Liquidity management remains a challenging area for corporates, particularly with the low interest rate environment, incoming regulatory change and new risks emerging. With this magnitude of change it is prudent to review investment policies and processes in order to ensure they properly manage risk, according to Hugo Parry-Wingfield, Investment Director, HSBC Global Asset Management.
Hugo Parry-Wingfield is the Investment Director and EMEA Head of Liquidity Product for HSBC Global Asset Management. Based in the UK, he has responsibility for the development and implementation of the liquidity product strategy in EMEA. Parry-Wingfield joined HSBC Global Asset Management in August 2013 and has been working in the cash management and liquidity industry for over 15 years. He joined from Citibank’s Treasury and Trade Solutions business, where he was Co-Head of EMEA Liquidity and Investment Products and Head of Liquidity Market Management. Prior to that Parry-Wingfield held senior liquidity sales, product management and consultancy positions at J.P. Morgan and at PwC.
Liquidity is the lifeblood of any company, and its management has consistently topped the corporate treasurer’s agenda over the past five years, both from a risk as well as a utility perspective. In order to protect their company’s business, treasurers need to know where their cash is and how quickly they can access it. They need both visibility and control.
HSBC is responding to our clients’ key requirement for effective liquidity management, by servicing them across all the markets we are present in, and providing a range of services to support their liquidity management activities. This core competency stretches across the whole Group, including HSBC Global Asset Management.
The risk of a loss of principal due to a counterparty default has not gone away and, therefore, the importance of robust investment policies and processes is as important today as it ever was. Protecting a company’s capital requires the ability to mitigate counterparty risk as best as they can.
A closely associated challenge is the ability to effectively diversify cash without diluting core investment principles. Today, corporates are sitting on historically high levels of cash, which clearly puts greater pressure on their investment policies and underlying liquidity management principles.
The changing regulatory environment is having a direct impact on corporates, as well as indirectly via banks and service providers. Although many incoming regulations are intended to benefit business, the pace and diversity of change is making the job much more difficult. For those corporates operating in multiple jurisdictions, treasurers are tasked with navigating complex and divergent regulatory environments.
The growing footprint of most corporate operations is another challenge. Clearly, this is a positive driver for change, as corporates are actively taking advantage of new market opportunities; however, it is creating new challenges for treasurers expanding their cash management operations into new markets and currencies. Above all, a consistent global risk-managed environment is best practice.
The low interest rate environment has also continued to be a challenge and is expected to persist for some time. Clearly this environment provides limited, if any, reward for cash. But on the other hand, it is driving best practice in terms of risk management if there is less focus on yield and greater focus on risk.
Getting the balance right in managing their access to liquidity, both in terms of meeting near-term cash flow needs and also being prudent when investing cash, due to concerns about what might be coming around the corner, is a growing challenge for many of our clients. But remember, holding ultra-liquid cash can come at a cost.
The market events over the past five to six years have fundamentally changed the investment environment. The decisions a treasurer has to take today are not the same as they were during the earlier phases of the financial crisis, let alone before the crisis.
Therefore, first and foremost, it is important to constantly evaluate investment policy – which includes the mechanics, process and strategy, as well as the written policy – to ensure its relevance. In addition, building a deep analysis of counterparty risk and classes of investment allocations, much more than previously and well beyond external credit ratings, is a key to success. The problem treasurers often come up against is that it is not easy for a treasury team to achieve this level of scrutiny, because they don’t necessarily have the resources or expertise.
Today, treasurers are putting more emphasis on segmenting their liquidity profile. Essentially this is based on a better understanding and profiling of their own liquidity, as it relates to their balances around the world and, more importantly, as it relates to their cash flows in and out, that generate that daily position. In response, many banks have been developing more flexible products, such as flexible call accounts – which are deposit products that reward stability with higher yields but still give the treasurer access to liquidity.
On the asset management side, as an add-on to their money market fund allocations, some clients are expressing greater interest in segregated mandates to better deploy cash in line with liquidity profiles, as well as seeking incremental yield, where available, compared to shorter-term options.
We also see increased demand for alternatives to traditional deposits, such as repos. An increasing number of treasurers are interested in using repos to enhance security, using collateral to underpin an otherwise unsecured deposit. Repos also provide opportunity for different yield profiles, so a treasurer could potentially enhance their yield over a normal short-term deposit depending on the collateral used.
In addition, clients continue to look for ways to automate investments, where possible, in order to ensure they are maximising the amount of cash deployed into their chosen investment strategy, in a controlled environment. For example, some are using daily automated sweeps from cash accounts or cash pools into money market funds (MMFs). This effectively links their cash and liquidity management activities with their end-of-day investments.
In the US and Europe the regulatory changes have yet to be finalised, so it would be premature to conclude how they will change treasurers’ behaviour, and we should keep in mind that it may be several years until any actual implementation. That said, HSBC supports regulatory proposals that aim to deliver a more robust or secure environment for MMFs and investors. We are engaging with the regulators, politicians and governments on both sides of the Atlantic, especially where we believe the changes will achieve greater stability in the market. In addition, we are providing feedback where we think that the proposals, as written, will not achieve the goals described by the regulators themselves or in some cases, where they could even have the opposite effect.
