Across the globe, the cash and liquidity landscape is changing. Once the dust settles from the extensive regulatory and market changes currently being witnessed, what will the new short-term investment world look like for the corporate treasurer?
Auna Dunlevy has been pondering the investment climate a lot of late. In just the past several years, the Head of Front Office at Royal Mail has witnessed euro rates dive into negative territory, banks becoming more selective around deposits, and regulatory upheaval within asset management that looks increasingly likely to eliminate one of her department’s preferred short-term investment vehicles, the euro CNAV money market fund (MMF).
Such has been the epochal scale of change in the European cash management landscape that treasurers like Dunlevy have had little choice but to almost go completely back to the drawing board (and many, indeed, to the corporate board) with respect to investment strategies. “Where possible we’ve tried to remove the ‘security blanket’ of overnight cash,” she explained to delegates at the Association of Treasurers Annual Conference 2015 in Manchester earlier this year. For what Dunlevy and her colleagues define as ‘primary liquidity’ the traditional investment prerogatives – security, then liquidity, then yield – remain the order of the day. Notwithstanding, treasury has worked hard to negotiate lower fees or higher rates on overnight deposits, leveraging where necessary relationships that banks have with the company’s pension department. But for secondary liquidity, yield is sought over liquidity in some cases.
“In order to maximise the duration of funds falling into this category, we make the decision as early in our cash flow cycle as possible,” she says. “We need to evaluate what the banks offer, check that it fits with our policy and make sure we understand the products. I’m not talking about anything fancy here – it is usually notice accounts or extendables but the fact is that every product is slightly different and they do change from bank to bank.”
Similar strategy discussions will have been taking place in corporate treasury departments across the globe, and especially within those that operate within the Eurozone. It is not just that the investment environment has become a much more challenging one in recent years, it is also that corporates, on aggregate, have much more to invest now than ever before. Companies have become increasingly accustomed to ultra-low borrowing costs (the other side of the low rate coin) and as they tapped the bond markets for record amounts the cash on balance sheets has swelled. Take as evidence the annual S&P Global Corporate Capex Survey, which tracks the top 2,000 global companies that spend the most on capital expenditure. The survey revealed, when it was published in August 2015, that companies are now holding some $4.4trn of cash and equivalents on the balance sheet.
But those prophesying the imminent demise of bank deposits as a corporate investment vehicle might be jumping the gun a little.
“Liquidity management is certainly a bigger activity for the typical corporate treasurer,” says Nick Burge, Managing Director, Head of Strategic Liquidity at Lloyds Bank. “Some of them are making the migration from managing a bit of cash on the side to an operation equivalent to a medium-sized asset business. So that will mean looking across a much broader range of products, different risk matrices, different maturity profiles; it’s all becoming about trying to get some return while still meeting that liquidity requirement.”
It is not just corporates in western markets that are facing investment challenges though. With the notable exception of Japan, treasurers in Asia Pacific have largely been spared the same ultra-low rates investment predicament facing their peers in the US and Europe. Nevertheless, central banks across the region now appear to be in a race to cut rates quickly in order to starve off the economic malaise now beginning to take hold in the region.
Since the beginning of 2015 a number of Asia Pacific’s major economies – China, India, South Korea, Australia, and Thailand – have reduced short-term policy rates to varying degrees. “In the emerging markets, we do see in our footprint a slight decline away from those double-digit interest rates there have been in the past to, depending on the market, between 7 – 10%,” Vanessa Manning, Head of Product Management, Transaction Banking, Europe, Standard Chartered told Treasury Today.
With corporates in the Asia Pacific sitting on more idle cash – an average of $4.2bn each according to S&P – this is news that treasurers in the region probably do not want to hear. Although the risk to preservation of principal for the time being (especially against the current deflationary backdrop) is arguably minimal, a new corporate investment dynamic is beginning to emerge all the same. “That is why, across the regulated markets especially, we are seeing a growing range of interest optimisation solutions for short term operating cash balances where you have a range of EM currencies building up and difficulty in repatriation – your bank will provide a notional aggregation of those, providing both a local arms length return with additional incentive on top of the worth of those currencies and offer you interest based on those,” says Manning.
This is all a part of the treasury efficiency story for multinationals operating in emerging markets and it is, in some respects, a necessary step for corporates that wish to improve their returns while continuing to comply with their own governance and compliance polices. By working with a single bank across a region like Africa or ASEAN and using such interest optimising solutions, corporates can secure a safe enhanced return on operating cash, without needing to move into potentially riskier and less liquid structured products.
The changing rate environment in Asia is also giving a lift to a number of nascent MMF markets across the region. “Malaysia, and Indonesia especially, have rapidly growing MMF sectors,” Manning adds. “We are seeing more and more funds setting up in Indonesia and taking advantage of both the surplus of investment going into that market and the requirement for funds as an alternative investment product.”
Demise of deposits?
The imperative to consider other types of investment product is not just being driven by the yield environment, however; several other factors are also at play here. First is the deterioration in the credit quality of many banking institutions witnessed post-crisis. Many investment-grade corporates are surveying the banking landscape and noting that a significant number of their banking counterparties are now deemed less creditworthy than they themselves are by the ratings agencies. And outlooks are tending more towards the negative than the stable.
“I’m moving away from investing in traditional bank deposits because with the reduced liquidity and the risk that a credit rating agency may change a view on a rating of a bank,” Asim Iqbal, Head of Treasury at British motoring association, the AA, said at the ACT Annual Conference 2015. “That would be putting me at risk of breaching my own treasury policy.”
