|Steve Everett, Global Head of Cash Management and Head of Transactional Services Product, RBS|
In addition, corporate treasurers have redoubled their efforts to optimise their liquidity structures, ensuring that their notional pooling and physical sweeping arrangements meet the requirements of the business and the realities of the markets. The goal in liquidity management is always to consolidate cash to as great an extent as possible in order to maximise value.
However, the changed financial environment has altered how corporates try to achieve that goal. For example, whereas before the crisis there was increasing talk of global mandates for treasury services, now the focus is on regional solutions to achieve diversification and limit counterparty risk. Rather than consolidating business to a single provider, an overlay structure is used to ensure that multiple providers (across different regions) deliver the control and visibility that is essential in the current volatile world.
Counterparty and indeed country risk management has become increasingly important as the eurozone crisis has gathered pace. Corporates are increasingly concerned about which countries are safe to keep cash in, explains Steve Everett, Global Head of Cash Management and Head of Transaction Services Product, EMEA, RBS. Consequently, there is greater focus on daily sweeps to locations deemed to be safe, such as the Netherlands and the UK.
The financial crisis has also increased corporates eagerness to have greater control over their banking relationships as a way of managing operational risk. Increasingly, companies want to be able to follow the progress of payments or queries without having to telephone a bank contact for an update. Banks such as RBS now offer visibility into their back office processes and a wide range of self-service tools and real-time information.
Interest rate and FX risk management
While areas of risk management such as counterparty risk that were of little concern to corporate treasurers just a few years ago are now paramount, other areas, such as interest rate risk management, have been less of a priority for treasurers in recent years. In terms of using their surplus cash, clients are not remotely focused on yield, says Everett. Coupled with the low rate environment (in the US, UK and Europe), interest rate risk management has not been at the top of treasurers risk agenda.
While the interest rate outlook in the UK and the US is fairly certain for the foreseeable future the Federal Reserve has said there will be no rate rises until late 2014 the rates environment is changing elsewhere. Rates are starting to fall in emerging markets South Africa, China, India and Brazil have all cut rates recently and in July the European Central Bank (ECB) also lowered rates. The ECB cut in particular is important as it takes us close to negative interest rates, says Everett. It remains to be seen how clients will balance the challenges of liquidity and counterparty risk against the need to achieve a positive yield.
In contrast, FX risk management has become increasingly important for corporate treasurers as currencies have become more volatile in recent years. All cross-currency payments and collections necessarily generate FX risk. Treasurers are seeking to execute FX for cash and settlement with greater visibility in relation to the price they will pay and the risk they will take on.
The need to manage FX risk is especially important for trade. For example, a trade transaction might have a 60-day settlement time, creating a need to manage FX risk for the day of settlement. In a stable FX environment that risk might be minimal, but because of the increased volatility of the current environment there is an increased appetite for transparency and visibility of risk. FX risk has been relatively neglected by corporate treasurers in recent years, relative to counterparty risk, for example, says Everett. However, as the global economy is driven increasingly by emerging markets, FX risks are becoming more important (because emerging market currencies are generally more volatile than G8 currencies) and have to be addressed.
One currency, the Chinese renminbi, is arousing special interest. Its gradual liberalisation since 2010 and the introduction of offshore settlement in Hong Kong (with the prospect of an offshore hub in London) could prove one of the most important developments in recent decades. If you have a supply chain in China, it can make sense to settle in renminbi rather than dollars, says Everett. It can be a way of reducing costs and also of eliminating FX risk. We remain in the early stages but even in twelve months volumes will have increased significantly. Its a way for companies to get maximum benefit from the opportunities available in China.
Once operational needs are met and assuming there is surplus cash available treasurers are relentlessly focused on liquidity and cash preservation for their short-term investment cash. According to the survey published in July by the Association for Financial Professionals, which is funded by RBS and RBS Citizens, short-term corporate cash is increasingly moving towards banks, with bank deposits now accounting for 51per cent of short-term corporate investment balances. Findings from the survey show the highest level in its seven-year lifespan, nine percentage points above last years findings. As recently as 2006, the average allocation was 2per cent.
