by François Masquelier, Head of Corporate Finance and Treasury, RTL Group, and Honorary Chairman of the European Association of Corporate Treasurers
Over the last five years, European treasurers have learned to manage counterparty risk. They have become less trusting and more cautious in investing their funds. Return had become necessary to correspond to risk. Unfortunately interest rates are so low today that security now has a cost. This is an economic paradox, if ever there was one. What can treasurers do to find a return while keeping down the risk incurred?
‘Mo Money Mo Problems’ (The Notorious B.I.G)
Over the last five years, corporate treasurers have (re)discovered a forgotten and theoretical risk, that of possible default by their bank counterparty. Therefore they gave priority to counterparty security. Clearly, for negotiating financial instruments the risk of non-delivery is small, and the possibility exists of recovering deposited collateral – if any, in the case of Credit Support Annex, or CSA, a legal document which regulates credit support (collateral) for derivatives transactions. For cash deposits, on the other hand, there is indeed a real risk of losing the whole amount. Treasurers have therefore become extremely cautious when investing their cash – and these cash surpluses, by the way, have kept on accumulating. This is paradoxical. While counterparty risk was rising and interest rates were falling, the amounts being invested were growing. Fearing uncertainty and because of future needs, treasurers have preferred short-term investment (a maximum of three months to fulfil the IAS 7 ‘Cash and Cash Equivalents’ conditions). Moreover, short-term investing is a way of mitigating default risk.
Another strategy involved investing in money market funds, particularly ones with a high credit rating (AAA) so as to subcontract the management and achieve greater diversity. This strategy worked well especially in an environment of falling interest rates, which gave returns of EONIA plus double digits basis points. Unfortunately, rates ended up hitting the floor and returns became ever slimmer, finally becoming nil or negative. The plan was to preserve the principal, even at the expense of return, but there is no longer any room for sophistication. Stay ‘short’ and stick with low risk. However, today this security has a cost. It is this cost that presents a problem for many treasurers.
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