Risk Management

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The Cost of Security Today Over the last five years, European treasurers have learned to manage counterparty risk, becoming more cautious when investing their funds. However, interest rates are so low today that security has a cost. How can treasurers find a return while keeping down the risk incurred?

The Cost of Security Today

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.

Security has a price, but not just any price

Security now has a price: no return or even a negative return, the last straw for treasurers with cash surpluses. How strange it is to have to pay to invest your funds. And perhaps in the short term we may even end up booking an interest charge on a bank investment. Unbelievable, isn’t it?

IMMFA AAA rated funds are closed to new investment, victims of their ‘Constant NAV’ approach. We can readily imagine that, if the low interest rates situation persists (and we have to fear that it will), these same IMMFA funds may possibly even have to repay their investor clients. The economic situation is such that it is not impossible to envisage this. So what should we do? The real challenge lies in reviewing investment strategies and revisiting policies to adapt them to one of the most exceptional economic climates ever. The alternatives are merely theoretical unless we accept that certain principles have to be reviewed.

Possible alternative strategies

Many companies have made use of share buyback operations or have distributed large dividends. However, for the remainder of their cash surpluses, they have to adopt mixed and varied strategies. By combining different products, they can increase their returns while keeping risks reasonable and still achieving an investment duration that is certainly longer but still acceptable. The solution therefore consists of maximising return by using a variety of solutions to offset a yield curve that is rather flat and close to rock bottom. There is no perfect solution. The first concession you should allow is that of not qualifying as a cash equivalent under IAS 7. You need to be able to use investments of greater than three months, which do not count as cash equivalents. The average investment term should then improve the portfolio’s overall return. By fragmenting deposits and investing them with different institutions, we can reduce risk and achieve a better spread over time. Time and the length of the investment period are the key factors to be considered. Sometimes short-term rates (

In the same line of thinking, some banks offer loyalty products of various types: for example deposit accounts for savings or ‘notice accounts’. These give a better return in exchange for a minimum notice period of between 35 (qualified for IAS 7) and 100 (non-qualified for IAS 7) days. These accounts have restrictions on the maximum deposit that the bank will accept. They can form part of the gamut of alternative techniques used to offset low interest rate levels. The solution certainly involves a combination of different products.

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