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Future-proofing the treasury function: The impact of regulatory changes on liquidity management in Asia

By Mario Tombazzi, Regional Head of Liquidity and Investments, Payment and Cash Management, Asia-Pacific, HSBC.

Mario Tombazzi discusses how regulatory developments including Basel III affect global liquidity management practices.


In recent years we have seen a significant number of international companies transition from a fragmented liquidity management approach to a more centralised, regional or even global structure that facilitates automated processes, enforces controls and standardisation, and realises the full value of the liquidity generated by the underlying business activities across several geographies. These structures have been proven to help companies strengthen and safeguard their cash holdings, properly deploy excess funds, increase self-funding and hedge against credit and liquidity risks.

Looking forward, the centralisation trend will continue to extend to more organisations and a growing number of geographies, and as such will remain a high priority item for every treasury department.

Together with the expanding availability of treasury services provided by global banks, external factors play a determinant role in influencing their commercial readiness and life cycles. In particular, the introduction of regulatory reforms and new banking standards has a significant bearing on liquidity and cash management practices on both a global and local scale.

For example, since the Global Financial Crisis, governments and regulators all over the world have been developing a series of measures designed to help strengthen the global banking system and ensure financial institutions have sufficient capital and liquidity in reserve to prevent a future financial crisis. In parallel we have also seen significant market liberalisation in large economies such as China, which means that companies can now integrate their local liquidity pools into their international structures, both in Renminbi and other currencies.

As such, corporate treasurers worldwide are looking for confirmation on whether their liquidity management structures will stand the test of time in the face of a rapidly changing environment.

What is Basel III?

One of the most important measures being introduced is Basel III, which includes several new guidelines on risk areas not explicitly addressed by the previous Basel Accords, with a phased implementation over the next six years. The updated regulatory standard was developed primarily to ensure a more robust set of criteria governing the capital adequacy and balance sheet structure of financial institutions, their leverage ratios, as well as their liquidity requirements, which also has several key implications for corporates, particularly in the area of liquidity management.

Basel III brings a significant change to the liquidity framework in the form of two key ratios that have been introduced in order to strengthen the supervision of liquidity risk. Firstly, the Liquidity Coverage Ratio (LCR), which will be phased in from 2015, has been designed to ensure that banks have adequate short-term liquidity and high quality liquid assets to meet customer deposit outflows and other financial commitments for at least a period of 30 days under a pre-determined stress scenario.

And secondly, the Net Stable Funding Ratio (NSFR) aims to limit maturity mismatches between the assets and liabilities on the balance sheet, thereby reducing funding risk, over a one-year period of extended stress. Financial institutions have until 2018 to meet this standard.

In addition, the framework also introduces four metrics for liquidity monitoring, such as contractual maturity mismatch, funding concentration, available unencumbered assets and market-related monitoring tools. But what does all of this mean for multinationals and corporates around the world?

The impact on corporates

Basel III will impact corporates indirectly, most notably in terms of pricing and availability of certain services offered to them by banks. One impact largely discussed from the early days of the Basel III proposal paper is the increase in the cost of lending and the reduction in the credit capacity of banks, as a consequence of the raise in the capital adequacy requirements.

Another significant impact is associated with the definition of operational deposits, which is important under the new LCR framework. As a result, it is essential that companies properly understand the implications of this, because they determine the most appropriate liquidity and cash management solution to suit their needs.

According to Basel III, corporate deposits can be classified as “operational” if they relate to payment, clearing or similar transactional banking arrangements, and are directly generated from the working capital-related activities resulting from the day-to-day running of the company’s business. As such, corporations are likely to continue to need these funds should another financial crisis hit, and the banks holding such deposits are required to simulate and prepare for pre-determined stress tests and deposit outflow scenarios. Any deposit that is not directly associated with operational requirements will be subject to larger outflow scenario assumptions, including a possible 100 per cent outflow under certain conditions.

Depending on the nature of the cash holdings – and particularly if they are associated with payment and clearing services such as operational deposits – the outflow scenarios are more favourable. In these instances, deposits that are categorised as operational become more valuable to financial institutions, and consequently also to companies. The definition of operational deposit is now subject to broad guidelines laid out in the consultative documents and papers produced by the Basel Committee on Banking Supervision, and these guidelines are being used to inform the application of the approach by banks. However, the customer base and market orientation of any financial institution, resulting in differing balance sheet structure and composition between banks will drive the appetite and ability to source operational deposits across retail and wholesale customers, and is expected to generate deposit pricing and deposit product differentiation as a result.

Under the new regime, while it is difficult to predict the changes in deposit sourcing dynamics across banks and markets, the one certainty is that the segregation of liquidity management from transactional banking services that fall under the remit of operational deposits will result in a less beneficial treatment, and needs to be considered even more carefully than before. The fully integrated model in which the liquidity bank also provides the majority of cash management services will continue to offer optimal efficiencies, both under these criteria as well as from a purely operational process efficiency standpoint.

