Published: July 21, 2008
Welcome to this special forum hosted by ATEL in which we are joined by some of the most significant players in corporate treasury today. Today’s objective is to discuss some of the key implications of the credit crisis and how it is affecting treasurers. How are you managing cash, how has life changed since a year ago and how are you responding to market events? We will also discuss the value of money market funds in the treasurer’s armoury.
Firstly, as Chairman of ATEL, I would like to add my thanks to Robin’s. Since the so-called sub-prime crisis last summer, there are still considerable consequences. The cost and difficulties in obtaining funding have increased and the money markets continue to change over a period of weeks and months. I’d like to share with you some of my views from a corporate perspective.
Like many companies, we have achieved high levels of cash surplus - at least a quarter of large corporations in Europe have a substantial liquidity portfolio.
This creates an issue of what to do to boost your return, especially in a low interest rate environment. Unfortunately, even as interest rates increase, inflation is also increasing, so it becomes difficult to achieve good returns in real terms. It might seem easier to manage cash than debt, but in these uncertain times, there are often problems.
Defensive investment is one way of using cash - we are investigating potential M&A opportunities as are many other companies. Nevertheless, it is important to avoid overpaying for assets and to maintain liquidity. Uncertainty about when cash will be required makes it difficult for treasurers to make investment decisions due to the need to remain highly liquid.
The sub-prime crisis has, of course, had a major impact on the buy and sell sides of the market. There is a limitation for investors as there is the balance between what return we could achieve by investing in our core business, and boosting returns and profitability, and what we could achieve in the money markets.
Money market funds are a good alternative to traditional bank deposits in terms of credit risk and return. Although most corporate treasurers have developed an investment policy which ensures that they manage their counterparty risks, there remain some questions about the future of the big banks, particularly bearing in mind the huge recapitalisation which has taken place.
One of the issues with money market funds is definition, and in particular the distinction between treasury-style and investment-style money market funds. These are quite different, so to clarify, I am talking about the AAA-rated, treasury-style funds as defined by IMMFA, which are highly liquid instruments with the opportunity to invest for a very short duration if necessary. This liquidity is important for corporate treasurers who are finding it difficult to identify the time horizon for investment. IMMFA money market funds have exceeded €440bn (or $600bn) in 2008 despite the current crisis. [[[PAGE]]]
Like all companies, we still have considerable challenges ahead of us. We still have a lot of income volatility and we need to manage cash in different currencies. Money market funds can help with this, but one problem with short-term investment is that it is difficult to identify a suitable benchmark: overnight, one, two or three months Libor/euribor? Budget interest rate? It’s very difficult to benchmark your return particularly with hindsight - it might have been better to find a three-month investment, for example, but treasurers cannot necessarily envisage when cash will be required.
Money market funds are a good alternative to traditional bank deposits in terms of credit risk and return.
So with this in mind, cash flow forecasting and centralisation is important in enabling us to manage our cash more effectively. Benchmarking is important as is credit risk management. For us, one of the issues has been IAS 7. The AMF in France, which is the equivalent of the SEC in the US, has decided to give a clearer definition of what is or should be considered as cash and cash equivalent. IMMFA-style money market funds are clearly in this category, which makes it easier in discussion with auditors.
One of the reactions to the recent crisis amongst some corporates is to go back to classic bank deposits for investment purposes. However, this results in concentrating the risk in one counterparty, leading to higher risk and potentially lower return, even if the opposite was the intention. Others, particularly in the UK, have emphasised sovereign investments such as gilts, which provide security but with a lower return Some corporates have decided to invest directly in CP, bonds, EMTNs etc. For most companies, this creates a lot more work, as the risks need to be carefully managed, and the CP market is a very difficult one in the present climate.
Best practices for corporate investment can perhaps be summarised as “Triple Flight”: flight to quality, flight to transparency and flight to liquidity. Diversification is an important element of this, and investing in money market funds, across one or more investment managers is an answer to this.