We do not expect the proposed reforms will remove the utility value that MMFs have provided to investors; professional credit management, credit diversification, a high degree of liquidity, a competitive return compared to short-term money market interest rates, and a high degree of transparency, all achieved through one transaction. For this reason we believe that investors will continue to use MMFs as part of their day-to-day cash investment needs. If the proposals are implemented, including any move to a floating net asset value, or a removal of external ratings paid for by the funds, then investors will rightly need to consider the implications.
HSBC is working with its clients to help them address these issues. Although we can’t have all the answers at present because it remains a moving target, we do, and will continue to, provide analysis and information to help investors make informed decisions at the appropriate time, as well as develop solutions that could help mitigate some of the impact to an investment process.
As well as numerous other demands, banks require significant resources to prepare for Basel III. Basel III’s new capital rules clearly influence the banks’ preference for different types of deposits. Already some banks are aligning their options against the deposits that have the best liquidity treatment – which affects how they price and position specific types of deposits, and to which types of clients.
MMFs are not directly affected by Basel III, as they are off balance sheet and not a capital-based investment product. However, the industry is facing its own regulatory reform, as mentioned previously.
Most corporate investment policies remain heavily weighted towards bank deposits, which means counterparty risk must be closely managed. Yet maintaining adequate lines with the highest quality counterparties continues to be a challenge, especially at a time when corporate liquidity continues to be historically high. Investment quality should be independent of a change in size of liquidity – eg it is recommended that treasurers should not take more risks, raise limits beyond previous tolerances, or use banks they previously avoided just because they have more cash to deploy.
Many corporates have not changed their attitudes to core relationship banks and also ‘national champion’ banks, or large domestic banks. The historic rationale behind this is that treasurers want to, rightly, ‘reward’ their relationship banks with deposits, but they also might think that they have some leverage with their relationship banks should a problem arise. Equally, the logic behind using a national champion bank is the perception that they are ‘too big to fail’ or that there is a high degree of likelihood that the government would step in to save the bank and protect its investors or deposit holders.
Yet, the political and regulatory landscape is changing. Much of the regulators focus is on putting in place processes to allow a bank to fail. But the focus of these new ‘bail in’ regulations is often geared to protect retail investors, rather than institutional investors, such as corporates.
It is no longer reasonable to make the assumption that investments are safe, either due to the relationship or the national position of the bank. Therefore, investors may need to rethink and revisit their policies and ensure the counterparty selection is first and foremost based on credit quality, before the lens of relationship is applied.
Most investors active in the money markets have made great progress since the financial crisis, in enhancing investment policies and risk management. However, when assessing counterparty risk, some continue to predominantly use external credit ratings.
Although ratings are a useful reference point, analysis of a counterparty’s credit quality needs to be supplemented with other inputs, for example financial statements, asset quality, historic and projected earnings, and liquidity and funding mix. These are key elements HSBC uses for selecting and monitoring our counterparties within MMFs specifically, and more generally across our investment teams.
Credit analysis is not just a one-off activity aimed solely at putting a counterparty on an investment list, but additionally, they should be regularly monitored. Once a counterparty is approved, there needs to be an ongoing assessment as to the appropriateness of that counterparty, and its corresponding limits; HSBC believes this should be done on a daily basis and adjustments made accordingly.
All this requires resources and expertise. Many treasurers see the advantages to using a professional investor whose job it is to manage risks and liquidity, has scale and expertise to fully understand issuers and instruments from many angles and the ability to apply their own scoring and monitoring, transacts volume in the market daily and operates within the boundaries of a robust policy with sufficient flexibility to adapt to changing risks day-by-day.
A key aim of many treasurers is to have a consistent global approach to liquidity management. Moving into new markets presents a challenge in integrating the new market and currency into a controlled treasury environment, which may have been in place for many years across more established markets. Local practices can create a further layer of confusion. Therefore, a treasurer might look to leverage a global bank’s presence in a new market and plug into its existing framework in order to achieve the visibility and control they desire.
This is also true on the investment side. A global asset manager that has capabilities in different markets and currencies can provide a level of consistency in a treasurer’s approach through using the same underlying investment standards, processes and risk management framework that the asset manager provides in other markets. Investors are, for example, looking for more investment options in markets such as China and India, as well as across Latin America.
There is so much going on in the cash investing world, facing the investors directly and the markets they serve, as well as the banks and asset managers who provide much of the solutions. This is driving innovation – new products, currencies, and so on – and providing increasing choice; however, investors must continue to focus on the fundamentals and evaluate what they are equipped to manage themselves as opposed to where there is value in using an external manager. Either way, any decision should be a thoroughly deliberated one that is reviewed on a regular basis.