Treasury Today Country Profiles in association with Citi

Building a best in class liquidity management structure

Two business people working together to build up blocks

Liquidity management is a fundamental concern for treasurers around the world – and putting in place a suitable structure is essential in order to achieve the required level of visibility and control over cash. The effectiveness of such structures can be affected by everything from M&A activity to regulatory change. Treasurers should regularly review the structures they have in place to ensure the company’s needs are met – but what does a best in class liquidity structure look like, and how can treasurers achieve this?

The scope of the treasurer’s role can vary considerably from company to company. But for all treasurers, knowing where the company’s cash is being held, and making the best use of that cash, is a fundamental concern – as indicated by surveys which consistently place cash and liquidity management at the top of the treasurer’s priority list.

In order to manage liquidity effectively, treasurers can draw upon a wide range of tools and techniques, from physical sweeping and notional pooling structures to centralised payment structures such as payment factories and in-house banks. But while these tools can help companies achieve goals such as reducing the cost of funding and maximising interest income, the effectiveness of liquidity management practices is also affected by considerably market conditions.

In the last few years, the liquidity landscape has changed considerably – and conditions are continuing to evolve. “Anyone answering the question of what has changed in liquidity management over the last year in early June would have been forgiven for assuming that 2016 typified another year of the “new normal” for corporate treasurers, with the general low rate environment continuing and only some slow shoots of recovery on the horizon,” comments Yera Hagopian, Head of Liquidity Services, Barclays Corporate Banking. “Subsequent political and market shocks have marked the start of a new phase, one that is far more volatile and less predictable even than the preceding period.”

Hagopian also points out that Europe and the US may be heading in very different directions where interest rates policy is concerned, with broader currency and economic implications. “In this environment, even seemingly conservative investment strategies can carry market risk that can damage underlying business performance.”

In this challenging market, it is more important than ever for companies to review their existing liquidity management structures and make sure that the processes in place continue to be a good fit for the company’s needs. This includes having a thorough understanding of the company’s specific requirements – and of the considerations that should be addressed in order to achieve a best in class liquidity solution.

Why review your liquidity structure?

Liquidity management structures are not set in stone. Companies should periodically review their structures to make sure they continue to suit the needs of the organisation, and that they continue to provide the expected benefits. Such a review might include questioning whether a different structure is needed, but could also include asking whether funds should be swept to a header account more or less frequently than they currently are.

“We work very closely with clients, and continuously review their structures with them to make sure they are operating efficiently,” says Suzanne Janse van Rensburg, Head of Liquidity, GTS EMEA at Bank of America Merrill Lynch. “As companies change and evolve, so too should the liquidity structure.”

In addition to regular reviews, a number of internal and external factors may prompt treasurers to review their existing structures. “Internal changes such as introduction of a payments factory can make more decentralised solutions redundant, giving rise to opportunities for stripping layers out of structures,” says Hagopian. She notes that a change in interest rates can also be a driver – as can a change in business profile which leads to a funding requirement where previously there was a surplus.

The introduction of new technology may also trigger a review. “The deployment of a new treasury management or ERP system will inevitably necessitate a review of end-to-end liquidity management practices to drive workflow and cost efficiencies,” says Conor Maher, Head of Cash and Liquidity, Product and Capital Management, NatWest. “These may include daily cash management routines, the type of bank reporting and payment interfaces, and a general curiosity to benchmark against the practices of other corporates.”

Other developments which could trigger a review include the following:

  • Changes in the tax or regulatory environment.

  • Geopolitical events, such as Brexit or changes to global trade agreements.

  • M&A activity.

  • The introduction of internal structures such as a payments factory.

  • Changes to the company’s funding requirements.

  • Changes to the company’s legal entity structure.

Impact of regulatory change

As noted above, regulatory changes can act as a catalyst for reviewing current practices. “There are of course periodic seismic shifts that require a major review,” says Hagopian. “Changes to regulations governing US Money Market Funds in 2016 can be described as such a change. This has led to many corporates reviewing their investment policies, resulting in changes to their portfolios or changes to their operations to deal with a VNAV (variable net asset value) world.”

