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Liquidity management products for corporate treasurers: the options continue to grow Back  
A current hot trend amongst both corporates and banks is cash management with many Treasurers now realising the benefits of bringing cash into their front office. With the recent ratings downgrades resulting in higher borrowing costs and banks suffering ratio limitations due to Basle 2, treasurers and bankers alike have been forced to look at alternatives for providing liquidity.

Acknowledging the need to now look at in-house cash reserves, treasurers sent their scouts out to their many legal entities to investigate how cash was being managed of those reserves locally. Apart from sunburn and upset stomachs many scouts returned with a recurring theme. Treasurers listened to reports advising them that their corporation held a vast number of cash wells, some of which had large sums and were invested to earn appropriate term interest whilst others had shallow levels of cash, ‘not worth doing anything with.’ May finance professionals recognized the benefit of now bringing cash management into the treasury arena with an across the board policy. The launch of the euro and the development of TARGET, the pan-European real time gross payment system, contributed to the practicality of this arrangement. European cash pooling or cash concentration became both feasible and fashionable and the cash management couturiers created more complex designs for sweeping and amalgamating cash reserves to the delight of the treasurer.

Running parallel to this development in operational cash management another change was taking place. Traditionally in Europe liquidity had been invested in simple bank deposits, government instruments and corporate products such as commercial paper and bonds. Whilst in the United States of America, Money market funds (mutual funds that invest in short-term debt instruments on average achieving better than overnight Libid deposit rates) havve been popular as an investment vehicle for corporations since the mid 1980’s.
With a bank credit squeeze corporations were increasingly issuing debt as a means of borrowing. This trend had been exacerbated by the recent historically low global interest rates which caused treasurers to take further opportunities to lock in long term debt. These factors resulted in an increase in instruments available as investment opportunities for the money market funds. At the same time bankers recognised that they needed to provide a competitive short-term investment mechanism for their clients. They realised that if they did not provide this service they would possibly lose the full relationship to an alternative supplier. As a result of both bank willingness and the availability of assets a growth in the number of European based money funds has taken place.

Factoring together increased operational cash control resulting in short term liquidity, the cash concentration concept and the increase in the number of money market funds; the opportunities are now there from some banks to create one integrated mechanism. Banks are realising the benefit of offering a cash pooling system that incorporates a stylish automatic sweep into one or more money market funds. However a decision then has to be made about which fund/funds to use.

As a general rule a money market fund is appropriate for liquidity that is available for up to three months. Beyond that term more attractive yields may be obtained by investing in longer instruments. Liquidity and safety has to be of prime importance to the treasurer and when looking at money market funds the liquidity aspect needs to be split into two areas, one the liquidity to the investor and the other liquidity inherent in the fund.
Generally the liquidity of the fund is comparable to an overnight deposit, yet receiving a slightly more competitive return such as that for one-week deposit.

However, minimum holdings, notice periods, dealing amounts and early cut-offs may apply. Whilst the treasurer may prefer to go for a fund with later cut-off for his own liquidity purposes; this may be at the expense of yield. Funds with later cut-offs have to remain liquid later and ultimately invest their overnight cash during a thin market period which often incurs lower overnight deposit rates. They may also suffer from lack of choice regarding lending opportunities at this time. A late cut-off fund may also have difficulty financing a late redemption request.

The other area of liquidity to consider is that embedded in the fund. Here the Treasurer needs to consider whether the overall size of the chosen fund would be substantially affected by his investment or withdrawal. In order to provide suitable liquidity to an investor a fund needs to have adequate assets which could be readily liquidated therefore average asset allocation should be a core consideration also when comparing funds. Whilst the average is for 35 per cent of assets to be in short term maturities and certificates of deposits, some funds fall as low as 12 per cent in this asset class.
Another important area to regard is the nature of the investors in the fund. If they are mainly of one industry type it could create a squeeze on the liquidity of the fund in the event of an industry related event requiring all the investors to withdraw funds. Investor diversification will also go some way to avoiding industry related tightening of liquidity due to uniformity of outflow/inflow dates. A good mix of investors to look for may be corporates, local authorities, housing associations, pension and insurance funds.

Integral within the philosophy of money market funds is capital preservation. Rating agencies vary in their approach and so many corporates look for a strong rating from all 3 major rating agencies (Standard & Poor’s, Moody’s and Fitch.) Another approach to minimise risk would be diversification. However in practice the Treasurer may find that by investing in several money market funds and with several providers his diversification is not as great as intended.

Funds of comparable rating generally are investing in similar asset class and corporate issuers due to their availability and similar restrictions. A further thought to consider is that fund management firms generally do not want their results to be too out of line with their peers, once again resulting in the funds investing in similar products.

Within the ratings world concerns have been mounting recently regarding the credibility of the process. Rating agencies rely on the data supplied by the entity to be rated. With recent high profile corporate failures doubt has been raised about the effectiveness of the issuers obligations. This has resulted in a proposed move to a Code of Standard Practices for Participants in the credit rating process. It is hoped that confidence would be restored to the investment arena if this were to be adopted.

Cash management is far from a dry area of banking and treasury at the moment. The need to utilize in-house funds and the simultaneous growth in money market funds has caused finance professionals to look at cash in a new light. The euro and microchip have speeded up the process. Treasurers would have found it considerably more difficult to create efficient cash pooling in Europe if it were not for the introduction of the euro.

Likewise advances in technology have aided the process with the banks and treasury systems providing up to date global cash position information. Cash management promises to continue to be an exciting area of treasury over the next few years.

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