I would now like to ask Mark to describe for us a little more fully what are talking about when we discuss money market funds, bearing in mind the distinction between treasury-style and investment-style funds.
Talking about money market funds can be hugely confusing The treasury-style funds on which we are focusing today originally came out of the US but like many things which have crossed the Atlantic, they have developed and been embraced in a slightly different way. Further, these instruments have not simply stopped in Europe either, but are travelling eastwards, becoming more popular in the Middle East (such as with sovereign and governmental agencies) and now in Asia. In China, for example, the newly formed money market fund market is already worth over a billion dollars. So rather than being a US or European concept, money market funds are now a global phenomenon.
These funds should be distinguished from investment-style money funds which have historically been popular in countries such as France and Luxembourg. In the early days of the credit crisis, in which many of these funds suffered, many people, including the press, became confused between the two, collectively describing any funds which invest in the money markets as money market funds That, of course, could be anything from cash deposits and short-term money market instruments through to short-dated bonds, derivatives and asset backed securities.
The liquidity, or treasury-style, money market funds are effectively operated, designed and managed as an alternative to a bank deposit or a call account. Like cash at bank, it maintains principal value which does not go up or down, it can be taken out when required (i.e. liquid) and it earns interest payable on the principal. In usage, it behaves like a call account, giving you a daily return and daily access, but in terms of the rate of return, it performs more like an overnight bank deposit.
For a liquidity or treasury-style money market fund, you could probably place security and liquidity as first and second priorities and return as a third. Conversely, the priority of an investment-style fund is to maximise investment return, with liquidity and security as the second and third priorities. Inevitably, the higher the return, the higher the risk which is inherent in an investment-style fund. [[[PAGE]]]
What has gone wrong is, of course, the confusion between the two. A number of treasurers who invested in investment-style funds in the past believed that they were investing in something which was highly rated, with strong liquidity and a higher rate of return, but did not ask about the risk inherent in that higher rate of return. Many of these treasurers have suffered as a result of the credit crisis.
There are certainly lessons that the market can learn from these experiences. Security and risk mitigation are imperative and the two types of money market funds need to be more clearly defined so that investors know what they are investing in. IMMFA, which is the association to which providers of treasury-style funds provide, is now working with the regulators, who are in turn working with the European Commission to devise a tighter definition.
Security and risk mitigation are imperative.
Our treasury needs to be flexible to manage the financial needs of today, tomorrow and the future, without knowing necessarily what cash will be required and when. As a private company, we have to explain to the owner of the company why we might want to do something different but getting his support is very difficult. In this situation, we end up investing for short periods, primarily in deposits, even if our business does not need that level of liquidity.
Your situation is quite a common one, I think, and emphasises the importance of definition. It might be that the owner of your company is cautious after seeing headlines in the paper and a lot of people are similarly confused.
When we were considering our investment options, we saw a lot of bankers and talked about all the different money market funds which were available. You really have really to be an expert to understand exactly what is being said, and when you ask a precise question, the salesman does not necessarily know the answer.
Over the past 12 years, I have seen the evolution of the money market fund market both in the UK and now in Europe. You’re absolutely right. To some extent, many in the business relied a good deal on the AAA rating and expected everyone to know what this meant. We then realised that we needed to go back to fundamentals and embark on far more of an education process.
In the past, very seldom were we asked to demonstrate what assets comprised the fund because, in a way, it operates rather like a bank; when you open an account with a bank and place your cash, you don’t ask the bank what it is going to do with it. Money market funds were therefore presented in a similar way up until the credit crisis began, i.e. they are AAA-rated, liquid, constant net asset value etc. If one were asked “What’s inside the fund?” the answer would have been “Why do you need to know?” A lot has now changed, and fund providers are now providing far more reporting on the portfolio and individual assets which puts the funds now at a higher level of disclosure than almost any other depositary arrangement.
Also, it’s been important for us to assess the key criteria. Each fund has different criteria and it is often difficult to compare them.
