Liquidity management debate: Liquidity management in an age of anxiety

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The eurozone crisis has prompted increasing concerns about risk among clients seeking liquidity management. But Euromoney’s debate suggests that bankers feel they have the mechanisms in place to meet customer needs for reassurance and safety.

EXECUTIVE SUMMARY

• With the eurozone crisis, corporates are more exercised by risk, putting security and liquidity well ahead of yield. They are demanding systems best suited to forestall upcoming market events

• In addition, clients want to know where their money is at all times, with counterparty risk a prominent concern

• Counterparty risk is a factor of intense concern, with clients looking at multiple components of it that previously did not much bother them

• Clients are demanding the capacity to achieve greater access to their own liquidity

• Cash forecasting is of growing importance to clients because of its contribution to visibility

Debate participants

Euromoney
What impact has the eurozone crisis had on corporate attitudes towards liquidity management?

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays The corporate market is still in robust health – it’s just trying to find the right way to react to the political and sovereign issues. For 20 years clients have been sweeping funds south to north across Europe. The political risk has made them focus on that a little more sharply. We saw it in individual countries that experienced problems; there was a sudden recognition of bank counterparty risk, which prompted a move towards safety. Now we see it on a pan-European scale: clients are asking what their risk appetite is for each country.

We are seeing two reactions from corporates. The first is a tactical reaction of moving towards security and placing yield a distant third behind security and liquidity. The second is a strategic reaction focused on having the best systems and policies in place so that clients don’t have to react to market events – they can get ahead of the game.

Jan Rottiers (JR) is head of liquidity management products at BNP ParibasJR, BNPP Counterparty risk has been an increasingly important issue for corporates. Before the crisis, the focus was on risk policies in relation to trading, for example, rather than where a corporates’ cash was residing at the end of the day. Now, knowing where the cash is at a given moment – especially from a counterparty risk perspective – is a top-level concern.

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB In addition to increased concerns over counterparty risk, there is a desire for greater control over liquidity positions. This control boils down to transparency – clients want to know where their money is at all times. That wasn’t exactly the case before. Consequently, more attention is being paid to how liquidity structures are set up to ensure they include all the necessary entities and relationships.

Many of our corporate clients have large cash balances sitting in their accounts. The big issue is where to put them. Of course, they are concerned about counterparty risk, but also face a challenge to earn interest. Some banks have mentioned the idea of negative interest rates. In the past, such a proposition would have been unthinkable.

Nick Claus (NC) is senior product manager, investments, international liquidity and investment management at RBSNC, RBS As a result of the crisis, the importance of liquidity has gone right up the corporate agenda. The overriding objective of corporates is to maintain liquidity so that they can continue to function in case of disruptions to funding. That manifests itself in a number of ways, including in discussions about counterparty risk management. Companies are sitting on huge cash piles and have to manage the risk that comes with that.

While the concern is about the eurozone, corporates want to get their hands on cash outside Europe in, for example, North America or in Asia. They want the tools and techniques to be able to use their own funds as a first source of liquidity.

In terms of counterparty risk, a few years ago corporates’ investment policies weren’t as frequently reviewed as they are now. Also, corporates have become more sophisticated in how they measure counterparty risk. In the past, credit ratings were the primary measure. Now credit default swap spreads are used and capital ratios and other measures are tracked. With regard to investment products, there is a desire to keep things as simple as possible in terms of products so the underlying elements are fully understood. For example, with money market funds there is a recognition that looking at the rating of the fund is not enough; clients want to analyse the underlying instruments and exposures that they have.

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB A number of corporate clients have hired analysts to start breaking down some of their mutual funds. Increased due diligence is being exercised at every level, particularly when it comes to short-term investments. We offer proprietary and third-party funds where the client can select exactly the portfolio they require. They are no longer relying solely on credit rating agencies, but rather augmenting their own research.

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays It’s true that ratings are seen as a bit of a blunt tool for analysis because triple-A rated banks hit a wall quickly – with little advance warning – during the crisis. A lot of clients now use gateways – they place money through a central resource that assesses every bank.

Euromoney But CDS can be driven by technical factors or can wildly overshoot. Aren’t they as blunt a tool as ratings?

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB The point is that they are not just looking at credit default swaps, but also rating information and the level of government backing or bank support. There are perhaps now three or four additional components that weren’t an issue five years ago.

