Cash & Liquidity Management

Seeking resilience

Published: May 2019
Lighthouse standing with waves crashing into it

From trade-related risks to regulatory change, the current market has many challenges from an investment point of view. How can treasurers in Asia structure their liquidity portfolios in such a way that they can maximise resiliency and achieve the flexibility needed to react to changing circumstances?

For corporate investors, achieving portfolio resilience is particularly important in the current market, given the challenges and risks currently shaping the region’s investment landscape. But what does portfolio resilience really look like – and how can treasurers achieve it?

Challenges and risks in the current market

The current market certainly has plenty of challenges, risks and pressures for treasurers to consider. Venkat ES, Head of Asia Treasury Product, Global Transaction Services at Bank of America Merrill Lynch (BofAML), says that treasurers currently have to consider two key factors when looking to manage liquidity in Asia.

“For one thing, ever since the US dollar rate started rising, we have seen local central banks trying to reduce interest rates on local currencies to offset any major capital outflow and manage their own monetary position,” he says, noting that treasurers in Asia face challenges in moving cash out of some countries with stricter regulatory frameworks. Nevertheless, many treasurers are seeking to take advantage of rising interest rates in more liberal markets, while some are looking to repatriate cash in order to take advantage of tax reforms in the US.

The second factor Venkat cites is the constant search for yield optimisation – a particular challenge when treasurers need to hold negative yielding currencies, like Japanese yen, in order to meet day-to-day operational and liquidity management needs. “Treasurers are constantly asking banks if there are any structures or strategies that will help them work on this challenge,” he says.

Uncertainty abounds

At the same time, treasurers are also keeping tabs on developing trade-related risks. In December, for example, China’s exports fell by 4.4% compared to the previous year – the biggest drop in two years. Meanwhile, China’s trade surplus with the US widened to US$323.32bn, stoking fears of further developments in the ongoing trade war.

These issues have a knock-on effect for other countries in the region. In March, Taiwan’s exports contracted for the fifth consecutive month alongside weakening demand from China. Singapore and Hong Kong likewise stand to lose out as a result as the US-China trade war continues to affect exports.

Aidan Shevlin, Head of Asia Pacific Liquidity Fund Management at J.P. Morgan Asset Management, points out that concern about economic, trading and geopolitical uncertainty are “feeding into investor and business confidence – that’s where we see people worried about portfolio resiliency.” Alongside these factors, other regional considerations include debt levels in China, as well as FX volatility and interest rate volatility.

So far this year, Shevlin notes that Chinese markets have been broadly stable, to an extent, “because the government has been proactive in trying to stabilise them.” He says that the current focus on economic stability has included fiscal measures such as tax cuts and increased spending on infrastructure investment, as well as interest rate cuts by the PBOC. These measures may have reduced the likelihood that portfolio resiliency will be tested – but nevertheless, Shevlin notes that achieving resiliency is still an important goal for companies in the region.

The need for resilience

“In my mind, resilience is incredibly important,” says Anton Abraham, Head of International Advisory, Global Transaction Services at Bank of America Merrill Lynch. He emphasises that treasurers should – and do – focus closely on their ability to respond to changing circumstances, from market turbulence to M&A opportunities. “The question is, how do you structure your liquidity portfolio in such a way that you have the flexibility to respond to these events?”

As such, he argues that effective cash flow forecasting is a prerequisite for portfolio resilience. “That might mean doing some stress testing, running models and understanding seasonal variances,” he says. “Once the organisation’s future liquidity requirements are well understood, it is much easier for the treasurer to diversify instruments across different investment classes, risks and levels of liquidity.”

What does resilience look like in practice? At its most basic level, corporates need security and access to liquidity – and to achieve this, investors should diversify and invest in a range of assets. “So even if you are dealing in the highest quality assets, you shouldn’t put all your eggs in one basket,” explains Shevlin. “You shouldn’t just buy all of one type of bond, in case of a specific event relating to that bond, or a specific type of volatility within the market which makes it very difficult to liquidate that bond.”