To some extent that’s true, but each rating agencies’ definition of a money market fund, their restrictions and parameters will be the same to ensure that there is a common fundamental standard between the funds. Individually, there can be certain differences of style and operation - e.g. some funds will use more commercial paper, FRNs, asset backed commercial paper, etc or have different fees and cut-off times, but largely the restrictions and the parameters are exactly the same.
There is a question of perception and I fully agree with what Mauro said. Even working for a public company, it is still an issue to convince the management, CFO, and audit committee about what we are doing. This is a pity because, at the end of the day, we agree that a genuine, treasury-style money market fund is safer than a bank deposit - less concentration of risk, better rating and these days, better returns. [[[PAGE]]]
Justin, as My Treasury is a money market funds portal, you are dealing with both the providers and the investors - are you seeing a change in behaviour?
I think there are two things to note. The first is that we try to make things easy for investors because the only funds on our platform are treasury-style funds. It’s not a platform for more esoteric investors who are looking to take high risk. So in a sense, we have done much of the preparatory work to make sure that all the funds traded on My Treasury are treasury-style funds that meet all of the basic requirements as they are currently defined. As these change in the future, we will continue to ensure that this remains the case.
Fund providers are now providing far more reporting on the portfolio and individual assets.
We had thought about putting some of the other styles of funds, particularly enhanced yield funds, onto the portal. Up until a year ago, treasurers were becoming more comfortable with the concept of enhanced funds, attracted by enhanced yields. Today, there is no appetite whatsoever, and we feel it would confuse the situation if we did start putting those funds on, so we are sticking to AAA treasury-style funds.
Following on from what Marc was saying, there are still differences between these kinds of funds e.g. sovereign funds are only invested in treasuries and government debt. We provide investors with information about the fund, what it comprises, what it invests in and what the investment strategy is. We also provide the weighted average maturity of those investments so you can see whether they’re investing long or short.
We provide this information as the issues which treasurers are raising today are exactly those that we picked up in our research. If companies were going to move away from deposits and other short-term instruments into money market funds, they needed this extra detail.
A portal therefore now provides an electronic means of making the comparison that you [Sophie] were trying to achieve. Given the common characteristics of AAA-rated funds, it can help populate the differences, so you can see where the bias is. This is going to be incredibly helpful.
As Sophie explained, the benchmark is an issue - it’s a real problem for treasurers to compare relative performance. Management expects that we will explain what we are investing in, of course, but what are the returns? To compare the returns across different types of funds with different distribution methods is as difficult as comparing a fund against an index.
It does need be made absolutely clear however: there are the investment funds which are performance driven. There are liquidity funds or treasury funds which are not performance driven. Their objective is not performance in terms of yield, their objectives are security and liquidity. As professional treasurers, performance is the last thing you look at because in a money market fund, performance is the end result of managing your security and liquidity objectives. If your objective is to produce the very highest level of security or liquidity, you will not be a top performer in yield terms because there’s a cost to achieving security and liquidity. The greater the liquidity and the greater the security, the yield will be reduced. So you do not start at yield, it is a function of the other two. If you want higher yield, then automatically you’re going to go down the credit scale or lose liquidity. It’s a perfect balance.
We should first start by asking ourselves about the company’s strategy. What is the point of keeping the cash in the first place? Cisco, for example, is building up $17bn of cash - they are not doing that for yield. So why do they do this? - because their strategy is to buy companies as quickly as possible, to be very flexible, snapping up acquisitions because this is how they grow. So cash is a means to an end from a business standpoint, not a means of obtaining yield.