In the post crisis-period, the challenge facing corporate treasurers needing to invest short-term cash has grown significantly. There is a decreasing number of counterparties as the financial sector has consolidated while the credit quality of the remaining banks has largely declined. As a consequence, treasury policies set just a few years ago requiring a minimum AA credit rating, for example may no longer be relevant. Ratings agencies have announced hundreds of ratings downgrades recently, including for many of the worlds largest banks.
At the same time, treasurers have had to contend with an environment in which banks have been flooded by cheap liquidity from central banks, in order to shore up the financial system and try to stimulate economic growth. As a consequence, banks simply do not need to attract additional liquidity and are therefore unwilling to offer attractive yields. The challenge facing corporate treasurers is exacerbated by the scale of the cash they currently hold: it is estimated that European corporates have as much as 1.3 trillion in cash while some US corporates have more cash than many asset managers (Apple is reported to have $100 billion).
While huge sums of cash may be a good problem to have, investing it is genuinely problematic in the current environment. As a result, preservation of principal is the most important priority. Yield is almost insignificant as a consideration: while good yields are available from Italian or Irish banks there is almost no interest from corporates in placing deposits with them. Instead, all attention is focused on a handful of banks deemed to be safe. In addition to the cheap liquidity they can access from central banks, they are consequently also awash with corporate liquidity that they barely have to pay for.
At the same time that some banks are swamped with corporate liquidity and others are desperate to source it new regulations such as the individual liquidity adequacy assessment (ILAA) in the UK and Basel III globally are requiring banks to hold larger liquidity buffers. As a consequence, banks have had to become more adept at valuing liquidity from different sources such as financial institutions and corporates.
The new rules mean that the value of a deposit varies considerably depending on the type of entity making it. The regulators assumption is that corporates move money less frequently than financial institutions and that their deposits are therefore more stable. Moreover, corporates are also likely to have operating accounts with the same bank providers, which reinforces this trend. Consequently, regulators consider corporates less likely to withdraw funds should a bank face problems, which means that their liquidity is valued more highly in terms of liquidity buffers.
However, the importance of corporate liquidity comes with a caveat: it is only valuable to banks if it is on deposit for greater than three months at which point regulators deem it to be stable and therefore it becomes eligible for preferential treatment as part of a liquidity buffer. Unfortunately, corporates do not typically like to invest short-term cash for over three months; from an accounting perspective, deposits of less than three months can be counted as cash or cash equivalent and are therefore an enhancement to their liquidity.
One solution to this challenge developed by banks is the rolling 95-day notice account. Some companies have been able to account for such deposits as cash equivalent while banks can claim regulatory benefits from them. However, while meeting regulatory requirements, such accounts still present banks with a challenge. In the event of a crisis such as a several-notch downgrade a bank would still face an exodus of deposits after 95 days. In an ideal world, banks would like deposits of six months or longer.
Banks such as RBS have been working to develop alternative short-term investment solutions that meet corporates need for security while offering acceptable yields. One bespoke solution is the use of secured deposits.
Banks necessarily have assets on their books that need funding. By using them as a pool of collateral it is possible to offer depositors greater security than on a regular deposit. Consequently, corporates may be more willing to extend their deposits to six months, providing additional regulatory benefits for banks.
While the deposit is not rated (it carries only the rating of the bank offering the product) and the bank remains the counterparty, the corporate is enabled to access the pool of collateral should anything go wrong at the bank. Consequently, the risk is lower than it would be for an unsecured deposit. Typically, the deposit is overcollateralized based on the risk profile of the assets used: for example, deposits collateralized by government securities might be 101per cent collateralized, whereas those collateralized using asset-backed securities might be 110per cent collateralized. The only disadvantage of secured deposits is that the documentation is more onerous than for a traditional unsecured deposit.
Another alternative solution that might prove sufficiently attractive to corporates to encourage them to deposit cash for six months uses an existing derivatives position to deliver improved returns. If a corporate has a derivatives position, such as an FX or interest rate swap, that is out-of-the-money they owe the bank on the contract they can place a deposit (larger than the derivatives position) with that bank. The bank will be willing to pay a higher yield than usual because it already has exposure to the client.
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