Hagopian points out that the focus on liquidity risk that Basel III brought to banks’ treasury risk framework is also now starting to take effect. “Although arguably the impact for corporates is secondary, many are now finding that their bank’s appetite for liquidity, especially of the non-operational kind, is limited,” she explains. “Negative rates in some currencies have only aggravated the problem. In order to preserve capacity, careful consideration is required regarding wallet allocation and maintaining close banking relationships with key providers of balance sheet capacity. This has always been true for debt provision but now extends to deposits.”

Where Basel III is concerned, Hagopian says that more nuanced impacts include the Liquidity Coverage Ratio and the benefits to a bank’s balance sheet of obtaining deposits with contractual maturity of greater than 30 days. “Many corporates have investment policies that heavily restrict use of instruments with greater than 30-day maturity, but increasingly corporates are reviewing these policies to see if cash can be tranched and internal processes improved to give greater certainty of when cash will be required,” she says. “Some businesses are of course better placed to do this depending on the nature of their clients and contracts.”

Hagopian notes that the regulation may also have unexpected consequences for liquidity management structures. “Notional pooling is one such area,” she says. “The requirement to report on a gross basis for leverage means that notional pooling can have a material capital footprint, even though by risk weighted measures, the same structure would have a minimal capital footprint. That does not make notional pooling unworkable in all circumstances but it does mean that structures requiring particularly large gross limits may become uneconomic to operate or future flexibility to support business growth is lacking.”

Hagopian points out that like overnight deposits, notional pooling structures are much loved by corporates because they provide low maintenance and flexibility. However, “the new regulatory environment puts a price on these features and therefore forces a proper evaluation.”

Nevertheless, Janse van Rensburg says that while companies may be reviewing the use of certain structures, such as notional pooling, she has not yet seen any companies stop using them due to regulatory considerations, albeit she has seen companies move providers. “We haven’t had any clients specifically request a change in location of the header accounts,” she says. “We have had one client which moved away from a notional pool to a physical pool – but that was due to the treasurer’s preference, rather than being driven by regulatory change.”

Section 385

While regulations such as Basel III have certain implications for liquidity management structures, some other areas of regulation have proved to have less of an impact than first anticipated. In the US, Section 385 of the Internal Revenue Code became a concern when proposed guidelines were published in April 2016.

The rules, which will require companies to recharacterise related party debt transactions as equity in certain situations, initially looked set to cover structures such as cash pooling. However, this was addressed later in the year with the publication of the final and temporary regulations, which included exemptions for this type of structure.

Best in class

What does a best in class structure look like? While the optimal liquidity structure may mean different things to different people, there are a number of considerations which treasurers should bear in mind when determining which structure is best suited to the company’s needs.

According to Maher, “The more obvious attributes include real-time visibility and same-day access to a corporate’s cash regardless of where it is domiciled within a multi-bank or multi-jurisdictional structure coupled with timely and accurate bank statement reporting for reconciliation purposes.

“Equally important, but much more difficult to achieve, is timely and accurate enterprise-wide cash forecasting capability – specifically the ability of the organisation to accurately predict periodic cash positioning (whether daily, weekly, etc), driven by a robust understanding and coordination of collections due from customers and disbursements to its suppliers.”

Maher notes that the larger the company, the more difficult – and indeed essential – it is to build “cultural and workflow arrangements that promote dynamic and accurate cash forecasting to avoid the opportunity cost of idle cash balances in bank accounts.”

No ‘one size fits all’

Above all, it is important to choose a structure that is suited to the company’s needs and the treasury’s capabilities. “Some people try to over-egg the complexity of what they do in this area,” says David Stebbings, Director, Head of Treasury Advisory at PwC. “Companies need to achieve a balance between what they need, their ability to manage and the associated costs. There’s no point setting up automated pooling structures if your flows are such you are only going to pool cash once a month – visibility will suffice in this instance. And remember, automated pooling is never a substitute a for good quality cash forecasting.”

It is also important to note that there is no one structure that is inherently better than another – the important thing is to adopt a structure that suits the specific needs of the company.

“There is no ‘one size fits all’,” says Janse van Rensburg. “A structure that is best in class to one company may not be suitable for another company. For a smaller or medium sized corporation, the priority may simply be to achieve visibility and control. A complex multinational may already have these elements in place, but may need a more complex solution such as a global or regional hybrid structure with a combination of physical and notional pools.”

