Maximising the Value of Liquidity Opportunities for Corporates

The Global Financial Crisis of 2007-08 saw major pressure on treasuries to maximise their use of internal liquidity, but finding ways to accomplish this has always been a concern for Asian corporates operating in a highly regulated region. Nevertheless, the visibility, control, efficiency and accessibility needed to achieve this can all perfectly intertwine - if corporates have the right strategy and tools.

As corporations grow, liquidity inefficiencies can easily develop. One subsidiary might accrue a surplus upon which it earns minimal or even no return, while another subsidiary incurs significant interest charges on an overdraft. If one replicates this situation across a larger corporation with subsidiaries scattered across many countries, then the opportunity cost can become substantial.

A primary benefit of self-funding is cost reduction: it will be less expensive to self-fund than to borrow externally. Furthermore, as a business expands, a natural liquidity synergy comes into play due to the differing lifecycle stages of entities. New entities that require cash to grow and help them become established can tap the surplus liquidity of more mature sibling entities that are already up and running and in cash-generative mode. Depending upon individual circumstances and how treasury chooses to structure the relationship, this can be a direct win/win. The new entity obtains funding at a lower cost than it could achieve externally, while its more mature counterpart attains a return on its surplus greater than it could achieve on the open market.

Asian Cash Concentration: Easy In Theory, Tough In Practice
Various established solutions are available for pooling liquidity, but there are limitations on their efficacy in Asia. Some countries in Asia have regulations that either restrict the level of interest banks can pay, or limit the movement of funds across borders. At an individual country level, these rules can also be complex. For instance, it may be possible to move US dollars freely out of a country but not the local currency. If one scales this up across the region and all its multiple jurisdictions, the situation can become extremely challenging to manage.

A standard technique used in the region is to physically concentrate the funds to a regional center such as Hong Kong or Singapore. There is a growing trend to overlay accounts in the concentration location with a multi-currency notional pool, which does not involve physically converting the funds into the company's functional currency. This step has the additional benefit of allowing corporates to leverage positive and negative balances across currencies without an actual FX conversion, thereby moving the self-funding concept up to a further level of efficiency.

Optimising Liquidity Yield
Whilst offsetting of entities' liquidity positions is in place, the onus is on treasury to optimise the yield on any resulting surplus balances. In the current low interest rate environment, this is no easy task, but is even tougher for Asian treasurers where local regulations may mean that any surplus is not directly accessible.

Achieving this requires a banking partner capable of developing solutions that can help consolidate the funds and optimise yields globally. Yield optimisation is not necessarily limited to higher credit interest rates or the use of term deposits. It can perhaps include innovative solutions like offsetting fees with balances which may also be attractive as it improves expense ratios. A solution that maximizes return on operating balances without involving treasury in juggling term deposits can optimise both the yield and the treasury workload.

Basel III: A Major Imperative
Apart from simple business efficiency, there is a further imperative to remedy sub-optimal liquidity management - whether it is structural or caused by local regulation. Basel III will soon directly affect the availability and cost of banks' regulatory capital, which means that banks will have to be more discerning about how they allocate their available resources among clients. This will make it harder for corporations in general to access external liquidity, and places further emphasis on the need for self-funding.

Self Funding: The Cutting Edge Response
Fortunately, certain global banks are expanding their range of solutions to maximise the self-funding and return opportunity to clients. Corporates can now look forward to more innovative products (especially from global banks) to derive more value from their deposits in these trapped cash locations. Basel III is causing banks around the world to place a much greater focus on operating balances as a source of funding, because they are assigned lower capital requirements. Corporate balances in transaction deposit accounts are considered as operating balances, so banks will be actively looking to attract these balances.

Whichever solution Corporates take, there is a need to address how yield is optimised even where cash is trapped, and how to maximise returns while minimizing the workload for treasury. Possible methods for accomplishing these include:

Global Earnings Credit Ratio (Global ECR)
One solution to having surplus cash in a country with currency movement or other controls (such as restrictions on credit interest rates) is to use this surplus to offset against bank fees in completely different jurisdictions around the globe 1 . This enables corporates to maximise the value they can derive from trapped cash locations.

In addition, they can also extract a hidden benefit which allows them to maximise shareholder value. Figure 1 illustrates the use of J.P. Morgan's Global ECR which can benefit not just in terms of Profit & Loss, but also on other metrics tracked by investors, such as expense ratios and operating margins. As a result, corporates may even find that a solution such as ECR delivers a better benefit in some jurisdictions than choosing to receive interest locally on balances.

Solutions such as Global ECR are also extremely time-efficient from a corporate treasury perspective because they are automatically applied to offset bank service fees. No active intervention by treasury staff is required, thereby saving time and resources. Using transactional accounts in conjunction with a solution such as Global ECR delivers the transparency treasurers need to manage cash efficiently. This is because balance and transaction information, along with fee details, are available on-demand and included in monthly account analysis statements. This in turn facilitates accurate forecasting of short-term cash, which is a major challenge for many treasuries.

Therefore, operating balances in jurisdictions where it would otherwise be impossible to extract surplus funds, are ideally suited to solutions such as Global ECR and allows corporates to unlock the maximum value from operating relationships.

image - Maximising the Value of Liquidity

Figure 1: Illustrates the benefits2 of J.P. Morgan's Global ECR

Liquidity Management Account (LMA)
A related solution that also facilitates this unlocking of value is LMA, which allows clients to receive an enhanced rate of return on their operating cash balances.  LMA pays increased rates for balances that are stable in the account, thereby allowing clients to enjoy same day liquidity and yet also receive enhanced rates for these balances.  

This approach confers multiple benefits. Like short-term cash flow management, cash forecasting is greatly simplified, because cash remains accessible in the operating account and is not subject to a term period lock-in and potential breakage fees, as it would with a conventional term deposit. It is also workflow-efficient, as there are no complex laddering or layering strategies for treasury to manage (balances are valued automatically), so the workload of analysing, executing and reconciling short-term investments is eliminated, as is the need for additional accounts.

The current low interest rate environment is imposing considerable pressure on treasuries to achieve tough yield targets. A LMA can add considerable value here - the intrinsic term value embedded in operating cash is automatically calculated and the appropriate enhanced yield applied. Furthermore, using operating liquidity intraday does not impact yield, since term value is calculated on end-of-day balances. Balances are always 100% invested and even if they are volatile, the appropriate effective term value is always recognised and delivered.

Corporates can achieve a significant degree of self-funding, even in a relatively challenging environment. The motivation to do so is certainly present in the form of Basel III, in addition to more general pressures, such as the scrutiny of cost and efficiency metrics by investors. Furthermore, as Asian corporations continue to expand geographically, the pressure to self-fund will only become more acute.

By combining conventional cash concentration techniques like physical and notional pooling, with new innovative products and solutions like Global ECR and LMA, corporates can look to better optimise their liquidity globally.

Irene Thng
Executive Director
Head of APAC Treasury and Liquidity Solutions
J.P. Morgan Treasury Solutions


1An important distinction here is that some providers claim to deliver this type of offset "globally", but in practice can only do so in countries within the same region as the surplus balance, where permitted by law.

2Applies in most cases. Please refer to an accounting professional in your region for reporting impact.
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