Cash & Liquidity Management

Corporate liquidity: the key to movement

Published: May 2013

Looking at liquidity requirements from a corporate perspective, there are several distinct elements, according to Ashutosh Kumar, Global Head of Corporate Cash and Trade, Transaction Banking, Standard Chartered. “Firstly, corporates simply need the liquidity for working capital purposes, so they go to a bank to borrow that liquidity. But the companies themselves generate liquidity in their day-to-day operations so they now want to look at how this can be used more efficiently. Furthermore, corporates are beginning to question why they actually need that amount of liquidity, trying to determine ways to reduce the liquidity requirement itself.

“There is a clear evolution there – treasurers are looking at all three aspects rather than just tapping the banking market for further liquidity. They are now having proactive conversations with their internal colleagues and banking partners to ensure that they have the appropriate liquidity profile in order to run their day-to-day operations.”

Some corporates may also look towards alternative finance options such as the bond market. In 2012 corporate bond issuance exceeded loan issuance, and even those corporates who do not have access to capital markets are monitoring the growing trend. Marc Navalón, Group Treasury Manager at Ficosa International, says that although his biggest priority is the evolution of the loan market and getting the most out of the corporate banking relationship, “I keep an eye on the corporate bonds market because I think that our access to bank financing would become easier if big corporates and banks continue the issuance trend that we saw last year.”

Making the capital work

Irrespective of anything else in the market at the moment, the biggest theme is that corporates are demanding much better control over their working capital, according to Raj Subramaniam, Head of Product Strategy and Marketing for Global CASHplus at Fundtech. “They see this as low hanging fruit and it is probably the first thing that they want to address in terms of improving their overall liquidity position.”

When surplus cash is available to corporates, they are looking at investing this in primarily short-term instruments. Subramaniam says, “Corporates are still not looking for the highest yield and the treasury is still not seen as the profit centre of the company. We see many mergers and acquisitions (M&As) now as corporates feel that, rather than invest the funds in financial assets, it’s better to invest it in new businesses.”

Working in the manufacturing business for a firm that fully relies on bank financing, Navalón reports that in recent years Ficosa has increased cash balances to protect against the squeeze on loan growth. “In addition to that, we try to take a proactive approach to short-term cash management and aim to increase our visibility – and mobility – of cash worldwide as much as possible.”

Ficosa has also placed a sharp focus on cash forecasting which it considers the core of corporate treasury and is extending its supply chain finance (SCF) products in order to reduce the cash consumption for working capital. “All these measures are helping us to sustain most of the financial needs of our businesses and are bringing cash awareness into the overall business,” says Navalón.

For the corporate treasurer, Utopia is a state of negative working capital, believes Subramaniam. “They want to be in a situation where they don’t need to put money aside for the working capital cycle as it is funded by their supply chain instead. Many corporates now see negative working capital as a way forward and are looking at the supply chain and the related available finance as ways for them to move towards that Nirvana state.”

Financing solutions

Among the many things that corporates are aiming for in the quest for liquidity is to increase their days payable outstanding (DPO), meaning that they want to pay their suppliers later. This effectively means that the suppliers will have less liquidity, says Kumar. “In many cases, therefore, corporates are establishing strategic relationships with their suppliers and seeking SCF from their banks to establish better credit terms.”

Different types of banks may show strength in different areas of SCF: multinational banks are very focused on vendor financing or supplier financing because the risk is mainly managed against the anchor corporate; while the strong domestic bank is very comfortable assessing the risk of, and providing financing to, dealers and distributors. Regardless of institution type, Subramaniam agrees that banks are offering SCF globally to strengthen and tighten the liquidity chain. “Banks are extending financing to the whole supply chain – not just to the main corporate but also to distributors, dealers and suppliers. This type of financial assistance is the quick win the corporates are looking for.”

Many banks, even up to one or two years ago, were adjusting their liquidity solutions more towards the large or regional corporates, notes Subramaniam. But in the last 12 months, significant demand is also stemming from mid-sized corporates. “Corporates are pushing the banks to give them much better services regarding financial products around the supply chain. These services are linked to payment processing – the corporates want to get that process under tight control so that they can pay out at the very last moment and also pinpoint when they are in need of funds to cover a particular payment,” he says.

Equally important is getting the receivables processing under control and corporates are moving away from paper and migrating towards more electronic ways of management in order to realise this. Subramaniam says, “many banks are looking at this space with interest and are actually outsourcing these facilities rather than putting the pressure on the corporates to make the change.”

Global management

Many international corporates have hubs and factories in a number of different countries and regions, yet still want all their balances from various accounts to be immediately visible and easily swept and pooled. Naturally, this can prove to be very complex so they are first looking at liquidity management solutions which will help them define what kind of liquidity control they actually need to have. For example, if a corporate has offices in Belgium and the Netherlands which are primarily production sites (factories) but has customers located in France and Spain (offices), most of the offices will always have a cash surplus, while the factories will ordinarily retain cash deficit as they are making the payments for salaries etc. Subramaniam explains, “the corporates will want to manage liquidity that leaves a higher buffer in the factory location, ie €1m in each of the related accounts. But in the accounts that are customer-related and where money is coming in, this may be completely cancelled out. This kind of fine tuning is what treasuries are doing on a daily basis. Not only do the balances constantly change but the corporate’s liquidity appetite will change too.”

Firms are getting hungry and each treasurer still has to examine the environment and geography they are working in, what opportunities are available and whether the firm can take the counterparty risk involved. Monitoring counterparty risk has not been such a strong focus area for corporates, according to Subramaniam – even in the recent past. He maintains that it was an accepted practice that the transactions were all in the interest of doing business, yet “monitoring these risks across various types of counterparties – both banks and corporates – has now become a very visible activity. Corporates are looking at banks to help them with liquidity management across a country (or region) where they have accounts with multiple banks.”

