Published: September 26, 2018
From money market fund (MMF) reform to new technologies, the way in which treasurers manage liquidity is evolving – or rather, it should be. Here, TMI examines some of the key changes happening in the liquidity landscape across Europe, the US and Asia. Industry experts also outline how corporate treasurers can prepare for these developments, embrace best practice, and future-proof their liquidity management strategy.
There has already been a lot of noise around changes in the liquidity landscape. But given that treasury teams are typically overstretched, not all treasurers have yet had time to think about or plan for the evolving environment. As Jim Fuell, Head of Global Liquidity Sales, International at J.P. Morgan Asset Management notes, “The key factors impacting today’s short-term investment landscape won’t come as much of a surprise to treasurers. They range from European MMF reform to interest rate changes and Brexit. What some companies aren’t necessarily planning for, though, is the possible knock-on effect of these factors – whether directly or indirectly – on their investments.”
Head of Global Liquidity Sales J.P. Morgan Asset Management |
As an example, “When fundamental tax reform changes were approved in the US last December, there were likely a few non-US corporations who didn’t pay much attention to the new rules,” Fuell points out. “However, with some USD 2.1tr held offshore by US corporations, the money put in motion by these reforms was one of several factors leading to the elevated USD LIBOR levels seen in the first half of 2018. So, the impacts might not necessarily be obvious, but they still bear thinking about.”
Czeslaw Piasek, EMEA Head of Liquidity Management Services, Citi, thinks that “geopolitical factors are certainly on corporates’ liquidity radar.” In addition to US tax reforms, Piasek says that sanctions in Russia remain a concern, and in Turkey currency devaluation and capital controls are top of mind for treasurers. “So, each country has its associated challenges, and these can have a knock-on effect elsewhere in the world,” he observes.
Regardless of geography, however, Piasek believes that what treasurers really want is efficient liquidity management processes that allow for automated funding, return optimisation, simplified structures and treasury risk management. But how can they go about achieving this?
Fuell says that “To be in a good position to respond to these market challenges, treasurers should have the ability to accurately forecast their expected cash flows. In turn, this will allow them to segment their cash – or as we like to say, to ‘put cash in its place’”.
Part of this process involves looking at operating cash and how it can be best put to use within the company; or invested in short-term instruments that offer more or less instant liquidity. One powerful external factor that is already impacting this cash segment, and will only do so more in the future, is real-time payments.
Citi |
As Piasek comments, “The advent of instant payments is already impacting the way treasurers manage their liquidity. The outside world is accelerating, and treasury functions need to keep pace. They have to be ready for 24/7/365 payments and the subsequent speeding up of the working capital cycle.”
In such a fast-paced environment, optimising funding across the group also becomes critical, he notes. “Global and regional treasurers need to carefully assess trapped liquidity – and how to optimise the company’s needs versus that trapped liquidity.”
Fig 1 - An evolving cash landscape creates challenges and opportunities for short-term investors
Source: J.P. Morgan Asset Management, as at 31 August 2018. |
Having the ability to mobilise funds, where permitted by the regulators, in this kind of environment is critical – in order to minimise liquidity and FX risks, he notes. “And where liquidity is trapped, exploring solutions such as timely regular repatriation and dividends can be beneficial. Banks are also increasingly offering innovative interest optimisation structures that allow corporates to earn returns on trapped liquidity. What’s more, trapped balances can be notionally aggregated, providing the desired level of visibility – even in challenging geographies.”
Of course, maximising returns is an ongoing liquidity challenge, “not just a hurdle associated with trapped cash. The short-term investment options available to treasurers are changing and the yield environment remains pretty tough,” Piasek points out. This is precisely why treasurers need to start thinking differently about their short-term investments.
To that end, “There are a number of tactical liquidity moves that treasurers can make – such as extending duration or taking a little more credit risk to enhance returns,” says Fuell. But while these tactics have a role to play in the day-to-day management of liquidity, he believes there is also room for treasurers to look at their investment policies and approaches in a more strategic manner that goes beyond cash segmentation. “After all, the new investment landscape merits a more sophisticated look at asset allocation,” he says.
One of the most significant changes currently taking place in the European short-term investment landscape is the introduction of the EU’s new MMF regulation, which comes into force on 21 January 2019.
This is causing treasurers to reconsider their short-term cash investments, since the classifications of MMFs – and the range of funds on offer – are changing. As Fuell comments, “if certain investment options are no longer available, treasurers need to truly understand what takes their place. That includes lifting the hood on new types of MMF.”
“As such, we are working with treasurers to help them understand what kind of portfolio their investment policy truly allows them to construct – and where they could be more strategic. This involves road-testing the investment policy, looking both backwards and forwards, to see how it might impact returns. As well as assessing the likelihood of volatility, this process also enables us to analyse the potential for unrealised gains and to examine the implications of passthrough losses to a company’s P&L, for example.”
Fuell also says that “more sophisticated treasurers are starting to see the value in this strategic approach to liquidity management as it can help them to balance multiple objectives, namely boosting interest income, whilst simultaneously reducing downside risk and preserving liquidity.”
To help treasurers achieve those goals, asset managers offer a range of investment management strategies and solutions, notes Fuell, “but the true differentiator is expertise – especially in areas such as credit risk. And as treasurers continue to seek positive returns in Europe, and perhaps take a little more risk than they would ordinarily, that kind of expertise becomes a huge asset.”
The same is true in China, where the short-term investment market is maturing, requiring new skills and expertise. As KL Cheah, Head of Global Liquidity Sales, Asia Pacific, J.P. Morgan Asset Management, explains: “There is a definite talent challenge in China – a shortage of personnel with significant treasury management and investment expertise. There is also an education piece to be done around credit risk, and the link between risk and return. Going forward, treasurers therefore need to think carefully about how they build out their teams in order to future-proof their liquidity management.”