Local considerations

The chosen structure will also depend on opportunities and limitations in the relevant countries. Jason Marsden, Head of Client Solutions – TPS International, Standard Bank says that the treasurers of large multinationals in Africa are looking to implement regional treasury centres similar to the structures operating across more mature markets.

“Whereas this is possible in a number of markets, regulations in most markets will only facilitate an effective domestic liquidity management structure,” he explains. “This is also limited in many instances to physical cash concentration or sweeping. However, there are clients who are starting to pilot shared service capabilities in some instances.”

The bigger picture

In addition, it is important to make sure that any structure is a good fit not only for a company’s immediate liquidity needs, but also for its wider business strategy.

“We’ve really changed the focus in terms of how we communicate with clients,” says Janse van Rensburg. “When we are designing a liquidity management solution for a client, we are not just looking at a siloed approach – we are getting into the nitty gritty with the client, working through the end-to-end working capital management cycle and downstream impacts, and then building a solution based on the broader picture to make sure it ticks all the boxes for the client.”

Harnessing technology

While technology certainly plays a part in supporting effective liquidity management, adopting the latest technology may not be a top priority for all companies.

“We always assume that most treasurers are at the ‘bleeding edge’ of technology,” says Marsden. “And yet a large number of clients are still requesting assistance in dealing with some of the basic treasury and liquidity management requirements, including having a clear, real time view in terms of the liquidity position in the various markets around Africa.”

Janse van Rensburg notes that while a lot of banks have focused on offerings such as automated investment sweeps and active investment linked to ebanking platforms, in reality “there hasn’t been a huge amount of take-up of those products”.

“This virtual world will impact the time taken to open accounts, improving implementation times, reducing costs and physical paper flow, allowing for more electronic authentication of both people and payment processes across the globe.”

Suzanne Janse van Rensburg, Head of Liquidity, GTS EMEA, Bank of America Merrill Lynch

Nevertheless, she says that technological advances are bringing new concepts to the table with developments such as the use of virtual currencies and consolidated KYC and AML. “This virtual world will impact the time taken to open accounts, improving implementation times, reducing costs and physical paper flow, allowing for more electronic authentication of both people and payment processes across the globe.”

Technology can also support liquidity management in other ways. Hagopian says that banks are realising the power of the content they capture through the card and payments data flowing through their systems. “Creating Operational Data Stores capable of containing millions of data lines, and providing this back as meaningful cash-flow analysis, can help illuminate win-win scenarios for clients looking for investment efficiencies and banks looking to preserve capital,” she explains. “It’s at the margin, but with low base rates here for a while at least, technology can help bring about change to liquidity management.”

Meanwhile, Hagopian notes that with treasurers hard pressed to increase yield in the current markets, there is an increasing trend for platform type aggregators, whereby corporates can consider multiple ‘bids’ simultaneously. “Where banks can respond and offer differentiation is the technology wrapper that brings their offering to clients, conveying a broad spectrum of services and solutions to clients through a unified channel,” she adds.

Building a structure

Finally, it is important to be aware that setting up a liquidity management structure is not without its obstacles. Stebbings points out that one of the biggest hurdles can be the fact that a cash pooling structure may take cash and banking autonomy away from local businesses, which local CFOs may resist.

“Having a strategy that says, ‘This is where I want to get to and this is why I’m going to get there’ is key,” he says. “It’s also important not to over extend yourself – companies should aim to be realistic. This might mean identifying that if the company is in say ten countries, six of which are key, the treasurer might automatically pool the six key countries in the first instance, and manually pool the remaining countries in order to see if it’s worth automating them in the longer term.”

Maher agrees that treasurers need to be clear on their objectives. “Systems investment may be required, so is a business case needed or is the driver more about visibility and control?” he says. “What about any tax consequences (eg withholding tax, changing the location where interest income is generated through pooling, etc)? What are the alternatives for ‘trapped cash’? Finally, bank charges are also relevant when determining reporting frequency and same-day cross-border movements to ensure ongoing liquidity management costs are proportionate.

Stebbings adds that treasurers should be careful not to underestimate the difficulties involved in putting in a new liquidity structure, both from a cost and resourcing point of view. “It’s not a two week project to put in a decent liquidity structure,” he concludes. “It’s important to get the business case right, be focused about what you’re doing and get the right support from your banks, internal IT and legal, and if required external consultants. This is common sense, but can sometimes be forgotten.”

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