Even in instances where the treasurer decides that the safest place for their cash is with one or more of their banks, they may find certain types of deposits are no longer welcomed. The beginning of 2015 marked the introduction of the Liquidity Coverage Ratio (LCR) under Basel III, designed to ensure that banks have sufficient assets on hand to withstand any liquidity crunch the market might throw at them. Prudent though that requirement may be, given everything that unfolded back in 2008, there is little doubt that it will impact the value of cash. Operational deposits are continuing to be sought after, but taking non-operational deposits, which have been assigned a higher run-off rate due to their perception as being less stable, is becoming far less attractive for banks under the new rules.
But those prophesying the imminent demise of bank deposits as a corporate investment vehicle might be jumping the gun a little. In fact, if a shift is indeed under way it appears, in the US at least, to be going in the opposite direction. To understand why, one would be advised to take a look at the 2015 Association of Financial Professionals (AFP) Liquidity Survey, which looked at what American corporates are doing with all that unused firepower accumulating on their balance sheets. The report notes that, in 2008, treasurers were keeping approximately half of their short-term liquidity in the capital markets, by way of MMFs, treasury bills and other such instruments. Around one-fifth, meanwhile was being stored in traditional bank deposits. Now we are seeing the reverse. Today, MMFs are storing a mere 15% of short-term cash, while 56% of is being placed into bank deposits.
That may well be a reflection of the fact that treasurers are now finally beginning to feel more confident about the health of US banks (in contrast to the picture in Europe) and that, in the current yield environment it is becoming extremely difficult to get any return on capital markets instruments. It may also be a manifestation of the growing concerns that treasurers have around the changing regulatory environment around the capital markets and, the reforms that the Securities and Exchange Commission (SEC) have introduced in the MMF space in particular. Either way, it would seem that a majority of corporates, having explored a variety of investment solutions, simply cannot find any better alternatives.
Recent talk around tri-party repos is a case in point. Superficially, at least, they look like a great alternative to bank deposits in the current environment. At a time when banks are not as safe as they once seemed, tri-party repos offer security. In markets where interest rates are flat or have minus signs next to them, tri-party repos are claimed to offer the rare prospect of some return. Indeed, tri-party repos would seem so advantageous for corporate investors in this current investment environment, greater direct participation from treasurers in this market would seem like a natural development.
Yet while some corporate treasurers have indeed begun experimenting with the tri-party repo, enthusiasm for the product within the profession has not quite been universal. “I have looked at repos but I have decided at the moment the time and cost in setting up a repo is quite significant,” says The AA’s Iqbal. “And from conversations I’ve had with other treasurers, I understand that the returns being offered by a repo might not be any more than that of a MMF deposit. So the question of tri-party repos is still out there for me.”
Bracing for VNAV
Although some treasurers like Iqbal might currently see no yield incentive to choose a tri-party repo over a MMF investment, there may soon, like in the US, be a regulatory one (at least for those who staunchly favour prime CNAV euro MMFs as a home for their short-term liquidity).
Earlier this year, the European Commission (EC) announced new regulations for the industry, which, once formally approved over the course of the next year will reshape the investment environment for corporates in Europe quite radically. Rather than impose a mandatory VNAV for prime institutional CNAV MMFs without delay, as the US has opted to do, the EC has agreed (still subject to approval from the Council of Ministers) to allow for a so-called Low Volatility (LVNAV) money fund product to operate for a five year interim period.
Treasurers with a view to the long term have, however, have grasped the fact that – LVNAV or otherwise – prime CNAV MMFs now have a death sentence hanging over them and are beginning to consider how their investment strategies might have to adapt in the coming years as a result. Unlike in the US, the persistently poor health of the European banking sector would appear to rule out a return, en-masse, to traditional deposits. Some treasurers, like the Royal Mail’s Delaney, believe there is little sense in delaying the inevitable.
“Perhaps the thing we spent longest thinking about is CNAV MMFs,” she says. Unlike some of its corporate peers, Royal Mail’s board policy already covered VNAV funds. But treasury, being very comfortable with the CNAV funds they had used since the early 2000s, had always shied away from VNAV products. As the policy direction at the European-level became apparent, however, the department decided it was time to revisit the products.
Many treasurers will feel obliged, in this new world, to experiment with new investment products and services, different durations and new cash segmentation strategies. But the prudent thing for treasurers to do would be to take their time.
The way they approached this task should serve as a useful best practice guide for other treasurers, many of whom are likely to have similar decisions to make in the coming years. “We looked at the volatility of VNAV and also the underlying volatility of CNAV funds,” she explains. “We considered the duration of which we could invest our funds. Then we considered some historical examples and, of course, checked out the accounting and spoke to some other corporates before we made the decision to invest.”
Many treasurers who, like Delaney, have gone through this process, have been pleasantly surprised by the muted volatility and general stability of the funds (Aviva Investors, which converted its daily sterling liquidity fund to VNAV seven years ago told Treasury Today in May 2015 that since its inception the valuation has never moved away from one). But a careful approach is nevertheless advisable, as it would be for any new instruments, and at Royal Mail investment limits are, for the time, at a lower level than for a corresponding CNAV fund.
Once the dust finally settles from regulatory and market adjustments of recent years the corporate treasurer is likely to see an investment world that has changed considerably, in some jurisdictions, perhaps beyond all recognition.
Caution, though, should be the name of the game for corporate treasurers right now. Many treasurers will feel obliged, in this new world, to experiment with new investment products and services, different durations and new cash segmentation strategies, as the insights offered by Delaney and Iqbal testify. But the prudent thing for treasurers to do would be to take their time. Only once each new product and strategy has been carefully considered and they have worked out what is the suitable to them, will the time be right to gradually implement the changes which need to be made.