However Basel III is not the only change on the regulatory landscape that companies need to consider. As global markets continue to expand and develop, regulators have started to adopt other initiatives that safeguard the stability of the domestic financial market, limit the effect of a systemic market risk spreading, or establish greater global governance. Hence, there have been enhanced requirements for Know Your Customer (KYC), the Foreign Account Tax Compliance Act (FATCA) and the intra-day liquidity buffers, to name but a few. These initiatives are enforced in the financial services industry, which play a key role in the enforcement and monitoring of these regulations. The adoption of more globally consistent governance standards is clearly a positive development, leading to a consolidation in the number of core banking relationships that any one company can sustain, due to the material increase in the cost of governance compliance to be incurred by all banks.

What this means for the in-house bank and self-funding

Given many of the world’s leading corporates have already developed a centralised approach to liquidity management, consolidating their cash position and often establishing an in-house bank with a view to optimising self-funding, corporate treasurers are obviously keen to understand how this will be affected by the changing face of regulation.

The good news is that recent regulatory changes may not necessarily have a drastic impact on the traditional approach. Basel III’s definition of operational deposits is consistent with the operating model of an in-house bank, and will actually encourage companies to structure their cash management activities in a way that will build the most appropriate foundation for the management of the resulting liquidity. In the Basel III compliant world, it is critical to establish the correct alignment of transactional services and of the optimal liquidity redistribution mechanism across the entities within the group. Structures that are well suited to this purpose include a fully centralised model such as those of an in-house bank, a financial shared services centre or an intra-group financing or trading centralisation vehicle (such as a finance company, a re-invoicing centre or a trading company).

There will however be an increasing reason for greater efficiency across the integration of cash and liquidity management services, as well as for stronger controls over internal self-funding and liquidity consolidation, especially on the investment of any structural cash excess. Basel III’s characterisation of excess and price sensitive deposits as non-operational deposits encourages companies to make the most efficient use of their internal liquidity first before looking to secure external funding or invest fragmented idle cash. The function and purpose of a sophisticated liquidity structure will therefore remain and provide the automated infrastructure or conduit for the dynamic redistribution and consolidation of liquidity across business entities, geographies and time zones. Just-in-time funding, cash mobilisation and concentration will continue to be supported by the liquidity solutions available in the market, and will also deliver the additional benefit of producing a more stable profile in the aggregated liquidity pools, which is another beneficial factor under Basel III. The added incentive for corporate treasurers already making use of an efficient liquidity structure will likely be to adopt a more active management approach, an automated investment solution or alternative deposit products to manage any large residual liquidity.

Specifically however, there are three key areas that companies will need to revisit in order to make sure their liquidity management practices are evolving in line with the changes in the market and continue to deliver the optimal results.

Companies operating an overlay liquidity structure in which the liquidity bank is not their transactional banking provider need to reconsider their mechanism under the changing regulatory framework. In most cases, a fully integrated bank that delivers both liquidity and cash management services will remain the most efficient approach, and will also provide the corporate treasurer with greater control, which is necessary under the new standards.

Operating in multiple currencies is a reality for the majority of corporate treasurers today, and partnering with a single global liquidity bank that is able to provide transaction services across multiple currencies as well as offer a multi-currency banking solution will work especially well under the new standards.

And corporates that have already, or are in the process of establishing an in-house bank should also properly evaluate their processes and structures in order to ensure they facilitate the control of cash and how liquidity is distributed and processed. It is critical that the company introduce the necessary processes and liquidity management techniques to give full control and optimise efficiencies in deploying liquidity across their geographic reach.

The future of liquidity management

As a result of the recent regulatory changes, many corporate treasurers are eager to learn whether today’s liquidity techniques will remain valid going forward. Given the increasing demands these new standards and requirements have imposed on companies to better manage their cash, physical techniques such as cash sweeping will remain critical, if not grow in importance, both domestically and cross borders. This is because these tools allow companies to achieve full control over the physical mobilisation of cash in terms of timing, destination and methodology (e.g. one way, two-way, reverse, and multiple other variations) including the strict enforcement of internal lending policies. The physical aggregation of cash is beneficial in achieving a direct netting effect on the balance sheets of both the company as well as of the bank providing the service. Notional techniques will also remain valid and effective, staying firmly at the heart of any cash management strategy, but will likely be offered more selectively due to the increasingly complex balance sheet implications they carry.

But while the combination of physical and notional liquidity will continue to exist, these mechanisms will need to be sufficiently flexible to be rapidly adapted from market to market, especially given the fast pace at which markets such as China are liberalising and the way new global regulatory standards are being introduced. The liquidity corridors that are in use today to mobilise cash across markets are continuously expanding to allow for the consolidation of liquidity in one or a few of the established international financial hubs that are commonly used to domicile global and regional liquidity structures. Renminbi is probably the best example of this trend. The combined effect of market liberalisation and the expansion of the liquidity corridors, and of the currencies supported, will continue to augment the amount of the geographically dispersed liquidity that can effectively be included in a single, fully connected, global liquidity structure.

Organisations that already partner with a global bank offering integrated liquidity and cash management solutions will be perfectly placed to adapt and adjust their techniques easily and quickly, responding to any changes that may arise. These institutions can help control how liquidity pools and flows are utilised, enforce governing limits and controls, and prevent the fragmentation of cash and liquidity to maximise financial efficiencies to the companies they service. They can also help corporate treasurers stay abreast of important industry and market changes such as Basel III, offering a host of services and propositions designed specifically to future-proof treasury processes.

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Vendredi 29 Août 2014