One key element which we keep forgetting is that if cash is a strategic asset, it has to yield a minimum cost of capital. I can’t see one investment fund that is going to achieve this. We as a company are running a business, not a business of managing cash. Cash is simply the result of the business. As finance people, we need to have some humility as I don’t believe that either as a private company or a public company, you can say to your board “I’m going to show you how much money we can make with the cash.” This isn’t the business of the company. So I would probably say that my role is to try to minimise the amount of cash on the balance sheet because by holding large amounts, I’m destroying value of the company. [[[PAGE]]]
I think this is absolutely right. The cash levels which corporates are holding are sky-rocketing for all sorts of reasons. Mergers and acquisitions mean that treasuries are coming together from different companies, making bigger pools, and there is a greater trend towards centralisation. So, whereas in the past a company may have had satellite treasuries in different locations, now the cash is often all swept into Luxembourg or Belgium, the US or London. While the money has probably always been there, now it’s being pooled into one account.
Walter, when you were treasurer at SES, you raised significant levels of cash and did some landmark deals. What was your strategy in terms of liquidity?
SES was, and continues to be, a company with a substantial leverage and which has high borrowings. The goal was not to hold a great deal of cash. As a service company, with long-term investments in satellites, the short-term cash requirements were effectively only salaries and costs relating to premises and marketing. The sector enjoys a high Ebitda margin. If I we had, let’s say, €500m or €700m cash on the balance sheet, I would be questioned by shareholders about why this was necessary. For a company with €1.2bn annual revenues at that time, I would have had half of the revenue on the balance sheet, which hardly made sense. So the goal was to maintain manage working capital management needs and levels and avoid borrowing money on one side and investing it on the other, losing the margin in between.
What is the point of keeping the cash in the first place.
Furthermore, over the last year, the margins have widened so there is an even greater cost for this security. At the other end of the spectrum, following the credit crisis, companies without cash on their balance sheet might have a problem.
When we had cash, we kept it simple and placed it on deposit with a bank. The treasury department was small and we did not have the time to look into money market funds, how they were performing or do due diligence into what they might offer us. In reality, we did not even have enough resources to look at dividing the cash across a number of banks, for which you need people to manage the process. Today I would certainly place cash across a number of banks but adding more complexity or work to the investment process is a problem for smaller treasuries. A treasury with only three or four people will always be strapped, and when somebody is ill or on vacation, you have even bigger problems.
This is a very good point. You mentioned that you didn’t have the time or the people do due diligence on the funds, but nevertheless you’re placing your cash at banks. I think that treasury management is actually very similar to asset management. In principle, you’re doing the same thing. You’ve got cash and you’re ‘investing’ it so that one way or another or you’re giving it to another party. If you look at the way that investment management companies are obliged to run their business in terms of the regulatory requirements, we are regulated almost as tightly as the banks, in terms of managing clients’ assets. But while investment managers are highly regulated, corporate treasurers are not, but they are doing the same job in managing their shareholders’ assets. Ultimately, it is worth bearing in mind the difference in the level of control, supervision and reporting which exists when placing cash with an investment manager versus managing it yourself, particularly as you say, a treasury team can be small and cannot necessarily implement the same high standards of operational, system or credit controls. Therefore, placing cash into a money market fund can import a number of important disciplines other than just investing for returns.
One of the issues which was raised earlier was banking relationships and the changes since last year.
I have the impression, having held discussions with some of the banks here in Luxembourg and foreign banks, that they are becoming tougher and tougher on the borrowing side. It’s not just interest rates and spreads which are higher but accessing capital is also far more difficult. Some of the banks tell me that they have reduced their allocation of credit to their corporate customers by 50%. Furthermore, the banks are looking more at qualitative criteria and so are far more selective. This is very significant for corporates as whatever your situation, cash rich or cash poor, circumstances can change and there are cycles in the business. So it’s important to maintain good relationships to make sure that if at some stage in the future you need to knock on the banks’ doors for credit, someone will be there to respond. So it’s also important to share your cash and asset management business and keep the banks up to date with the business strategy. Maintaining these relationships, talking with and listening to them is certainly far more important than it was two years ago. [[[PAGE]]]
There would seem to be a certain irony here. The problems we have today are because the banks didn’t want the cash on their balance sheet. The troubles that banks have got themselves into are because they realised that cash on their balance sheet is expensive because of the capital adequacy requirements. So what was their solution? They took it off their balance sheet, securitised it and sold it off.
