Financial stresses can develop a life of their own, as the aftershocks of 2008
evolved into sovereign concerns. Various banks continue to face challenges, with
questions arising from their own financial exposures and resiliency, coupled with
increasing regulatory obligations. This has compelled corporates, even as their
cash balances rise, to revisit their banking strategies, with increased emphasis
on counterparty quality and contingency capacity. Fortunately, as David Li, Head
of Liquidity, Asia Pacific at J.P. Morgan Treasury & Securities Services explains,
there are still ways in which both risk and return can be managed.
Today's liquidity landscape
As Asia commands an ever increasing share of global trade, Asian business is
similarly commanding a larger share of a company’s overall business. Such
a phenomenon translates to companies building up a sizeable amount of cash in
Asia. While corporate cash levels in the region may not have matched the current
high levels in the US, they are still quite significant and material in the
context of an average company’s balance sheet. With continued economic
growth projected for Asia, cash buildup is expected to continue, even after
taking into account the capital expenditures that will be needed to bring capacity
online to support future growth.
The increase in cash balances has brought about a challenge for Corporate Treasurers.
While surplus liquidity has increased, the number of safe havens in which to
deposit it has declined. Since mid 2008, many banks have suffered multiple downgrades
from all three major rating agencies, while some banks continue to face challenges
in financial stress tests. As a result, some corporations are having to more
deeply consider their positions on counterparty diversification and contingency.
Just as the risk landscape associated with liquidity management has become more
demanding, so has the return landscape, impacting historical risk-return relationships.
A major factor here is the monetary response to the 2008 financial crisis, in
particular protracted quantitative easing. We have now seen an unprecedented period
of near-zero interest rates in various major economies, accompanied by a general
elevation of risk levels, and downgrades for previously pristine obligors and
sovereigns. Whilst we are now seeing some tentative signs of growth in the US,
the potential for stagnation in Europe impacting Asia growth remains.
The impact of this inclement economic backdrop on bank counterparties is exacerbated
by the impending introduction of Basel III.
One of Basel III’s objectives is to ensure banks are better capitalized
and resilient, a consequence being that banks will become far more focused on
ensuring that they have a sticky funding base that is linked to operating bank
activities, rather than funding from discretionary deposits or hot money. The
key part of Basel III that affects their behavior is the liquidity coverage
ratio (LCR), which will make the taking of short term deposits in isolation
relatively unattractive. Therefore, corporates only offering short term liquidity
without other business may find banks unwilling to accept these deposits or
only prepared to accept them in return for unattractive rates.
This combination of a dwindling number of well-rated banks and the focus of
banks on stable funding strongly suggests that both deposits and transactional
business will become increasingly concentrated with a few better rated transaction
banks.
How corporates are managing their risks
While Asia treasuries may not be able to directly influence macro factors such
as monetary policies or banking regulations, they can modify their banking strategy
to improve the risk/reward of their liquidity position and to shape their individual
liquidity landscape.
Decision support and visibility
Liquidity shortages during the financial crisis prompted many corporations to
refocus on improving the visibility and mobility of corporate cash. Therefore,
solutions that can enhance access or returns on trapped cash are in focus in
Asia Pacific.
As regards visibility for supporting informed decision making, corporations
in the region continue to invest in treasury management and ERP systems. There
is also growing interest in the functionality of bank reporting systems. However,
financial pressures on some banks are sometimes impacting their ability and
commitment to invest in these capabilities and we are seeing growing variations
on banks’ commitments to invest and enhance their offerings.
Transaction banking and especially cash management is a scale business. The
cost of investing in technology platforms and maintaining full-service branch
networks are becomingly prohibitively expensive, and while making such investments
is good business sense, fewer and fewer banks are able to afford it. Only those
with sufficient capital and robust balance sheets are able to do so. Corporates,
in their quest to increase visibility and control over their cash, will be better
off working with banks which have the same vision, and most importantly, capability
to support their vision and initiatives. Ultimately, any improvement in visibility
and control of cash will lead to better and more accurate cash forecasting and
the potential to improve risk adjusted return, as it allows treasuries to better
segment their cash balances among operating, surplus, strategic and reserve
cash.