But despite enjoying a sense of cautious optimism and growth potential in 2013, the first year in several relatively unmarred by impending crisis, the package of capital and liquidity measures that constitutes Basel III still needs to be dealt with by the industry. Basically crafted to compensate for the pitfalls of the financial crisis, Kumar says, “this new regulation modified a one-dimensional Basel concerned with only risk capital to a three-dimensional regulation that covers risk capital, liquidity and leverage. The different requirements under the three areas have an impact on banks and corporates that are both intended and unintended.”

Trade finance

One significant consequence of Basel III is the heavy burden attached to trade finance, so much so that it will become unattractive for banks to continue to offer these services to corporates, says Subramaniam. But with the relaxed deadlines, has the worry been postponed to a certain extent? “The banks and corporates are continuing to operate in a status quo mode. They have not changed their behaviour too much. They feel there is sufficient time for them to operate current business and still have time to think about what to do next when the deadline comes,” he says.

Nevertheless, the strict measures are expected to deliver quite a blow to trade finance, which many corporates use for their imports and exports and their day-to-day working capital. A survey conducted by Asian Development Bank (ADB) in December 2012 revealed that if Basel was implemented as is currently stands, trade finance supply would reduce by around 13%. Kumar explains, “for different asset classes (mortgages/credit cards, etc), there are different risk curves on the basis of which banks would maintain capital. Yet, for trade finance, there is one risk curve which is applicable for trade and all other forms of corporate lending.”

“Similarly with liquidity, there are both intended and unintended impacts. The measures state that banks should have liquid assets that can be used in times of stress – and these assets were defined as government bonds and certain other liquid assets. But the unintended impact was that not all countries/regions had enough available assets in which to invest.”

Basel III implications

According to Arvind Ronad, Senior Executive Product Strategy and Marketing for Global CASHplus at Fundtech, the corporate treasury impact of the impending measures can be classified into different areas. “It involves more expensive bank funding as banks have to retain more capital to stay inside of their asset portfolio. Secondly, there are the casualties of trade finance as off balance sheet activity, such as the letter of guarantee, which requires five times more capital. The cost must be passed on in both of these cases.”

Corporates will also be forced to rely heavily on the domestic debt market instead of raising funds in the cheaper market elsewhere, as accessing global markets and hedging through cross-currency swaps will be seriously curtailed due to credit value adjustment, says Ronad, “but there is an opportunity for the corporate to create a relationship with the bank because the Basel III liquidity standards will have a significant impact on how banks assess customer liquidity he added. Transaction banking, for example, holds more security as it gives stability to the corporate deposits – a win-win situation for both bank and corporate.”

But the strain of meeting the Liquidity Coverage Ratio (LCR), the increasing amount and quality of bank capital, and pressure from local politicians to lend more to customers has led the banks to plead with the Basel Committee and local regulators for some reprieve. Dmitry Pugachevsky, Director of Research at Quantifi Solutions, says, “in January they received some relief, now that implementation of LCR is being phased in, starting with 60% of full requirement in 2015 and full implementation in 2019. Rules were also changed regarding what can be considered as high-quality liquid assets. Understandably, many local regulators didn’t exactly welcome these changes in Basel III LCR treatment and warned banks who already comply at the 60% of full requirement not to decrease the level of high-liquidity assets.”

From a corporate perspective, though, Navalón believes the decision to ease and to postpone the liquidity deadline for banks makes a lot of sense. “Four years ago we entered the ‘new normal’ era, whose fundamental forces are de-leveraging, de-globalisation and re-regulation. And it is the latter we are talking about here. Politicians risk over-reaction to their attempt at controlling the banks activities and this urge to regulate is causing a pro-cyclical effect on the credit channel and, therefore, in corporate access to liquidity. The postponement could be good for corporates if banks resume lending.”

An expanding market

Another level of complexity to the whole liquidity situation is added by the fact that institutions in the US under Dodd-Frank have been mandated to start clearing swaps and other vanilla derivatives since March 2013, says Pugachevsky. “Initial and variation margins presented by central counterparties (CCPs) are putting another strain on banks’ cash and high-quality assets reserves. How this situation will develop remains to be seen because it is just starting, but the fact that there is no cross-netting agreement between CCPs doesn’t help.”

As active as the regulatory space is, however, the corporate environment is continuing to evolve with an increasing drive for growth, says Kumar. Corporates are taking more counterparty risk – and country risk – but they want to manage this risk in a much more holistic manner. “Even in the open account scenario, which is picking up quite a bit in terms of a growing trend, you have a receivable financing product where the bank would take the risk of the buyers and finance the corporate, and so the risk is mitigated. Some corporates tap into the credit insurance market and buy insurance for their buyers and hence mitigate counterparty risk.”

Credit insurance is very readily available in the West, but in emerging markets, the market for credit insurance may not be deep enough. However, SWIFT and ICC have jointly been working on the first end-to-end automated trade finance transaction – the Bank Payment Obligation (BPO). With an April 2013 approval scheduled, the BPO has already gained traction across Asia, providing customers with the flexibility of open account trade combined with the payment certainty of letters of credit (LCs).

Concluding on a positive note, Subramaniam believes that one common trend that can be seen among corporates is that the global worries about financial contagion have decreased considerably. “The panic which was there one or two years back has subsided. Risk is very much on the radar but it’s not the only thing that people are looking at – they are also looking at opportunities,” he says.

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