, if environmental changes - such as cost - mean that notional pooling is no longer the viable option for the company, then this could ironically represent a major opportunity to fully optimise global corporate cash efficiency.
The interplay of these four trends results in a medium-term outlook for global liquidity management very different from what the market has come to expect in recent years. Corporations will need to contend with diminished economic benefits due to:
On the other hand, global liquidity management techniques will continue to evolve and adapt to external constraints. Partial or hybrid solutions will be revisited by corporations and more readily available, as international banks will have the global systems and infrastructure to support these. In other words, full balance offsetting in non-regulated markets combined with interested optimisation in regulated markets on an after-tax basis will probably become the modus operandi for global corporations.
The quest for the ‘Holy Grail’ of global liquidity management will unfortunately remain unsatisfied until the global economy picks up and liquidity in the banking sector improves. This will provide the backdrop for regulatory and tax reforms to move back towards the promotion of international business growth. When that time will arrive is anybody’s guess. But when it eventually does, those international banks that have already invested in and established global liquidity solutions during these volatile times will be well positioned to provide solutions.
How Thought Leadership Can Reduce the Cost of Sales by Patrik Havander, Havander & Partners A focused attention on the costs incurred by the global sales and marketing processes is becoming increasingly important for corporate banks and their transaction banking departments. While the client/bank relationship remains vital, research has shown that in fact relationship selling […]
