Basel III is having a significant impact on how corporates manage Australian dollar cash deposits.
Corporates investing excess cash in Australia have historically had a relatively easy job. The ‘Big 4’ local banks have dominated the market with very high credit ratings, an almost implicit government guarantee and the ability to maintain extremely large balance sheets.
This, combined with large loan and investment books, has seen these banks deposit-hungry and able to pay higher rates relative to their highly rated developed market peers. “As a result, there has been little incentive for treasurers to seek alternative investment solutions or opportunities for disrupters to enter the market,” says Michael Larsen, Asia Pacific Head of Liquidity Product at HSBC Global Asset Management.
However, as Basel III begins to bite, corporates investing in Australia are facing an unfamiliar challenge as Australian banks pay less for or even turn away non-operational deposits. This is so that they can comply with the regulation’s Liquidity Coverage Ratio (LCR) that requires banks to hold reserves of as much as 40% against some corporate deposits deemed likely to flee during times of crisis.
The deposit-taking ability of the Australian banks has come under further pressure recently, notes Larsen. For instance, following the global financial crisis, the governments and regulators in general, including those in Australia, have “backed away from implicitly guaranteeing banks via taxpayer funded bail outs and focused more on resolution and recovery concepts on how to wind down failing banks”.
This coupled with 2017 downgrades of the Australian banks by S&P and Moody’s and the recently announced royal commission to review conduct at the banks means the market is now looking for alternatives away from the traditional ‘Big 4’ banks, he adds.
Time and effort
The issue for treasurers is that because of the historical lack of need for alternative investment options in Australia, suitable products are few and far between. This is seeing corporates struggle to diversify their deposit base and spend a disproportionate amount of time placing cash with a range of banks to reduce concentration.
“Treasurers are also having to spend more time justifying their credit exposures and limits with banks and market participants,” says Larsen. “Overall it increases the workload on already stretched teams.”
Given this dilemma that corporates are facing, it is unsurprising to hear that asset managers sense an opportunity to break into the market. And, in the case of HSBC Global Asset Management launching an Australian Dollar Liquidity Fund, joining peers such as J.P. Morgan Asset Management, which operates a similar fund.
The benefit for treasurers using these funds is that it automates their cash management activity, explains Larsen. “The fund invests in a diversified set of highly rated money market instruments onshore and offshore and is rated AAA by S&P and Moody’s. This is a significantly better rating than any bank and helps diversify country risk.”
What is more, using these funds allows the treasurer to see all the underlying holdings of the fund daily for monitoring and internal reporting purposes. “It also allows them to understand any concentration issues with their other investments in their portfolio,” adds Larsen.
Given that Basel III is not due to be fully phased in until January 2019 there are some corporates who have not yet felt the pinch. This does not mean they won’t in the months to come, however.
“Banks are continually evaluating their balance sheets and trying to optimise the impacts of the regulations,” he says. “The banks will continue to try to reduce non-operating deposits which means corporates need new outlets for their cash.”
Larsen also notes that as the regulators get smarter about how to implement the new rules and adopt best practices, the definition of what is an operating deposit may become narrower.
“This means, even if the bank is happy with your deposit today they may not be tomorrow,” he says. “Corporates need to get ahead of this and ensure their investment guidelines allow them to place cash in money funds and other instruments if this happens.”