Interoperability
In terms of banking and clearing infrastructure, Asia Pacific is relatively
fragmented. In certain countries it may therefore be necessary to use local
banks to provide sufficient coverage or specialist services. This immediately
raises the question of interoperability between these local banks and the corporation's
primary banking partner.
SWIFT is top of mind in any discussion on connectivity and interoperability.
However, in
J.P. Morgan's recent Asia Pacific Corporate Treasury Benchmarking
Study, 66% of respondents stated that they did not currently use nor plan to
use SWIFT in the next 12 months. Such a response appears counter intuitive.
However, the reason could be due to the fact that a smaller number of banks
in the region have the necessary capabilities and also because the cost of maintaining
SWIFT corporate access may make commercial sense only where transaction volumes
are sufficiently large. As such, SWIFT corporate access may currently be limited
to the very largest corporates.
As the pressure grows to improve liquidity capture and mobilization, this inevitably
throws the spotlight on the delivery of automated multi-bank overlay structures.
As the tools/techniques readily available in other regions may not be as prevalent
here, achieving the right structures in Asia Pacific is heavily dependent upon
selecting a primary banking partner with the right technology and mindset.
Therefore, if a treasury is consolidating liquidity and transactional activity
to a better-rated bank, it is vital to choose one that is experienced at collaborating
on a SWIFT and non-SWIFT basis across the region.
Good. What about the returns?
What is the incentive then, for a corporate to bank with the lower interest-paying bank? One attraction could be earnings credit rates (ECR).
With all the right moves undertaken by corporate treasurers, they would be expecting
some decent returns for their effort. Corporate treasurers may be disappointed
if they expect pre-2008 levels of return. However, what may be a revelation
is that there are marked differences in rates across what was once a uniform
landscape of global financial institutions. For example, where USD deposit rates
used to be markedly similar across the similarly-rated global financial institutions
across the various countries, divergence has appeared in certain markets. Such
divergence has also appeared in other currencies in certain countries as well.
This could mean that some financial institutions are lacking deposit bases.
What is the incentive then, for a corporate to bank with the lower interest-paying
bank? One attraction could be earnings credit rates (ECR).
In view of Basel III and the need for LCR-friendly products, it is likely that
the use of ECR
1 approaches (which adopt less direct ways of compensating clients
for balances) will increase. At a basic level, these approaches include interest
optimization, but the consolidation of both deposits and transaction banking
business with well-rated banks opens the door to alternative hybrid instruments.
A very simple example is a short term deposit that may have a low headline rate
but that if not withdrawn within a certain period additionally attracts a rebate
on transaction banking fees, resulting in an effective higher rate on the deposit.
The logical extension to this is for the fee rebate to be granted in an area
outside cash management, such as FX. However, only a select few will be able
to provide these products because the internal structure of most banks will
raise issues over which unit will bear the cost of the subsidy - a point that
will be especially problematic with global clients.
1 Where local regulations allow for such offerings
Conclusion
The management of counterparty risk is becoming more important among corporates,
and is commanding an increasing amount of attention as part of their treasury
and risk management. Over time, corporates will naturally move towards a more
objective risk-assessment model, and will therefore be re-assessing financial
counterparties and their own processes.
The second aspect of counterparty risk is ensuring that once corporate cash
is at the desired bank it achieves an acceptable risk/return trade-off. That
requires an insight into the way banks will be reacting to pending regulation
and a willingness to realign corporate thinking to take best advantage of the
shift.
A common theme in both these areas is choice of provider. While credit quality
will be a major factor in this, it is by no means the only criteria. For treasury
to remain competitive in the new liquidity landscape, it requires a provider
with a global and flexible mindset that can square the risk/reward circle in
these challenging times.