Jan Rottiers (JR) is head of liquidity management products at BNP ParibasJR, BNPP Ratings are and will remain important. Other elements, such as the way that the customer perceives, for example, how a bank is able to prepare for Basle III – the degree of preparedness to attain the different ratios – has also become important.

Reacting to the crisis

Euromoney How quickly can banks put in place the kind of structures that corporates need in order to address their concerns about the eurozone crisis?

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB We can work with our clients and very quickly create new structures that are tailored to their specific needs.

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays At the simplest level, payments are easily made. Of course, complex netting, pooling and sweeping structures take time to establish, but the fundamental requirement is to move money from somewhere you don’t like to somewhere you do.

Nick Claus (NC) is senior product manager, investments, international liquidity and investment management at RBSNC, RBS The change is in the importance of liquidity management not the techniques.

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB For pooling and netting products, the limitations are related to domicile, tax and regulatory issues – none of which has changed dramatically recently. The only real difference is that corporates are now paying more attention to these structures and whether they provide a new opportunity.

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays Many of the big companies that have gone public about their sweeping arrangements in recent months have had similar arrangements for years, if not decades. The political situation may have accelerated or deepened that sweep or they may have changed it to a zero-balancing account structure but essentially, for many of these organizations, everything was already in place.

Nick Claus (NC) is senior product manager, investments, international liquidity and investment management at RBSNC, RBS The objective has always been to have zero or very little idle cash around the organization and that hasn’t changed.

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB What will finally change as a result of this crisis is cash forecasting and planning. Clients say they can do this on their existing treasury workstation – but they either fail to fully leverage that capability or still use Excel. Corporates have many platforms and applications that can give them the transparency to facilitate the mobilization of cash or cross-currency pooling scenarios. However, many of these tools are too complicated and, consequently, not used. Treasurers require simpler applications. Greater attention will be paid to repatriation of funds as well – and I am curious to see if governments will facilitate that to some degree.

Jan Rottiers (JR) is head of liquidity management products at BNP ParibasJR, BNPP Forecasting is becoming more important because it is all about visibility. Coming back to cash pooling, there is another important trend occurring. A lot of clients historically selected the location for their cash pool header account for legal and tax reasons. Now customers are also reflecting on header account location because of counterparty risk. Having the ability to easily switch the header account has therefore become important. We expect that interest in cross-currency type solutions will also increase further.

Euromoney In a worst-case scenario – such as a euro exit and the introduction of capital controls – to what extent does it make a difference whether a notional pool or physical sweep is in place?

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays If you are pooling cross border then the currencies aren’t moving. In theory you therefore have an issue if a currency is redenominated. Physical sweeping to a perceived safe haven is safer than just leaving funds in situ and notionally pooling them.

Euromoney Have you seen that having an impact on clients’ behaviour?

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays A little bit. We don’t want to be seen to be assisting clients to speculate against whichever country is bottom of their risk spectrum on any given day, but clearly clients are looking at the risk of redenomination and perhaps shortening their tenors on cash deposits to ensure flexibility. But it’s true that if you physically sweep every day, particularly if it is euros to London, for example, that is demonstrably safer than keeping things spread across a European footprint and pooling.

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB I haven’t seen a great deal of relocating of header accounts. That said I have seen some movement of funds into branch accounts in countries perceived to be less risky. But it’s important to state that Deutsche Bank feels strongly that the stability of the euro is important and we would not want to see market disruption, or facilitate speculation that could damage that strength.

Euromoney But if your clients come to you with these concerns you have to be able to address them, don’t you?

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB We do get asked what would happen from a transaction banking standpoint if Greece left the euro. However these questions are raised more by regulators keen to ensure we are prepared for any situation rather than concerned corporate clients.

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays Clients that are in Europe are there to trade. Often, the only cash they have there is to meet their payables. So if there is idle cash overnight it is not a huge issue deciding what to do with it – it’s just that it would ice the cake if they could take that risk out of the business. There isn’t a lot of speculation taking place – it’s just where there are structural surpluses that we see them being swept out.

Dealing with the unknown

Euromoney How do you plan for a scenario where we know few of the possible details, such as the imposition of capital controls following a euro exit?

Nick Claus (NC) is senior product manager, investments, international liquidity and investment management at RBSNC, RBS RBS has spent a lot of time and effort evaluating different scenarios. Our aims are to make sure that we are secure, that we can continue to function as a bank in whichever country and that we are able to minimize any disruption to clients.