Placing cash into a money market fund can import disciplines other than just investing for returns.
A vicious circle had been created: the more deposits, the more loans they made, so the more deposits they needed. Their balance sheets exploded and they had to keep on building up capital. However, as soon as banks started to get into other areas such as insurance, brokerage, investment, capital markets which are hugely demanding of capital, it didn’t take them long to recognise that all this capital could be put to far better use than just supporting their deposit taking activities. In other words, by continually removing the loans, they could considerably expand their lending business without demanding more cash deposits and incurring the capital required.
In fact, the end result is that banks themselves began selling money market funds to their clients as an off-balance sheet product as a means of continuing to take their clients’ cash, but without attracting the additional capital. So therefore yes - you should continue to support your bank but there is a greater chance that they will now be offering you a money market fund!
I feel it may be a little more complicated than that. Talking first about the relationship between a bank and its corporate customers, over the last ten years we have seen that a lot of banks were not interested in corporates because they were not earning anything from them. In foreign exchange and lending, the margins were narrow, so banks were no longer interested.
When we look more generally, it has a lot to do with leverage. We are coming out of an era of leverage and removing assets from the balance sheet. Why? Because interest rates have been low, you could boost your return on equity invested. Now, corporates need their banks more and vice versa. The financing alternatives for a corporate are at the moment limited, and it is more difficult, if not impossible to go to the public debt markets.
Today, it’s not the big name banks which are underwriting credit, it’s the small names with whom a corporate may not have maintained a direct relationship in the past. This certainly illustrates the importance of maintaining a diversity of banking relationships.
From my point of view, I would rather work with a couple of banks, big or small, whom I can trust, rather than cherry pick across banks. All the banks we were working with before have stayed with us. This could be because they find our business interesting or it could be because we have a good relationship and we have worked with them through good and bad times - for them and for us. So from that perspective, I’m rather reluctant to work with a bank which calls me when the sun shines to lend me an umbrella because I’m quite sure that when the rain starts, either for them or for us, they will take the umbrella back. So I’m definitely reluctant with that side.
For me there are two critical elements in working with a bank. The first is the strategy of the bank. Is the bank really a bank that wants to work with corporates? Or is it just interested in doing financing or whatever? The second is the people you are speaking with. If you speak with just with a salesman, once you have refused three deals, he will not come back to you. Our business is not to do deposits or go into money markets or whatever; as treasurers we are there to finance what the business requires. Consequently, you need banks which take an interest in your business and are willing to go the way you are. This is one of the reasons why I think some of the smaller banks which a treasurer may not have considered in the past are becoming more attractive as they have often better understood the needs of the businesses with which they work. [[[PAGE]]]
When we look at the business a corporate can give to a bank, depositing cash is certainly one of the elements to the relationship. If we invest this cash in a money market fund, then we can’t give it to a bank which could prove detrimental to the relationship.
This has always been a very important issue as to why corporates will think they can not use a money market fund. There may be occasions where the bank does not want the cash. Treasurers are tasked with achieving the best rates for their cash, within the bounds of security and liquidity we have discussed. Banks will invite cash so long as it’s cheap, but when treasurers demand market rates, and therefore the deposit becomes more expensive for the bank, they actually don’t want it any more.
You need banks which take an interest in your business and are willing to go the way you are.
Most companies will have a number of lines into their banks supported by a number of services which the banks provide, some of which will be cheaper and others more expensive. Surrounding all these activities, the companies will have counterparty limits with their banks. So when it comes to the company utilising that limit, the bank may not wish to have this credit line used up with just cash as they don’t make much revenue from it. The bank will be interested in offering more profitable services than taking deposits. Therefore, as previously mentioned, banks are now providing money market funds for the cash as means of keeping these lines open for the more profitable business.
