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The 2012 guide to Liquidity Management: JP Morgan - Is your treasury ready for the new global rules?

For most of the past decade, treasurers have coped with challenges to their corporations’ liquidity management – from financial markets melting down to a global recession, potential national defaults and regional debt imbalances. In response to these increased stresses and a sustained low interest rate environment, these finance executives have accumulated historically unprecedented levels of cash.

The objective of the cash accumulation has been to maintain a cushion against future challenges to their organizations’ access to capital and provide flexibility to fund strategic opportunities. A recent Treasury Strategies study placed corporate cash holdings by US companies at $2.23 trillion, €1.9 billion for companies in the eurozone and £785 billion for those in the UK (as of 31 December 2011). And, in the US, corporations hold almost 75% of total liquidity in overnight investments, money funds and bank deposits, according to the treasury consulting firm’s study. Although a survey last year by the Association for Financial Professionals (AFP) indicates that the drive to build cash has abated somewhat as economic conditions have improved, most corporations still find themselves awash with short-term funds. Now, however, they face more limited options for cash placement, thanks to a host of shifting market conditions and impending rule changes.

Rather than another global challenge, finance executives are about to confront a raft of new global and US regulations instituted in the wake of the economic collapse and designed to strengthen the overall stability of the markets. Ostensibly aimed at financial institutions to prevent some future unknown threat from spilling over into the broader economy, these new rules are also likely to drive treasurers to rethink investment choices for short-term cash in terms of risk profile, liquidity and return.

A quick look at the regulations

In the US, the Dodd-Frank Wall Street Reform and Consumer Protection Act mandates, among other things, unlimited Federal Deposit Insurance Corporation (FDIC) protection for balances in non-interest bearing transaction accounts. However, that protection may expire at the end of this year. The end of this insurance coverage may add a degree of risk to an otherwise conservative cash strategy.

The Basel III Accord will take effect over the next several years. It will establish new global standards on bank capital adequacy and market risk. Banks will be required to maintain strong liquidity buffers of high-quality assets – mainly government-backed – against a portion of any deposit that does not have a term of greater than 30 days. In cases where deposits are not considered operating funds this new requirement may significantly limit the value and desirability of short-term funds for banks.

Finally, there is also the potential for new regulations affecting money market funds. The changes under consideration include capital requirements, holdback provisions and variable fund net asset values.

Preparing your treasury

While the full impact of the rule changes has yet to play out, their aim is to require a higher degree of precision in liquidity and investment management.

Here is a checklist of questions treasurers may want to consider, not only to protect short-term funds and invest them wisely, but also to maximize their value in this changing environment. The list is simply an attempt to raise awareness about some initial issues facing treasuries, and help to begin a dialogue within your companies and with your bankers about the impact of change.

Operating cash at banks

First, take a look at operating cash being held at banks. This is cash that can provide a tremendous source of value in times of crisis. Key elements to consider are the complexity of managing cash flows across your operating relationships, particularly in times of market stress, and the importance placed on having the right partnership with your primary operating bank. 

  • Have you adequately assessed the resilience of your operating banks? Have you examined their capital strength?

  • Have you explored how the expected removal of unlimited FDIC insurance at the end of 2012 for non-interest bearing balances will impact your management of counterparty limits? 

  • Should full FDIC coverage expire, will you require additional counterparties? If yes, have you calculated the risks and costs of managing a larger number of counterparties?

  • Have you identified the implied term extension of your operating cash?

  • Where possible, have you explored how cash concentration structures – within a currency and cross-currency – can help provide visibility into counterparty exposures and mobilize cash quickly?

  • Are you regularly reviewing your investment policy to ensure that there is enough flexibility to make changes quickly?

  • When looking at counterparty limits vis-à-vis investment duration, have you analyzed your level of liquid versus term cash in determining limits?

  • Have you maximized the return on your bank operating balances through earnings credit rate (ECR) programmes? 

  • Have you explored extending your ECR programmes globally to get more value for operating cash? Have you talked to your bank about extending ECR value to non-traditional operating product classes?

Non-operating short-term deposits at banks

Under Basel III, financial institutions will have to maintain liquidity buffers of high-quality assets against a portion of any deposit that does not have a term of greater than 30 days. In many cases, this may significantly limit the value of these funds to both banks and corporations.

  • Have you discussed with your counterparties the disposition of non-operating balances post-Basel III?

  • Have you asked if pro-forma reporting by banks in 2012 through 2014 could accelerate the impact of Basel III regulations prior to full industry adoption in 2015?

  • Have you examined your balances and sources of cash to determine which funds might qualify as operating balances?

  • Are there other options for these funds, such as laddered contractual terms or other means of extending contractual term while retaining liquidity?

Money market fund placements

Money market mutual funds are still among the most popular investments for corporate cash, providing an excellent source of liquidity and diversification. However, the new rules being considered, especially for funds operating in FINRA jurisdictions, may ultimately affect their overall utility and raise questions about how and when to appropriately use them.

  • Have you considered expanding your money market fund programme to include additional currencies?

  • For non-operating short-term cash, how do you balance diversification while effectively monitoring counterparty investment limits?

  • Are you considering changes in response to the new regulations? For example, will you alter the amount of money you will put into money market funds given new liquidity requirements?

  • Have you considered the implications for your investment guidelines of floating net asset values or holdback provisions? What Enterprise Risk Management (ERM) or other systems (eg, tax) updates would you require?

  • Have you looked at the potential impact on operating accounts if funds are swept to a floating Net Asset Value (NAV) programme? On reconciliation systems?

Secured investment alternatives

The regulatory changes and market dynamics, including the proposed expiration of unlimited FDIC insurance, may also drive financial managers to consider alternative, high-quality secured investments.

  • Are you appropriately positioned in terms of credit and concentration risk? Will your positioning change if unlimited FDIC insurance expires for transaction balances?

  • Are you prepared as short-term market rates trend negative in a growing number of currencies?

  • Have you explored secured short-term investments, such as non-traditional repo or collateralized commercial paper, as part of a diversified cash management strategy in light of expiring unlimited FDIC coverage?

The time seems ripe to assess how best to prepare for the impending changes and begin to review the innovative ways available to meet these new challenges. J.P. Morgan stands ready to assist. If you would like to discuss these issues further, contact your local relationship manager or e-mail:

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