Actions that may help to achieve a resilient portfolio include the following:

  • Diversifying investments. By diversifying across issuers and instrument types, companies can minimise the likelihood of a disruption relating to a specific issuer or asset class. Companies may also seek to diversify across the maturity spectrum in order to achieve a range of different maturities.
  • Due diligence. When it comes to achieving resilience, Shevlin emphasises the importance of carrying out sufficient due diligence on the investments a company is investing into. “For direct investments, do you understand the counterparty risks you are facing on these? If you are buying a fund, are you comfortable with both the fund itself and with the fund manager? Have they got the experience and ability you are looking for – and are they prepared to explain their investment philosophy and underlying investments? Asking these questions beforehand, and being satisfied with the answers, is a very important step in making sure your investments are resilient during times of stress.”
  • Being prepared for regulatory change. Also key to achieving resilience is the need to protect the company from regulatory changes, particularly in large markets like China and India. Again, stress testing and scenario planning can be a valuable tool in managing these risks. “Several years back, regulations changed and companies weren’t able to move liquidity out of China cross-border to include in regional or global cash pools,” recalls Abraham. “Treasurers who had planned for this scenario – and modelled what the impact might be for their investments or general banking facilities – were in a better position.”
  • Segmenting cash. Achieving portfolio resilience isn’t just a question of making suitable investment choices – treasurers also need to make sure mechanisms are in place to identify which funds are available for investment, and at which tenor. Venkat notes that treasurers typically distinguish between their operating surplus and investment surplus. The former includes cash needed for day-to-day liquidity needs, as well as cash earmarked for obligations such as tax payments or loan repayments that can be invested at a longer tenor. For the investment surplus, meanwhile, Venkat says that where feasible, companies typically pull funds into a tax-friendly location with better yield opportunities.

Investment strategies and instruments

Of course, there is no one-size-fits-all when it comes to choosing an investment strategy. “The strategy will absolutely depend on the nature of the organisation and the industry they operate in,” says BofAML’s Abraham. “For example, a commodity trading company will have a very different strategy versus a car manufacturer.” He also points out that different companies’ view of risk can vary considerably – and that companies in the same industry may have very different risk appetites.

Risk appetite is a major factor in determining individual companies’ investment strategies. Adhitya Wisesa, Director, Head of Institutional Liquidity Management APAC Global Coverage Group of DWS, says that investors who are concerned about rising risk in financial markets may consider decreasing their allocation to higher-risk assets such as stocks, and increasing their allocation to lower-risk assets such as cash.

“Money market mutual funds represent a popular cash option for investors, particularly corporates,” Wisesa adds. “Such funds typically provide higher yields than bank deposits by investing in highly liquid short-term debt securities that have minimal credit risk.” He comments that in today’s interest rate environment, money market funds have been becoming a more attractive investment option relative to current account positions that earn little to no interest.

In practice, most treasuries stick with bank deposits, money market funds and, in some cases, government securities, adds David Blair, an independent treasury consultant based in Singapore. “Anything else is rare outside of large cash-rich tech companies, which generally outsource such investment anyway,” he notes.

Seeking yield

J.P. Morgan Asset Management’s Shevlin says that while he hasn’t seen a significant change in terms of the instruments used by companies, higher yields in the US are helping to “drag yields around the world higher” in markets including Hong Kong and Singapore – and this is giving companies more opportunities to invest cash effectively.

Where time deposits are concerned, Shevlin points out that banks are trying to come up with new structures to help adjust for Basel III. “Banks much prefer to have deposits which are longer term in nature, so if investors can dissect their money into short-term and long-term buckets, they can take advantage of the longer-term instruments that banks are now offering,” he says.