Jan Rottiers (JR) is head of liquidity management products at BNP ParibasJR, BNPP We also receive ‘what if’ questions and our answers are honest: there are a lot of uncertainties in such scenarios. What we therefore need to ensure is that we have absolute contingency and technical capabilities to adapt.

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB At the simplest level, we talk to clients about how our systems would be able to handle a new currency, and how this would affect their liquidity structures. We also put our research analyst in touch with clients to go over country-specific issues.

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays Some banks didn’t get all the legacy currencies off their systems, so they could probably go back quite easily. But generally, the introduction of a new currency would be challenging for both banks and companies. You have to look at not just scenario planning, but contingency planning: banks have to be open and honest about where they might be a risk to a client. Clients can’t be expected to set up a parallel infrastructure in every country as an insurance policy, but where it really matters a lot of corporates have been taking that approach.

Nick Claus (NC) is senior product manager, investments, international liquidity and investment management at RBSNC, RBS One development that has come out of the eurozone crisis that we haven’t touched on is the shift from the idea that big is beautiful and that the best liquidity structures are built on having one bank globally. Companies often want to diversify their local bank providers, so liquidity structures need to have the flexibility to include local banks in countries or sub-regions whose cash positions are then consolidated in a way that provides the necessary visibility and control.

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB But at the same time, the number of banks may decrease due to the scale of regulatory change. While the big banks can’t have everything everywhere – foreign banks might not offer cash-concentration structures in China, for example – the industry still looks to them for support with information reporting, improving transparency, consolidating and facilitating forecasting. In addition, treasurers are spending more time addressing forward strategy – largely shaped by regulatory developments – which significantly eats into the time they can dedicate to resolving operational issues. They are therefore turning to banks for support in this respect and this is where the large global banks – with the scalable technology, resources and international network needed to address clients’ global requirements – stand to benefit.

Nick Claus (NC) is senior product manager, investments, international liquidity and investment management at RBSNC, RBS From our perspective, as regional or global liquidity providers, we act as the overlay bank. But at a local level we increasingly see local banks being used for local subsidiary banking and the resulting balance being absorbed into a liquidity structure that we provide. This is often because of the requirement to maintain relationships with those banks that provide credit support.

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays Big is still beautiful in terms of the ability to do consolidated reporting, management information (MI) and regulatory returns. If one bank can make that easy for a client then it really is beneficial. But we do take issue with the idea of one size fits all and everything being provided by one bank: there isn’t one bank that can do that worldwide. Also there is the counterparty issue: clients rightly don’t want to put all their eggs into one basket. Instead, they trim a bit off and give it to another bank. Instead of having just two banks, clients might give business to four or five, although transactional, reporting, MI, internet, consolidation and regulations are likely to go through one player to make it effective.

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB That change is partly driven by the credit situation as well: one bank is unlikely to extend 100% of the credit that a client might need.

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays And from a scenario-planning perspective, what if one bank could provide all that credit – and then stopped being able to?

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB Exactly. Credit is more difficult to come by and the cost dynamics have changed.

Euromoney Do clients have to pay more in overall costs to achieve diversification of provision?

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB To an extent they don’t, because competition and commoditization have lowered costs.

Jan Rottiers (JR) is head of liquidity management products at BNP ParibasJR, BNPP I agree that one bank is not always able to do everything in whatever region. Customers could have a need to work with local banks for some services. Moreover, the issue of risk and credit will become increasingly important because of intraday liquidity costs. For example, a local subsidiary account with a local bank that executes payments may be covered at the end of the day by money sent downstream from a global cash pool to cover that position. To date, this has been done at no cost by that local bank. However, this could change given the higher cost of intraday liquidity.

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB The market has been debating intraday costs for a while, and I understand what you are saying. But if banks are not able to pay clients interest on positive balances, then there is an inequality in the market: clients will push back on charges for intraday liquidity if they are not being compensated for positive intraday balances. How is the market going to adapt? Just from a logistical perspective, you need a system that is going to be able to quantify the intraday cost. This may pose a challenge for some banks.

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays It is hard and consequently our industry has not got around to charging for intraday liquidity.

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB One solution I have seen is a slight reduction in the interest earned for a time deposit to accommodate an early morning delivery of funds.

Jan Rottiers (JR) is head of liquidity management products at BNP ParibasJR, BNPP As an overlay bank, we are not about to start charging for intraday liquidity but local banks could – especially where they are acting as part of an overlay structure provided by another bank.

Changing investment objectives

Euromoney How have corporates’ investment policies and objectives changed in the light of the eurozone crisis?

