Cash & Liquidity ManagementCash ManagementCash ForecastingWhy Cash is King at the Moment

Why Cash is King at the Moment

British businesses are now sitting on the greatest stockpile of corporate cash ever seen in this country. In fact, according to the Treasury Strategies consultancy, corporate deposits in the UK have grown from £220bn to a record £770bn in the last 10 years, and now sit at around half of the UK’s annual gross domestic product (GDP).

The reasons for this cash build up are myriad but one fact is clear, with economic uncertainty seemingly the new norm, businesses have become significantly more conservative. Indeed, over the past four years it has been much easier to say no to major investment, no to ambitious growth plans and, conversely, yes to building up cash as a buffer to protect operations in case things were to take a major turn for the worse.

The global economy has remained more resilient, however, than many commentators expected. What to do with this built up cash, particularly where to put it, has become one of the key questions of the day among many UK corporates.

The first task has been to ensure this cash is safe. Prior to the financial crisis the focus for corporates was often how best to make their cash work for them. Securing the best overnight, 30 day or long-term rates drove treasury policy, and sovereign and institutional security was often a secondary concern or taken for granted. In fact some companies pursued unrealistically high returns in the lead up to the credit crunch, and were willing to take sometimes high risks to achieve this. But as the crisis intensified and worries increased about possible weaknesses in the global financial system the thinking among treasurers has changed rapidly.

Security has returned to the fore, and cash management decisions are now heavily influenced by both institutional and, increasingly, sovereign credit ratings. As a financial institution we have seen massive shifts in cash deposit behaviours as various countries and banks have seen their credit ratings downgraded, with these downgrades often triggering red flags, in the form of credit limits on counterparties, within treasury functions.

Counterparty Risk

Given the market conditions and unprecedented regulatory change, corporates are reviewing their current counterparties. This increased focus on counterparty risk management and the current ratings of banks has led treasurers to review their policies. There is an increasing view that banks are treated in many ways as just another debtor, as some financial institutions have lower credit ratings than their corporate clients.

Following the recession, many corporates have reviewed their banking counterparties to ensure that their banking group can meet their current and future needs. In some cases this has increased the number of banks used, particularly where the corporate used to place the majority of its business with one or two banks. In others, the number of banks has decreased where the financial strength of previous providers was in doubt, or where the benefits of a common and consistent service model (and related management information) can be achieved. In many cases lesser rated banking and debtor counterparties have been rationalised.

For global companies with the ability to sweep and hold cash in different countries, the quest for security means that during the height of financial and economic uncertainty in Europe, cash balances were frequently being swept out of continental European countries and into UK bank accounts on a nightly basis by many of the world’s largest companies. This is starting to ease now, but the UK does remain a comparative safe haven in this part of the world, particularly with its coveted AAA rating.

Liquidity Management

For companies that have been able to amass cash, the ability to access it readily remains vital. Liquidity management is one of the key tasks of corporate treasurers today, with accurate forecasting essential in maximising cash returns while allowing businesses to access this cash as soon as there is a need for it. A recent study of UK companies, carried out by the Treasury Strategies consultancy, shows that one in three will invest in improved cash forecasting over the next six months to do just that, while one in four plans to spend on upgrading their treasury technology.

Once security and liquidity have been covered, the focus for any good treasurer will still be how best to make their money work for them. With banks competing for deposits to boost balance sheets, including some institutions that are having significant challenges in raising wholesale funds, there are excellent rates that can be secured on even overnight money today. Rates depend on several factors, but the overall relationship a corporate has with its banks and what else this business wants from its cash deposits is key.

Treasury policies are regularly being reviewed in light of the rates on offer. A good example is a Barclays’ corporate client that had imposed a maximum three months on all bank deposits. The rate offered for 100-day notice deposits was significantly better and the treasurer approached the board to secure authorisation to increase the maximum period in order to benefit from the higher yield. For companies with global operations, there is also an ability to sweep money into countries providing higher yield, with some companies pooling cash in Brazil to take advantage of above-average interest rates in that market.

Regulation: Basel III

A further impact on corporate deposits will come from the introduction of the Basel III capital adequacy rules, which are already having an impact on the types of products available to corporates. This is being driven by some disparities between what banks and companies are looking to achieve with corporate deposits.

Under Basel III, stable operational corporate balances have the greatest value from a bank’s point of view. Balances which are more volatile (i.e. discretionary balances) will attract lower returns reward because banks holding those deposits will have higher capital requirements to ensure sufficient liquidity in times of stress.

As Basel III moves closer there will be an increasing polarisation between how banks value operational balances and discretionary balances. This will in time lead to a dilution of the return on investment for discretionary balances, increasingly forcing the hand of corporate treasurers to either surrender yield for liquidity; or conversely to term out deposits for greater returns. Operational cash balances will be increasingly the bedrock in the bank/client relationship and will represent an increasing source of value between clients and their bankers.

Corporate treasury policy in recent years has prioritised short notice/instant access to funds to safeguard business liquidity and treasurers are presently less inclined to lock their balances into rigid term deposits, while those with seasonal businesses will inevitably see variation in their balances over the course of the year.

In light of this discrepancy, products have already come to market which reward longer term, more stable corporate balances that provide greater flexibility than if funds were placed in a term deposit. Rather than requiring treasurers to lock up their money for a prescribed period – whether that’s three months, six months or 12 months – these newer solutions retrospectively pay bonus accruals of interest for balances which stay within a certain range during a set period.

These products can give treasurers the opportunity to pick up additional yield at a time when rates continue to be low. However, in order to keep a deposit within a certain range, the treasurer first needs to have a good level of control over the company’s cash and to know in advance what the funding requirements will be. This comes back to the perennial cash management techniques discussed earlier: with good visibility and accurate cash flow forecasting, companies will be better placed to take advantage of the rewards on offer.

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