With greater opportunities for yield, companies have more incentive to consider placing cash that is not immediately needed further out the maturity curve – thereby giving up liquidity, and potentially taking more credit risk, in return for a higher return. Consequently, Shevlin says that treasurers should not just focus on short-term time deposits and money market funds, “but invest across the spectrum in terms of different levels of credit risk, different maturities and different levels of liquidity.”

Investment policy

A robust investment policy is a crucial tool when it comes to achieving portfolio resiliency, but not all companies have a policy in place. Shevlin says that an investment policy should be broad and wide enough in scope to cover a lot of eventualities. “If it’s too narrow in focus and too detailed, it may curtail your ability to do things which could improve your flexibility,” he comments. “It’s also important to make sure the policy is suitable for the markets you are operating in.”

Companies based in the US or Europe may have a policy which is closely tuned to conditions in their home market – but when those companies move into Asian markets, they may find the policy is no longer a good fit for the market composition and the instruments available. For example, the policy may stipulate that the company can only invest in a money market fund that is over a certain size in order to avoid representing too great a percentage of the fund’s total investments. While this may be a prudent decision in a market such as the US, younger markets may have a limited number of funds available that are large enough to qualify. Likewise, stipulating that investments must be AAA-rated may be an effective strategy in some markets, but impractical in others.

Investment policies therefore need to be a good fit for the market the company is operating in – and they also need to be adjusted as market conditions evolve. Developments such as regulatory change and rising interest rates may prompt a review to check whether the company’s investment policy is still suitable – in Europe and the US, for example, recent money market fund reform would mean that an investment policy stipulating constant net asset value funds would no longer be fit for purpose.

Changes to the company may also prompt an investment policy review. BofAML’s Abraham says that while companies do not typically review their policies more often than every 18-24 months, events such as M&A activity, a significant change in the organisation or the appointment of a new CFO could prompt a review. “In such cases companies may take the opportunity to make sure the policy is still aligned with the business strategy,” he says.

In order to avoid frequent updates, it may be advantageous to build a more flexible policy which is able to accommodate certain developments. “Rather than focusing on whether a fund has to be stable net asset value or variable net asset value, you should be thinking more holistically about what the risk level is, how much risk tolerance you want in the fund, how much liquidity you are looking for and how much security you need,” says Shevlin. “These are the things you would want to think about, rather than specifying numbers or allocations in a way that makes the policy less flexible over time.”

Money market funds in China

China’s money market fund industry may be relatively young – but the market has grown rapidly in the last 15 years. It also has the world’s largest money market fund in its Yu’E Bao platform, which is run by Alibaba Group’s Ant Financial Services Group. While Yu’E Bao’s assets under management had reached over RMB1.7trn by the end of March 2018, the size of the fund had shrunk to RMB1.13trn by the end of the year amid pressure from Chinese regulators and concerns about liquidity risk and systemic instability. That said, the fund attracted 114 million new investors in 2018 – and in March, the Wall Street Journal reported in March that over a third of China’s population was invested in the fund.

China may not have gone as far as replicating the types of money market fund reforms introduced in the US in 2016, and in Europe last year. Nevertheless, the China Securities Regulatory Commission (CSRC) has introduced new rules to keep the burgeoning money market fund industry in check. These included limiting instant redemptions from a single money market fund to RMB10,000 per day.

Much of the growth of China’s money market fund industry has been driven by retail investors – but as Shevlin notes, retail and institutional investors may differ somewhat in terms of their approach and their priorities. “Institutional investors’ tolerance of risk is different than retail investors,” he explains. “Retail investors typically focus on looking for the highest yield, whereas an institutional investor’s key priorities are liquidity and security. The priority for them is to have a safe product.”

Shevlin predicts that regulatory reform will lead to greater interest from institutional investors in the next couple of years. “China’s regulators are quite forward looking and have tightened the regulations a number of times over the last few years,” he says. “We have seen Chinese regulations for money market funds move closer to Western standards over the last few years – but there’s still a gap, and in that gap there’s an opportunity for AAA-rated funds which have tighter guidelines and are more in line with international standards.”

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