Many banks now have their own money market funds and all are awash with short-term cash which they would like to divert into funds rather than deposits. But if they don’t have their own funds, then it’s a different matter as they need to find a way to divert cash off the balance sheet but still make a return. Offering third party MMFs to their customers through a white labelled portal is one way to achieve this.
But it is a consequence of the way that banks were cutting their pricing in the past - everything was very cheap or free. And so, due to the commoditisation of some products, they have become pure commodities today with almost no margin. At the end of the day, something, whether cash management or lending, has to bring in some money. Yes, there is money to be made by arranging bond issuance but we don’t issue bonds every day. So the banks have become a victim of their own system - and consequently the corporates too.
When we talk about money market funds, maintaining a relationship with the fund managers is also very important, whether using a portal or not. The fund managers are becoming more proactive in providing more detailed information but I’m often surprised about how little corporate treasurers read the information they receive.
I would make two points here. First of all, fund manager reporting is available through our platform so you can get it directly from a single source rather than sourcing information on each fund individually. Secondly, the platform incorporates an in-built instant messaging system, so the communication between all the parties involved, the Fund Manager and the Treasurer is facilitated and stored there. So the aim is to promote the relationship not to dis-intermediate between funds and the investors.
Coming back to what Walter said, we have small teams, limited resources and potentially high turnover, particularly here in Luxembourg where it is difficult to acquire and to retain talent in treasury. So it is important to make sure that you can streamline your processes and achieve straight-through-processing of treasury transactions. This is partly an issue of managing risk and ensuring internal controls of course, but also to free up more time for the issue Robin mentioned, namely the value you can add to the business. You can do this by protecting the company’s assets, better investing your cash, lowering the risk, increasing the return and optimising strategies, rather than spending time producing reporting or on manual administration. Many banks providing money market funds are still using highly manual processes, such as faxes. Some banks have on-line dealing platforms but these are generally single-bank portals. I think that we still use faxes to deal in some money market funds, at least on the continent.
My senior management and internal audit committee were quite surprised by the manual way of dealing in money market funds and we wanted to achieve greater automation. For us, using a portal has been key to obtaining better information and to allow us to spend time with the fund manager discussing strategic issues rather than operational ones. I’m hoping too that the use of a platform will also be a way to simplify or to standardise the administration and documentation for opening accounts. [[[PAGE]]]
One question I have is that for such a regulated industry as the investment management industry, how can money market funds have so little definition?
It is important to make sure that you can streamline your processes and achieve straightthrough - processing of treasury transactions.
Money market funds are regulated in the EU to the extent that the fund is classified as a UCITS investment fund, but you are right in saying that there is no regulation in terms of its specific characteristic as a money market fund. IMMFA, our industry association, is working with the regulator and also with the European Commission, and there is now a great deal of momentum in trying to define a liquidity or treasury-style fund. What we are seeking now is not redefinition but a separate definition of money market funds which is more specific.
I can see significant potential in money market funds. In treasury, you don’t have the resources or the time for managing short-term investment issues on a continuous basis. The question remains, how do you sell it internally unless you fully understand the fund and how to perform due diligence on it. Furthermore, what criteria should be written into the investment policy apart from the AAA rating? While consultants can be helpful in this, it is important that the treasurer understands what he is doing.
One thing which is clear is that treasury doesn’t seem to be getting any easier, not only managing the external markets but also managing the expectations of internal stakeholders. From our discussion today, it seems clear that treasury-style money market funds and portals such as My Treasury will go some way to easing some of the burden of short-term investment. Going back to François’ summary earlier of ‘Triple Flight’ - quality, transparency and liquidity: investing in this way, in these products, would seem to tick the boxes.
I would like to thank everybody for their participation. Particular thanks to François in his three capacities - RTL, EACT and ATEL; to Justin Meadows of My Treasury which is making a big impact in the industry; and last but not least, to Marc Doman of Invesco Aim - as always, thanks for your excellent input.
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