From negative interest rates to significant currency volatility and geopolitical risk, today’s treasurers are operating in largely uncharted territory. Exploring and exploiting this new liquidity landscape will require skilful navigation – and an open mind.

Amit Agarwal

EMEA Head of Liquidity Management Services, Treasury and Trade Solutions

Steven Elms

EMEA Head of Industrials Sector Sales, Treasury and Trade Solutions

With ongoing speculation around the future of the Eurozone, crisis-driven regulation still being implemented across the financial sector, and emerging economies continuing to outperform their Western counterparts, any casual observer could be forgiven for thinking that little has changed in the macro business environment over the last five years. But as any treasurer will tell you, nothing could be further from the truth.

The first and perhaps hardest hitting change – at least for those in the corporate treasury profession – is the introduction of negative interest rates. “Whilst interest rates have been extremely low across Europe and the US in recent years, the move by the European Central Bank (ECB) in June 2014 to lower the deposit rate from zero to -0.1% took us into a new phase in the interest rate cycle,” explains Amit Agarwal, EMEA Head of Liquidity Management Services, Treasury and Trade Solutions, Citi.

This triggered a domino effect of rate cuts across Europe with the Danish, Swedish and Swiss National Banks all choosing to follow suit in an effort to protect their currencies and reduce market volatility. “For treasurers, the impact of these changes in monetary policy is wide-reaching,” says Agarwal. “We are entering new territory when it comes to the traditional treasury priorities of security, liquidity and yield. Liquidity is being challenged by regulations such as Basel III, and yields on investments and currencies are scarce, but capital preservation is even trickier.

“Take investment policies, for example. These typically dictate that treasurers must retain capital and maintain the value of that capital, but doing so in a world where deposit rates are suddenly negative poses a real challenge.” As a result, many treasurers are left questioning the validity of their investment policies and priorities, as well as their accounting practices.

Treasurers are also still wondering where interest rates will go next, as they do not appear to have bottomed out yet. As Steven Elms, EMEA Head of Industrials Sector Sales, Treasury and Trade Solutions, Citi observes, “this uncertainty around rates is a genuine challenge for corporates trying to navigate the new business environment. Not only are they trying to understand where the policy moves are heading but also as to how banks are responding and how this will impact their deposits, investments and wider currency market movements.”

Against this backdrop of uncertainty, there is one safe bet, says Elms, namely that this new territory for interest and FX rates is here to stay, for the foreseeable future at least. “This is the new normal – and it is this environment that treasurers and banks need to be comfortable operating in.”

Adapting to change

What this means is that whilst it is important to continue to build on the best practices that have been honed within treasury departments in recent years, forward-looking treasurers must also examine ways to adapt and optimise their liquidity structures accordingly.

“One very noticeable trend that we are observing among leading treasuries is the conscious decision to exclude certain pockets of daily liquidity from global liquidity structures in response to the lower rate environment,” says Elms. After all, why should a company move balances away from a jurisdiction and incur an FX cost, only then to be impacted by the negative rate environment?

“As long as there is complete visibility over the cash and at a near-term use of that local liquidity, then leaving it in-country may be the best course of action,” he notes. “That said, it is still fundamentally important that the liquidity structure the company has in place allows the treasurer to move and mobilise that cash when needed – not least because of the level of geopolitical unrest today. Trapped cash is a growing concern in politically unstable countries, as is significant FX volatility, so having a flexible and nimble liquidity structure is now more important than ever.”

Liquidity is being challenged by regulations such as Basel III, and yields on investments and currencies are scarce, but capital preservation is even trickier.

Amit Agarwal, EMEA Head of Liquidity Management Services, Treasury and Trade Solutions, Citi

Offsetting the negative

When we overlay all of these challenges – the negative rate, low yield environment; the geopolitical challenges which are creating further FX swings, sovereign and counterparty risk concerns; and of course the liquidity constraints of Basel III, “this creates a perfect environment for clients to sit down around the table with their banks and discuss the optimal liquidity structure that brings together the right mix of cash management, investment and the risk management tools, whilst observing best practice,” says Agarwal.

A good example of this is the work Citi has been undertaking with clients to help them meet their goal of capital preservation in this era of negative rates. “From an investment point of view, we have introduced smart investment options, such as the minimum maturity deposit, which provides enhanced returns over short tenor time deposits with a minimum notice period before funds can be withdrawn,” he explains.

Elsewhere, multicurrency cash pools – as part of a global liquidity structure – are proving extremely popular among Citi’s clients as a means to gain liquidity and operational efficiencies, whilst also replacing or at least reducing the need for FX swaps. “With a multicurrency pool, it is possible to offset charges in certain low-yielding currencies by changing the mix of the company’s assets and increasing those currencies which have a wider spread. Furthermore, for the day-to-day operating business, rather than having to spend resources and investment dollars executing FX transactions, they can effectively use the multicurrency cash pool as an implicit way of executing their FX swap transactions. With that in mind, we are seeing double digit growth in the adoption of cash pools, in particular the multicurrency cash pool,” notes Agarwal.

Recently, Flextronics, a leading end-to-end supply chain solutions company, worked with Citi to create a multi-currency pool for its EMEA operations. By automating the FX conversion and draining of pool funds to the US, 90% of the cash in Europe is now available to the US – including US dollars in Israel for the first time.

We are seeing more and more requests to set up actions that occur without manual intervention when a particular currency – typically a negative yielding one – reaches a specified amount.

Steven Elms, EMEA Head of Industrials Sector Sales, Treasury and Trade Solutions, Citi

Regulatory change is another driver behind the focus on multicurrency cash pools. According to Elms, a common request is to include the renminbi as part of a multicurrency pool structure, not only because it is an additional currency that can help to offset negative yields, but also because banks such as Citi have grown their capabilities in the currency (since it has been gradually liberalised by the Chinese authorities) to ensure that locally generated liquidity that was previously trapped in-country can now be brought up into a company’s central liquidity structure, even through automated sweeping options.

“Automation is another huge theme in this new liquidity environment,” Elms continues. “We are seeing more and more requests to set up actions that occur without manual intervention when a particular currency – typically a negative yielding one – reaches a specified amount.” Once the level is hit, Citi can then help to push some of that liquidity into a different destination; whether that be a higher yielding account with a longer maturity, or a money market fund, for example.

Embracing the positive

“These kinds of innovations are only going to become more popular as people adjust to the new normal,” predicts Elms. And over the last five years, treasurers have already demonstrated great flexibility in their mind-sets, adjusting their investment comfort zones to include instruments such as tri-party repos and secured lending, so thinking outside the box has almost become part of the job description for those at the top of the profession.

Nevertheless, if innovation is to succeed, it must be built on solid foundations – in this case best practice. “Now is not the time for treasurers to start undoing all of the hard work they have put in post-crisis, centralising, rationalising and automating their liquidity management. Rather, this is the time to examine how external market influences, such as negative interest rates, actually present opportunities for further efficiency,” concludes Agarwal.