Published: January 01, 2010
During this series of articles, J.P. Morgan has explored some of the priorities for corporate treasurers that have emerged since the financial crisis. Many of these, such as risk management, the need for efficiency and the value of bank relationships, are not new but have been given greater priority as the markets have become more constrained. In this article, we look at another issue which, while a universal theme for treasury, has become far more compelling: liquidity management. While it has always been a priority for every treasurer, a new set of concerns has arisen, coupled with an increased focus from the CFO and the board. Here we will explore these concerns and how treasurers, in partnership with their banking partners, are responding.
Before the crisis, corporations pushed the risk-return spectrum in search of higher yields with some serious consequences. In reaction, many organisations sought safe harbour in traditional, risk-free investments, became more focused on counterparty risk and on moving liquidity to well-capitalised banks. Capital preservation, risk management and ensuring access to liquidity and funding are the dominant themes, only re-emphasised by the debt crisis in Dubai.
Confidence amongst market participants in the interbank market is a major driver of credit availability.
Government and central bank intervention, both explicit and implicit, has changed the risk management picture considerably. Interest rate markets have become dislocated, with unprecedented low investment rates, while borrowing rates remain high. Some banks have changed their strategy or exited markets altogether, creating new banking risks for treasurers in addition to the repricing of credit. Weaknesses in the interest rate markets, contrasting with strong equity performance, create new questions for treasurers as to how cash should be invested.
In such a rapidly changing market environment, treasurers do not have the luxury of time to determine whether or not a liquidity strategy is proving sufficiently resilient to withstand market pressures. If the low interest rates we have witnessed in major currencies were reflected on both sides of the balance sheet there would be fewer problems, but the cost of funding remains high, even for those for whom funding is accessible. Confidence amongst market participants in the interbank market is a major driver of credit availability, and it is taking some time for confidence to return to pre-crisis levels. While the US dollar has shown a more rapid recovery than other currencies, events in the United Arab Emirates have skaken confidence. Inevitably, any change in market confidence, positive or negative, will continue to have an impact in terms of the availability and cost of credit.
The new market landscape creates a variety of new questions and issues for treasurers; for example, comparing the value that is gained from bank relationships, including providers of payments, banking services and investments, with the risks posed by these providers. Secondly, with low yields creating a drag on financial performance, except in the equity markets, how can conservatism in investment decisions be aligned with the need for competitive performance? In our discussions with clients, we are seeing a variety of clear trends in how treasurers are responding to the new market environment:
Simplifying banking relationships. With these myriad challenges, treasurers are keen to simplify their business as far as possible, and reducing the total number of bank providers and accounts where it makes sense to do so is one way to find efficiencies and increase cash visibility. Treasurers are making a clear choice for providers with whom they are familiar and have long-standing relationships. Rationalising banking partners is a major step towards enhancing cash and liquidity management, including identifying where cash is located and how much control treasury has over this cash. This is difficult for companies operating in regions such as Asia, Latin America and Africa though, where currency and regulatory restrictions exist, as well as greater variance in banking capabilities. However, bank partner consolidation (where it can be achieved) can establish greater cash control by enabling the treasurer to aggregate cash and optimise the use of liquidity for internal funding, investment optimisation and debt reduction.
Defining investment priorities. Treasurers are re-evaluating investment policies to be more explicit about the relative priorities of yield, liquidity, credit and operational risk. In the case of counterparty risk, risk management has become more proactive, evidenced by less reliance on credit ratings in favour of more internal evaluation and the desire for greater visibility over investments, such as the assets held in a money market fund. In operational risk terms, if an investment strategy which appears ideal on paper requires new resources, systems or reporting overheads, it may not be feasible in practice. As a consequence of this re-evaluation, treasurers are selecting vanilla investment products such as deposits with highly-graded banks, AAA-rated money market funds and repos based on government debt.
Focusing on core competencies. Treasurers are refocusing their efforts on their core competencies, a trend which extends across the business landscape, with more willingness to outsource non-core activities. Treasurers are also reviewing their providers of core services, such as technology, outsourcing services, etc., to ensure that they are in a position to provide continuity of service.
These trends are comparable across all regions, although there are some differences in more highly-regulated markets such as in parts of Asia. Many treasurers have focused on increasing the resilience of the finance function and transparency over cash flow. This is particularly important in an environment where issues that may be taken for granted in Europe and North America, such as daily visibility over bank account balances, may be more difficult to achieve. We are seeing corporate clients focusing not only on cash management, but taking a more holistic approach to working capital management. The foundation for this is working with a bank provider who can help accelerate collections, make payments and enhance the cash conversion cycle, but also help integrate other cash flow sources from non-traditional areas such as the procurement or supply chain offices. The banking partner should also be able to support the company’s funding and investment needs, both in-country and cross-border.
From an investment perspective, most treasurers focus on bank deposits, particularly as many countries in Asia have deposit insurance schemes. Therefore, the concept of counterparty risk differs from other parts of the world, with more of a focus on bank concentration and avoiding excessive reliance on a single banking partner.[[[PAGE]]]
Maintaining a strong liquidity position is a strategic asset, which is why closely managing liquidity risk seems likely to be a permanent feature of the new world in which we operate, particularly as globalisation continues and more companies deal with the challenges of cash trapped in highly regulated jurisdictions. Consequently, initiatives that treasurers put in place need to be resilient to market shocks and continue to perform through different market cycles.
The initiatives which are likely to be most successful are those that form the basis of a long-term strategy. Clients understand that managing risk is not just about choosing the right counterparty, it is about ensuring that the end-to-end process is managed and optimised, and that liquidity is properly defined, valued and aligned to the needs of the company.
A well-designed liquidity management structure can help a company optimise its short-term working capital position, improving the level of operating cash and reducing cash fragmentation.
The right banking partners can help treasurers to develop and deliver a sustainable liquidity strategy in a variety of ways. Providing core advisory and cash management solutions is one element, but often there are specific solutions available to solve particular challenges. In Asia, for example, multi-bank balance and transaction reporting is less common than in Europe and North America, so J.P. Morgan has provided considerable advantage to its clients by providing this capability. The bank has also been instrumental in sharing industry best practices. In China, where entrust loans are used in place of intercompany lending, it can be difficult for multinational firms with business across multiple entities in China to consolidate its external cash positions with their entrust loan positions. Again, J.P. Morgan has developed an integrated solution to give treasurers this visibility.
On a global basis, as we have established, counterparty risk and the need to diversify investments are becoming a greater priority. Treasurers meanwhile, still need to minimise operational overheads and so J.P. Morgan has introduced a solution; Cash Trade Execution (CTE). CTE enables companies to deposit cash with multiple banks, without the need to contact or seek rates from banks individually, whilst still being able to invest in the required currency, for an appropriate duration and with the preferred counterparty.
The crisis has served to illustrate that there is no certainty over future economic conditions, and treasurers constantly need to be prepared for the unexpected. Furthermore, companies’ strategies will continue to develop and the treasurer has to have the right resources to adapt to meet the new requirements. Consequently, it is important that treasurers remain vigilant and continually re-evaluate the way they manage and optimise their liquidity, and mitigate their liquidity risks. Working with the right providers, of banking and related services, is a key element to success, taking advantage of their advice, solutions and long-term stability.
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