Jan Rottiers (JR) is head of liquidity management products at BNP ParibasJR, BNPP Customers are averse to products that are too complex. There is a linkage made between complexity and risk. At the same time, close attention is being paid to counterparty risk. In practical terms, there is renewed interest in all types of deposit and term products.

Euromoney Proponents of money market funds claim that momentum is shifting to their market rather than deposits – is that untrue?

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB With the recent rate reduction in Europe, the return on money market mutual funds may be affected, and therefore they may become less attractive. There are also proposed regulatory changes in the US that could make mutual funds a less viable alternative.

Clients are reassessing their investment parameters. First, they are eliminating whatever wriggle room there used to be in terms of investment flexibility and conducting more thorough due diligence on where they are placing funds. Secondly, they are making liquidity a priority. Thirdly, they are carefully selecting their counterparties. Clients are allocating deposits to their key banks for improved asset allocation as opposed to using only one bank.

Nick Claus (NC) is senior product manager, investments, international liquidity and investment management at RBSNC, RBS What clients do with cash depends on the type of cash it is: we typically segment clients’ cash into three buckets: operational cash (frictional day-to-day cash); longer-term cash (with a maturity horizon of six to 12 months plus); and a middle tier that we call flexible cash.

That middle tier has characteristics of both operational and fixed term. Lisa, you made the point that liquidity is key for clients and that they want to keep their investment horizons short. For that middle tier of cash, there is a conflict between instant access and the reality of not needing it every day – it has a term element to it as well. Once you’ve segmented the cash, then you can look at the different products that fit the buckets. In the middle we have created products that are smart and can measure how long that operational type cash has been there and then reward it based on the term.

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays Treasury policy is more fluid now than it used to be and clients reassess it more regularly. They are carefully considering their approach to the three buckets of cash and working out what they need urgently and what contingencies they have in place if something goes awry. Then, once they have identified structural surplus cash, they work out what tenors they can commit to and what yield they want to chase, if any. There is also a broader balance sheet perspective about companies’ equity and debt. Once all of those parameters have been addressed there should be a clear policy that states approved counterparties, tenors and other details. There is undoubtedly a move towards much shorter tenors because people have learned their lessons but corporates also want rewards for being loyal to a particular bank over a demonstrable period of time – our industry is evolving a behavioural suite of products in response.

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB Clients had investment policies but they either did not always adhere to them, or the respective parties were simply not aware of them. Now, because of the more volatile nature of the global economy, regulatory changes and the eurozone crisis, clients are re-evaluating their policies. Regulation is no doubt the main driver, but clients also recognize they have to look beyond a mere current account deposit.

Euromoney Isn’t there a centralization imperative, because to enforce a policy there must be central control?

Nick Claus (NC) is senior product manager, investments, international liquidity and investment management at RBSNC, RBS That’s absolutely right, but the advent of regional and global liquidity structures has brought responsibility for investment management to the centre of the treasury organization.

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays There are still some decentralized treasury operators, but they are a minority these days. Instead, the gateway approach I mentioned earlier is flourishing: a certain proportion of overall cash is allocated to certain banks based on risk parameters. Increasingly, there is an outsourced model where a think-tank sets treasury policy by counterparty and tenor and takes it to the board. While decisions on aggregated funds might be set in stone, if someone in Portugal wants to be with bank A that’s fine as long as France is using bank B – at an aggregate level, the treasury policy is still met.

Euromoney Is such a gateway structure only possible for the biggest clients with the greatest resources for due diligence?

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays It is coming down the scale. Even relatively modest operations with four or five operations across Europe now have that type of treasury policy.

Jan Rottiers (JR) is head of liquidity management products at BNP ParibasJR, BNPP We see it for larger mid-cap corporates. Even if there is some autonomy at a local level, all limits are set centrally and imposed centrally.

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB But obviously, cash cannot just be divided up based on risk profile: the product capabilities and systems resilience of each bank need to be considered. It is not a free for all; you have to show that you have the capabilities to be in the beauty pageant.

Basle III

Euromoney What impact will Basle III have on liquidity management for corporates?

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays The issue is one of polarization of cash. Basle III results in two categories of cash: one assumed to have 25% outflow and one with 100% outflow – that figure refers to how reliable that funding is perceived to be in the event of a downgrade/stress event at the bank. In practice, it will mean that corporates’ operating cash will have value for banks’ clients while more discretionary cash will become increasingly valueless.

