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Optimisation: Unlock Liquidity and Mitigate Risk

 

Optimisation: Unlock Liquidity and Mitigate Risk

 by Justin Silsbury
Senior Consultant, Liquidity,iGTB

“CASH IS KING”. I recall my first manager saying to me. At this time I was a junior portfolio manager working for a global bank investing customers surplus cash into short-term money market instruments.  Yield was a priority for customers and with high interest rates the bank was also taking a handsome spread, everyone was happy. “Cash is King” seemed an obvious expression, this was easy revenue for customers, rather than leaving money on the banks balance sheet where they would earn close zero, have the bank place the money out in the market for them.

With over 15 years in transaction banking later, and the aftermath of the global financial crisis, which started in 2008, I believe I have a better understanding of the expression. It is about liquidity, rather than just being cash rich. It is about security as well as yield. Customers are looking for this middle ground and expect banks to provide solutions supporting their requirements.

Cash should not only be available, but working hard until a time it is required. It is about having sufficient, reliable liquidity to address everyday settlement and operational demands. Having cash available at the right time, in the right place sounds simple. However, for many corporates cash management is complicated by their size and geographical spread. Multi-nationals are working across a number of time zones, dealing with different legal and regulatory regimes and having to manage a number of data formats and reporting requirements

Customers require a cash optimisation strategy, which takes into consideration the 3 key elements: security, yield and liquidity. In any market environment, corporate treasurers must preserve capital and ensure sufficient liquidity to meet business needs. At the same time, they will want to maximise the return on their surplus cash.

SECURITY

The crisis of 2008 catapulted security of cash above yield in terms of importance. Security remains a high priority for corporate treasurers today. However as the economy is improving keeping cash as secure as possible is being questioned even by the most risk adverse. With interest rates remaining at all time lows across all the major currencies, investors are now beginning to look at taking calculated risks to improve returns but with the confidence principal will be preserved. By keeping close to market conditions and how they may impact business helps mitigate risk. Without the ability to adapt the safety of cash will always be under threat.

YIELD

Few can afford to keep cash inactive for long periods of time. Accepted, and possibly commended directly after events such as the collapse of Lehman Brothers, corporate treasurers are now being asked if they can actually be too careful. With low interest rates for the foreseeable future and Banks putting a squeeze on corporate lending, surplus cash is a primary means of funding business development, therefore making a return on this excess cash is all the more important

LIQUIDITY

Here lies the age-old problem; nothing has changed from pre 2008 crisis to today. Although appetite for risk may have changed, the challenge remains the same – balancing risk and reward. A key need for all business is having the appropriate liquidity to address day-to-day settlement and operational demands. It is critical for corporate treasurers to manage the process, understand the situation and be able to take the most appropriate actions. 

PORTFOLIO COMPOSITION

The financial crisis has driven companies to stockpile cash to ensure liquidity in the event of another crisis. Therefore, cash as a percentage of total assets on corporate balance sheets has generally grown since 2008.

One reason for the healthy cash balances could be due to improving economies and revenues on the up.  However, the increase could be linked to nervousness around another crisis. Companies with aggressive growth plans have made a conscious decision to hold larger amounts of cash to manage liquidity risk in case of a credit squeeze and companies are unable to receive loans from banks.

So it looks like cash will continue to represent a significant portion of a company’s portfolios, perhaps it is just accepted as a cost of doing business now. Companies must start to achieve higher returns on this cash to avoid impacting the overall company performance.

INVESTMENT POLICY

The company Board of Directors will review the investment policy periodically focusing on compliance, performance and strategy. Money market funds still top the list of permissible instruments, other most common cash investments are term deposits and overnight sweep accounts. As cash remains an integral part of the overall portfolio, it may be time for the Board to reconsider their investment policies.

Is there an opportunity to take additional risk and earn a higher return while still achieving objectives around security and liquidity? Most policy’s have a credit rating linked to investments of A- or better. Loosening the credit restrictions slightly to BBB+/- will open up the opportunities for investments, for example into commercial paper, and provide higher returns.

Generally policies will have a weighted average duration, as cash surplus has increased over time, the weighted average of the portfolios have significantly reduced. Corporate treasurers have an opportunity to put additional cash out to term. Perhaps the resistance to do this is the low interest environment and the flat yield curve. Investing in term may provide a small increase in interest rates, but if interest rates rise and the treasurer has locked themselves into investments they will then be scrutinized on under performance of the portfolio.  

MAKING BETTER USE OF INTERNAL LIQUIDITY AND FUNDING

So there is more money than ever, corporate treasurers have to get the balance right between yield and security while still adhering to the investment policy governed by a Board of Directors. Banks can provide specialist services and are investing in new products and enhancing the functionality of existing offerings. “Best in class” banks are working to deliver global consistency and visibility across their liquidity management services. Banks recognize a priority for treasurers of multi national enterprises is making use of internal liquidity and funding. Country and counterparty exposure is still a major concern for companies, where possible corporate treasurers look at alternative sources of liquidity through their self-funding solutions and optimizing interest returns and costs.   

Moving cash, either physically or notionally, is at the heart of liquidity management. Banks have continued to invest in liquidity structure capabilities, expanding the number of countries and currencies offered enabling a fully automated, cross border cash concentration and pooling global solution.

End of day investment options are also now available by the major banks allowing automated sweeps into money market instruments in line with corporate investment policies

OPTIMISING LIQUIDITY

For many multi national enterprises deploying liquidity structures through notional pooling and cash concentration is the key to unlock liquidity and mitigate risk. Companies will have their own requirements when it comes to putting liquidity management solutions in place. However, the expected outcomes for most will be the same: reduced borrowing costs; maximizing opportunity for investment; reducing transaction and administration costs; improved control and visibility of group cash.

Corporate treasurers need to set clear objectives when establishing liquidity management structures. 

  • How will the solution provide operational efficiencies? 
  • What will the cost of implementing a group structure be versus the benefits? 
  • What accounts should be pooled to a central header account and what is the best location? 
  • What accounts should be concentrated in-country? 
  • How will the solution provide better transparency over cash positions?

Taking the above points into consideration will help determine the most cost-effective solution that meets the group’s objectives.

As a global leader in liquidity management technology, iGTB has helped banks provide their customers with solutions that address individual requirements. Small and large customers can benefit from the “out-of-the-box” suite of liquidity products, whether they require simple pooling or concentration solutions or more complex hybrids overlayed with investments sweeps iGTB can help banks meet their needs. 

About the author

Justin Silsbury
Senior Consultant, Liquidity,iGTB

Majority of his career at J.P. Morgan Bank as portfolio manager, investing clients’ money to maximize return. Successfully transitioned clients and assets to J.P. Morgan.  Product manager for liquidity and cash management.

 

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