The 2013 guide to Liquidity Management: RBS – Beyond compliance: Strategies for a post-Basel III landscape

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Basel III presents many challenges for treasurers. Steve Everett, Global Head of Cash Management at Royal Bank of Scotland plc, looks at how getting to grips with trapped cash and rethinking investment strategies can help to address them.

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Steve Everett, global head of cash management, RBS
The 2013 guide to Liquidity Management

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Basel III reforms imposing stricter capital and liquidity requirements on banks may significantly reduce their ability to lend to clients. As a result, lending rates are expected to rise and a significant amount of liquidity may be removed from the market.

Releasing trapped cash

In light of this, post-Basel III, companies will need to maximize internal liquidity to reduce their reliance on other sources. The need to release trapped cash will therefore move higher up the treasurer’s agenda. Trapped cash, most significantly, prevents companies from using surplus funds they hold in one part of the world to offset their borrowing elsewhere. It can also restrict key strategic investment decisions and impede global plans for a business’s growth, by keeping cash within the country where it was generated. In this context, strict rules on releasing funds from emerging markets – where many companies have invested heavily – are a major roadblock.

Broadly speaking, cash may be trapped in some parts of the world due to local or external factors, or the firm holding minority shares in that market. Limitations on certain financial structures, regulatory insistence on compulsory reserves for loans and deposits, or tax implications for financial transactions, are all key factors. External causes include restrictions on investing abroad or intercompany lending, controls on converting and transferring currencies and high withholding taxes on dividends paid.

Opportunities as well as challenges

The good news is that cash previously caught behind a country’s borders is becoming more accessible. Regulatory reforms dealing with the issue in countries such as China, India, Russia and Turkey are easing the cross-border flow of funds and helping companies ensure strong liquidity management across their business.

For example, companies in India are now able to lend money to their overseas subsidiaries, as long as it doesn’t exceed 400% of their net worth. Central bank-approved pilot schemes in China that target cross-border intercompany lending (in both renminbi and foreign currencies), and cross-border netting, are enabling firms to tap into internal sources of liquidity and reduce funding costs. To ensure they manage their liquidity in the best way possible, companies need to understand fully what these reforms can enable and how they can use them in a way that facilitates liquidity and easier cash flow across their global operations.

At the same time, companies can also benefit from financial structures designed by banks to help clients manage their global currency positions. These include cross-border cash optimization and cross-currency notional pooling, both of which drive greater value from cash balances that would otherwise remain trapped in either the affected jurisdiction or a subsidiary.

Realizing the benefits – a case study

Maximizing the value of trapped cash involves managing cash across borders, while maximizing liquidity throughout the business and aggregating balances to drive improved returns.

One RBS client – a leading provider of wireless technology and services with global operations – was looking to do just this. Of particular concern was how to enhance the management of, and interest result on, its growing portfolio of local currency accounts. The treasury team was looking for a way to increase the interest earned from its operating balances, without losing the convenience of local accounts or entering into complex pooling structures. This was achieved by using our Cross Border Cash Optimization (CBCO) solution, part of our wider award-winning liquidity offering, a far less labour-intensive and more cost-effective alternative to sweeping balances into notional pools according to region and currency.

Without having to centralize accounts to a single location, CBCO automatically adds up the different balances and uses the total – notionally converted into an agreed base currency – to calculate a bonus interest payment. This benefit is paid monthly in the currency of the company’s choice, in addition to the monthly interest earned by each local account.

The company can now enjoy the interest rate advantages of a single account, together with the practical benefits of local accounts, while minimizing the time and resources needed to fund its local operations. Of course, this is just one of the solutions available, and the needs of each company should be carefully understood, through working with banking, tax and legal partners, before taking action.

Any approach to releasing trapped cash needs to be tailor-made to the company and the regulations involved. For example, it requires in-depth analysis of the relevant countries’ laws, the business’s organizational structure and its tax set-up.

Companies need to work with banks that have both the global reach and the local expertise to help them address local conditions and regulations, so that they can simultaneously minimize their trapped balances and maximize their liquidity and working capital efficiency.