Liquidity Management Strategies for Uncertain Times
With so many factors affecting multinational businesses today, it’s more important than ever for leaders to determine the liquidity management strategy that best fits their corporations.
Market volatility has introduced a number of challenges to multinational businesses, particularly in managing day-to-day and long-term liquidity. That said, these challenges can create an incentive and opportunity to optimize liquidity structures and prepare for future uncertainty.
There are several factors that could impact business considerations for liquidity management. Interest rates in the US, which had been held at historic lows for almost a decade, are now starting to rise as the Federal Reserve withdraws accommodative policies it put in place during the recession. So far, the Fed has raised short-term interest rates three times since December 2015 by a quarter of a percentage point each time, leaving its benchmark overnight lending rate target in a range of 0.75 percent to 1 percent. Furthermore, weighing US unemployment rates and inflation targets, the Fed forecasts that it will continue to raise interest rates in 2017 and 2018. Expected policies from the Trump administration—including tax reform, the repatriation of corporate capital and deficit spending—could stimulate growth but also accelerate inflation, which, in turn, may prompt policymakers to raise US interest rates more rapidly.
In contrast, the European Central Bank, Bank of Japan and Swiss National Bank continue to hold their policy rates down and buy assets. That adds further pressure on multinational companies to manage their cash balances effectively in order to not only enhance returns but also to mitigate costs for negative yielding currencies.
Given the growing disparity between global interest rates and the uncertain impact and timing of US policy changes, the current environment creates an opportunity for US multinational businesses to optimize their liquidity management and to position themselves to realize the maximum benefit from higher US dollar interest rates and/or a tax holiday for repatriation of foreign earnings.
The fundamental requirements for any “best-in-class” liquidity structure are visibility of cash flows and currency positions, control over those balances and yield optimization. However, a multinational company’s organizational structure often influences which strategy best aligns with its corporate culture and is therefore best suited to achieving its liquidity objectives.
Decentralized companies often contend with local autonomy, in-country profit and loss objectives, challenges with matrix reporting—both locally and to headquarters—and disparate enterprise resource planning (ERP) platforms.
Regionalized companies maintain staff in hubs typically responsible for treasury operations for a specific region while also reporting into headquarters. This structure may allow companies to leverage Regional Treasury Centers (RTC), Shared Service Centers (SSC) for investments, borrowing, foreign exchange (FX) management and accounts payable/accounts receivable.
Lastly, in centralized structures, headquarters typically manage FX, investments and borrowing, and employ a single ERP platform across the organization. Often, they also endeavor to fully leverage process centralization and automation through RTCs, SSCs, payment factories, an in-house bank and other resources.
As the adage goes, “If you don’t know where you’re going, any road will get you there.” Multinational companies should first determine and prioritize their key liquidity objectives relative to their organizational structure before deciding which liquidity management strategy to employ. These objectives can include:
- Gaining visibility and control of global cash holdings
- Centralizing balances into one account or location
- Reducing interest expense or improving investment returns
- Maintaining operating business with local banking partners
- Enhancing efficiency with automated processes
- Managing FX or counterparty risk
- Mitigating intercompany loans
Types of Strategies
There are three common types of liquidity management strategies, each raising potential benefits and considerations.
- Physical concentration: This is the most straight-forward strategy for consolidating balances. It yields a central account containing surplus cash for the entire structure. Physical concentration is transparent, easily controlled and provides the opportunity to use excess cash for debt pay-down, investments, dividends and more. It can also leverage automated bank systems to track intercompany loan positions. However, physically consolidating balances into one account or location may not be appropriate for decentralized companies; moreover, the structure will bring administrative costs, and foreign currencies can’t be directly combined into a single account without incurring FX conversion costs. Other considerations or restrictions may apply for countries with currency controls.
- Notional pooling: In this approach, balances are maintained in their respective accounts and currencies, but for the purposes of calculating interest, the bank combines the balances into a single net currency and balance. This strategy eliminates intercompany loans, and in cases of a multicurrency pool, the organization is able to operate with multiple currencies without incurring FX conversion costs. Considerations include subsidiary joint liability for incurred debts, which could be challenging for jointly owned organizations. Additionally, not all countries permit notional pooling participation and these structures are often heavily scrutinized by auditors and tax authorities.
- Overlay structures: This strategy allows companies to employ or maintain local banking relationships to manage day-to-day banking activities while leveraging the benefits of a cash concentration or even a notional pool structure by automating the concentration of balances with an overlay bank—typically through an end-of-day sweep process. However, applicable cut-off times for the remitting and receiving banks can impact structural efficiency and often results in the duplication of accounts and costs.
Deciding which liquidity management strategy offers the most advantages is a complex process. Finding the right solution based on unique objectives and local market requirements takes expert support and guidance to help navigate these uncertain times.