Nick Claus (NC) is senior product manager, investments, international liquidity and investment management at RBSNC, RBS The change from the current situation is significant. Essentially it boils down to the fact that all deposits are now not equal. There are certain types of deposits that are more valuable to the bank – which include operational type deposits, or deposits that have a contractual term of over 30 days. Every bank is going to have to look at the regulations, understand what the impact is on their own balance sheets, understand how their products fit in with the new regulations and how they can continue to meet their clients’ needs.

Euromoney Have banks fully worked out the implications of Basle III in terms of the products that they can offer to clients?

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB It depends on the bank. Transaction banking has been built on the premise that you would have float or balances. This model will have to change dramatically and will challenge part of the revenue component of our business.

Deutsche Bank has already started to apply the liquidity coverage ratio (LCR) internally, so that we can better understand our business. We have already developed updated features for our products to accommodate the new regulations and market conditions. The products are not completely new, but they are products that we did not traditionally offer through transaction banking as an investment option, such as longer-dated term deposits or call deposits. If a call deposit is uncalled beyond 30 days, 60 days or 90 days, it becomes increasingly more beneficial to us as a bank for the LCR, and we are able to offer a better return.

Clients want available liquidity and thus shorter-term conditions, but Basle III favours longer-term stable deposits. We won’t be able to offer our clients the same attractive interest rates on current accounts that they have historically received. Treasurers, therefore, are going to have to respond by improving their forecasting capabilities to secure better interest rates on longer-term deposits or investments.

Jan Rottiers (JR) is head of liquidity management products at BNP ParibasJR, BNPP Each bank is preparing for the implications of Basle III internally based on simulations for the LCR ratio or the net stable funding ratio. In terms of product development, BNP Paribas has put a lot of effort into developing Basle III-compliant products. It should be remembered that there are still uncertainties and incomplete legislation and transposition. But overall, the trend is clearly to develop more term-deposit-type products that take account of duration.

Euromoney If companies need these funds, can they access the deposit at any time and forfeit the yield benefits?

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays They can give notice, but these are not breakable deposits, which will not be Basle III compliant.

Corporates and Basle III

Euromoney How much do corporates need to know about Basle III?

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB We have regional client advisory committees made up of our top clients. We explain the changes in regulation and how they impact the products we are able to offer. They are increasingly aware of stress testing required for banks, and need to understand, for example, what variables drive the calculations behind those ratios.

Jan Rottiers (JR) is head of liquidity management products at BNP ParibasJR, BNPP We focus on products: that doesn’t mean not discussing the drivers but the features are more important. Treasurers want to know what is happening in banking but they don’t want to be made aware of each individual detail.

Nick Claus (NC) is senior product manager, investments, international liquidity and investment management at RBSNC, RBS We have a responsibility to our clients to try to educate them about Basle III. We also run client sessions about Basle III and its implications.

Euromoney What feedback do you get from clients in client sessions?

Nick Claus (NC) is senior product manager, investments, international liquidity and investment management at RBSNC, RBS The reaction has been positive.



Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB Recently, feedback has focused on the potential for a zero or negative rate environment as a result of Basle III. Clients want to understand how they would manage their liquidity needs in such circumstances and how their working capital formulas will be affected. That brings the debate back to the increased importance of forecasting.

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays Of course, the broader upside for clients is a better regulated, more transparent, better governed, level playing field for all banks in all countries. If that costs a bit of short-term interest, then most clients are prepared to live with it.

Euromoney Is there scope for other types of financial institutions to innovate to create a new market for corporates’ surplus cash?

David Manson (DM) is global head of liquidity management at BarclaysDM, Barclays Our bread and butter is providing good transactional services for operational balances, providing liquidity and getting client cash in the right place at the right time. If there are structural surpluses – frothy balances – they are at the end of our value chain. They certainly don’t produce much margin for our industry.

Jan Rottiers (JR) is head of liquidity management products at BNP ParibasJR, BNPP Corporate cash has been piled up because of the overall environment and the limited potential for investment, as well as the economic cycle. But given time, investment in the business will use up part of that cash.

Lisa Rossi (LR) is global head of liquidity management at Deutsche BankLR, DB Perhaps some of the cash-rich corporates will start to use their own liquidity to lend to others in different ways. After all, they are not regulated in the same way as banks. It will be interesting to see if these corporates with healthy cash balances will partner with banks to create better technology for various concentration or pooling schemes. Sometimes, these tough spells result in the best innovative ideas.