Centralization, standardization and consolidation
LIQUIDITY MANAGEMENT, WHICH includes the mechanics of moving money between subsidiaries as well the investment of that cash, has become immeasurably more important to corporate treasurers in the past year. As credit has become scarcer – and a global economic slowdown has loomed – corporates’ focus has inevitably turned to maximizing the efficient use of their existing cash.
The simplest way to increase working capital is to increase the speed with which cash moves in a company. Using physical cash concentration and notional pooling, leading banks can now perform near-wonders: netting long and short positions across different global accounts – including those subject to exchange controls – in order to minimize a company’s overdraft costs and maximize funds for investment.
However, it is what happens at the end of that process – short-term investment – that has taken centre stage in recent months. The turmoil in the banking sector has led to a wholesale reassessment of the risks of leaving excess funds in bank deposits. Meanwhile, the rush into government bonds, a common alternative investment, has lowered yields to unattractive levels.
And in the money market fund sector – the most rapidly growing area for short-term investment by corporates – the inability of the Reserve Primary fund, one of the oldest in the industry, to return the full value of funds invested has shaken confidence. The challenges, complexity and risks in choosing a short-term investment have never been greater. Treasurers have their work cut out for them.
Choice of short-term investment essentially comes down to the requirements of the corporate treasurer: when they will need access to the funds, the level of safety of the investment and its yield. Typically, the shortest-term investments – overnight deposits – have the lowest yield. But once a treasurer can afford to put funds away for more than seven days, a world of opportunities opens up.
To be sure, treasurers – for reasons of inertia or caution – have been slow to take advantage of new investment options. As Kevin Thompson, managing director of the institutional cash fund at Fidelity International, says, bank deposits remain the primary liquidity tool for corporate treasurers. Nevertheless, the move to minimize bank balances and seek higher yields elsewhere has been the defining trend in recent years.
Risk aversion
Now, as Lisa Rossi, global head of liquidity at Deutsche Bank in New York, notes, that trend has stalled. "The goal is to reduce risk and to maintain balances," she says. "Consequently, there has been an increase in cash on account and a willingness to accept a lower return in exchange for security." But, as Thompson notes, security is a relative concept with bank deposits. "By placing a deposit an investor becomes an unsecured lender with 100% bank risk," he says.
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"There has been an increase in cash on account and a willingness to accept a lower return in exchange for security"
Lisa Rossi, Deutsche Bank |
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"As a result, the huge inflow into bank deposits has been to institutions deemed stable," says Elyse Weiner, global head of liquidity for treasury and trade solutions at Citi. "We’ve seen evidence that money has been pulled out of smaller regional and local banks. Banks that have been backed by government guarantees are also considered safe bets. Certainly, in Europe, banks in countries that have guaranteed deposits – such as Ireland – have benefited from those assurances in attracting and retaining deposits. In the US, the [Federal Deposit Insurance Corporation] has temporarily raised insurance limits for individual depositors and instituted a programme to insure total deposits held in certain transaction accounts."
Weiner says that the level of detail clients now require about the banks that they do business with is unprecedented. "They are no longer confident simply with ratings and instead ask about capital adequacy, the size of the balance sheet, the diversity of the bank’s portfolio and the regulatory oversight of its operations," she says. Provided clients do their homework, they may be pleasantly surprised at what’s on offer. "Banks have rediscovered the value of core deposits, and with the interbank markets more difficult to access, attractive returns are available," she says.
Money market jitters
One alternative to traditional investment with a bank deposit is direct investment in short-term instruments, including government bonds. Although there can be attractions to such investment, it requires a sophisticated approach to risk management and a thorough understanding of how instruments work. Alternatively, such investment might require a dedicated cash manager to be employed, which can prove costly.
The lack of knowledge about short-term instruments of some corporate treasurers was on display recently. As concerns mounted about counterparty risk, many treasurers fled to the safety of government securities. "However, in their haste, some buyers did not realize that if you liquidate government bonds prior to maturity there is market risk that could lower the return," notes Weiner. "That error indicates the level of panic among some investors."
A simpler alternative to direct investment is money market funds. These invest in money market instruments on behalf of clients – the sector is essentially the outsourcing of short-term cash management. Clients then benefit both from the diversification achieved through the fund and the reduction in administrative and overheads costs compared with an in-house approach.
Money market funds are designed to provide capital security and same-day liquidity. The short-term nature of the funds allows them to alter portfolio composition quickly to reflect investor needs and sentiment. This enables the funds to continue to provide both security of capital and liquidity; two objectives that have become increasingly important for all investors as financial markets have become more volatile.
Consequently, money market funds enjoyed substantial growth in the year following the onset of the credit crisis. According to the Institutional Money Market Funds Association (IMMFA) – the trade body representing providers of triple-A-rated money market funds – from August 2007 to September 2008, total assets in members’ money market funds grew by 38% to €463 billion.