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‘Cash is King’ - a Report on corporate liquidity management Back  
With interest rates at historic lows, corporate treasurers are looking to yield-enhancing products such as range accruals to increase their cash management returns.
The financial economy of the twenty first century has conspired to underline the critical importance for all asset managers (including corporate treasurers and finance directors) of cash as an asset class in a way that most people will find unique in their career.

Interest rates are at historic lows. Yield curves are flatter than ever (offering little pick up opportunities for those willing to reduce their liquidity). The first three years of the 2000s brought one of the worst bear markets in history with equity markets down by over 40 per cent in real terms. Throughout the global economy liquidity is on the rise, and corporations have built up their liquidity to increase.

In part this is a reaction to the shocks of the late 1990s and early 2000s, but also it reflects uncertainty about the future course of asset markets. In Ireland this uncertainty particularly centres on the property market, and this has been reflected by the flow of capital seeking overseas property investments in the belief that the home market is fully valued.

In times of uncertainty, cash becomes not just an asset that produces an effort free and (low) risk yield but, as Eugene Kiernan, head of asset allocation with Irish Life Investment Managers says in his article below, a tactical asset as well.

There is no better corporate example of how cash can be a tactical asset than that illustrated in Ryanair plc’s strategy. In a survey published in June 2005 of the top 200 corporations in Europe, CFO Europe magazine found a huge range of liquidity between companies, with no particular pattern by sector, or by company type, with cash holdings in companies ranging from less than 5 per cent to over 100 per cent of turnover. Ryanair was revealed as one of the most liquid companies in Europe, with cash at 110 per cent of turnover in June 2005. This puts an interesting context to Michael O’Leary’s comment in August that he might even welcome an oil price of $100. It indicates that company’s reading of the risks inherent in the oil market have influenced its cash strategy – putting Ryanair in a strong position in the event of an oil price hike to take advantage of less liquid competitors.

Corporates and investors/ fund managers have a different fundamental approaches to cash. Corporates must treat cash as the net result of a cash flow residual between two big variable magnitudes (revenue and outgoings) that can vary substantially. When the variance is negative in both directions, cash flow, and perhaps even cash reserves (in a very negative situation) suffers to a degree not faced by plain portfolio managers.

Thus, for corporates in a time of uncertainty, which this is, cash must be king. And it must be king, even though interest rates are at historically low levels.

In this report we survey the broad options and products available, and highlight new possibilities including the arrival of liquidity funds. We discuss the changing role of cash management in a corporate treasurer’s overall strategy, and we assess the role of risk, and what some of the hidden costs might be behind a decision to go for lower rates.

Credit ratings
The credit ratings of banks offering deposits, is a key decision factor for many corporates, when choosing where to place their funds on deposit. The offerings of Ireland’s main clearing banks reflect their higher credit ratings, and the fact that they can source funds at somewhat lower rates in the market than their slightly higher rated counterparts.

In an article on page 5, John Coffey, head of treasury of BNP Paribas Dublin, argues the case for corporates accepting lower yields in favour of higher credit ratings. He writes, ‘each extra basis point in yield that you achieve, may bring you no more than an extra 28 cent per million per day – for example switching from an A rated bank to an AA rated one brings 84 cent per million for the cost of a 60 per cent increase in default risk (0.04 versus 0.11 )’.

Credit ratings are of course a critical issue for corporate treasurers, and many treasurers in Ireland have corporate governance guidelines indicating a policy of not placing funds in banks below certain specified minimum credit rating levels. Indeed, one corporate in Ireland has a policy of not depositing with a bank at all – the only acceptable local entity being the triple A rated National Treasury Management Agency.

Products available
Other issues for corporates in considering their liquidity management strategies are the range of products available. For example, AIB emphasises the range and variety of foreign currency hold accounts that are available to its customers. It also offers ‘Section 69s’ to international firms based in Ireland. These provide an alternative to deposits and commercial paper, and were introduced with a view to encouraging the retention of earnings in Ireland by such companies.

Others, such as Ulster Bank, offer structured product potentials, such as callable range accruals.
John Moclair, head of domestic sales with Bank of Ireland Global Markets, says that they have noticed an increasing interest from corporate treasurers in products that enhance yields. These include dual currency deposits (mostly EUR/STG, but also EUR/USD) and range accruals, which he says, have given some treasurers yields of 8 per cent a week.

Other products in demand include liquidity funds, which BOI uniquely pioneered the availability of, in the Irish market money market (mutual/ UCIT) funds.

Mark Barnes, head of corporate treasury with IIB Bank, is also seeing a lot of interest in products such as range accruals amongst corporate treasurers. These products offer treasurers the chance to enhance their yields, but they incur a higher degree of risk. For example, some of these products would offer yields of +4 per cent 3-month European rates stayed within pre-determined bands.

IIB Bank offers EUR callable deposits, which are capital protected but give an enhanced fixed rate of interest. On €1 million, a corporate treasurer can expect to earn an interest rate of 3.2 per cent.
Investec Ireland offers deposit facilities in euros and all major currencies at consistently competitive market rates. It recently launched a new 32-Day Notice Deposit Account. This account pays a variable rate, which is at present 2.40 per cent. Interest accrues daily and is credited to the account twice yearly. The interest rate will be at least equal to the European Central Bank (ECB) rate, until 1 January 2006.

A range of deposit products is also on offer from Anglo Irish Bank, including the following: flexible one-month demand deposits; fixed short-term deposits (overnight to 1 year); and structured long-term deposit product (2 to 5 years).

On a more complicated level, Barclays Bank Ireland plc, offers solutions to corporates looking to safe-guard their cash against inflation. The most common products traded in the inflation-linked derivatives market are various types of swap. Generally one side of the trade has a dependence on a defined price index, and the other is a standard fixed or floating stream of cash-flows. Inflation derivatives

EBS offers its ‘Diamond Account’, which is designed to provide a highly competitive rate of return for corporate customers who wish to keep funds on call. It has a minimum account opening of €150,000, and offers a rate of 1 month EURIBOR.

Certificates of deposit
Since a rule change in the Finance Act 2003, it is now possible for Irish resident financial institutions to issue certificates of deposit (CD) to Irish investors, and since, a number of Irish based financial institutions have availed of the opportunity to issue including EBS, Depfa Bank and UniCredito Italiano Bank (Ireland) plc.

According to John O’Farrell, head of treasury with UniCredito Italiano Bank (Ireland) plc, CDs are an effective cash management tool, ‘because they are more flexible than deposits, as they can be sold in the secondary market, should the buyer need liquidity or wish to close their position due to market conditions’.

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