Nevertheless, many corporates do not have the resources to attract this kind of talent themselves, notes Cheah. “This is where having a mandate with an external fund manager can help. The client not only gets access to external expertise but can also use the fund manager’s offering as a benchmark and training tool for their in-house teams. So, it’s a mutually beneficial relationship.”
Aidan Shevlin, Head of Asia Pacific Liquidity Fund Management, J.P. Morgan Asset Management, goes on to explain some of the areas that are making liquidity management a little more complex in the country – and where fund managers can add value. “Corporates in China are dealing with two major challenges in the short-term investment space today. The first is the impact of the macro environment: trade tensions between China and the West continue to escalate; currency volatility is a concern; and headline risk is re-emerging in the country. Together, these macro factors make the day-to-day choice of short-term investments a little tougher for corporates.”
The second challenge, he says, is that “regulatory change is happening at a rapid pace in China and this is moving the goalposts for short-term investments.” One of the major shifts in regulation has been the introduction of the new Asset Management Product (AMP) rules, which came into force on 27 April 2018.
For those who are unfamiliar with the new AMP rules, they are designed to curtail the shadow banking sector and reduce financial risks by banning principal guarantees, harmonising regulatory standards and reducing regulatory arbitrage. “For some more adventurous treasurers, this means that certain wealth management and trust products that they have relied on in the past for returns will no longer be available. Those treasurers will therefore need to rethink where they place their liquidity – and the level of risk they are prepared to take,” says Shevlin.
Moreover, the new AMP rules have shone a spotlight on credit risk – which has not previously been a significant concern for investors in China, due to the perception of implicit government support, Shevlin notes. “The Chinese authorities are keen for investors to better understand the risk-reward relationship. As such, we anticipate greater focus on credit management going forward, and treasurers will need to spend more time assessing their counterparty risk.”
J.P. Morgan Asset Management |
Where treasurers may have dealt with one or two local banks previously, Shevlin expects to see corporates diversifying their banking partners on the back of this counterparty risk focus – broadening out their relationships to include global banks and other types of financial institution, such as fund managers. This should not only help them to get a better handle on counterparty risks but should also give them access to a wider range of appropriate investment products – from MMFs to separately managed accounts.
Moreover, Shevlin says that we will see innovation from banks and fund managers on the back of these new rules, which could open up new products to treasurers, whether they are adventurous or conservative. So rather than sticking solely to time deposits, treasurers in China may soon have access to a range of short-term investments that is similar to Western markets.
Separately managed accounts are steadily gaining popularity in geographies across the globe, including China. Shevlin explains the rationale behind their rise. “A highly-rated MMF can be an extremely efficient product for treasurers in China – offering liquidity and tax benefits, with a very clear, transparent structure. For treasurers who are looking for a little more yield in a different type of fund, however, the options in China are not necessarily as straightforward as elsewhere in the world,” he says.
“In China, each type of mutual fund has its own set of guidelines, so the guidelines for MMFs differ from the guidelines for equity funds or fixed income funds. This can make life challenging for corporates, and they often prefer a more customised approach whereby they can invest with a particular return or duration target in mind, or work towards an asset allocation that perhaps isn’t allowed under the government’s fund guidelines. Fortunately, separate accounts – where we have seen growing interest - can be a solution, managed by fund managers with the same high-quality credit and macro research, but with guidelines customised to the individual client’s needs.”
Cheah echoes these thoughts, adding that “we are seeing growing interest in separately managed accounts, especially among local corporates in China, and we expect this trend to accelerate as the 2020 deadline for enacting the new AMP rules approaches.” To be clear here, all newly created AMPs have had to comply with the rules since 27 April 2018, while existing AMPs have until the end of 2020 to be fully compliant.
Cheah also notes that “separately managed accounts are proving particularly popular with local tech companies who have built up large cash balances, either through IPOs or simply though their own success. Naturally, they want to invest their cash and get a decent return, but they also need to be able to access that cash at fairly short notice – in case they wish to invest in developing their products or to make an acquisition, for example.”
Back in Western markets, meanwhile, Fuell notes that, “the appetite for separately managed accounts is growing as treasurers continue to take incremental risk, since SMAs allow companies to customise their portfolio in a way that is closely aligned to the risk they’ve already approved in their investment policy.”
So, what does all of this mean in terms of staying prepared? How can treasurers best get ready for these changes in the liquidity arena?
“As well as continuing to focus on security, liquidity, and yield, treasurers would do well to ensure that their investment policies are kept up-to-date and that they have enough flexibility built-in to deal with the changes that may happen to the products they use,” says Shevlin.
Fuell agrees, saying that “treasurers will want to think about whether their investment policy contains sufficient flexibility to future-proof the organisation against some of the changes taking place in the short-term investment landscape. In addition, treasury leaders may also need to consider whether they have enough people, with the right knowledge and the right skills, to understand the investment environment of the future.”
Meanwhile, Piasek emphasises the importance of keeping an open mind to new solutions and technologies. “Given that treasury functions are typically lean from a staffing perspective, treasurers must embrace new technologies to ensure that their cash and liquidity management processes are as automated and simplified as possible,” he says.
“Take application programming interfaces, APIs, for example. Today, APIs can connect the ERP directly to bank platforms and investment portals, so that the treasurer can have a real-time view of their liquidity positions in one place – without the headache of installing new technology. This is a real game-changer for treasurers.”
In conclusion, then, while many of the changes happening in the liquidity space are beyond treasurers’ control, with careful planning and a willingness to examine new possibilities, treasury can position itself to take advantage of the opportunities the new environment offers, whilst simultaneously managing the risks.
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