Cash & Liquidity Management

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Liquidity Management: is Europe the new Asia? A mixture of recent and forthcoming changes, including Brexit, bank ring fencing and the second Payment Services Directive (PSD2), will make Europe a far more demanding environment for many treasurers over the next few years.

Liquidity Management: is Europe the new Asia?

 Liquidity Management: is Europe the new Asia?

By Adnan Ahmed, Regional Head of Liquidity for Europe, Global Liquidity and Cash Management, HSBC

HSBC

For many treasurers, Europe has historically been a benign environment for liquidity management. In contrast with regions such as Asia or Latin America, consistent regulation and unrestricted movement of funds has made for comparatively straightforward liquidity management. However, a variety of recent and forthcoming changes, including Brexit, bank ring fencing and the second Payment Services Directive (PSD2), will make Europe far more demanding over the next few years. Nevertheless, as Adnan Ahmed, Regional Head of Liquidity for Europe, Global Liquidity and Cash Management, explains, these changes are considerable opportunities for those treasuries that act now to ensure that their businesses, banks, systems, infrastructure and processes are agile.

 

Brexit

Brexit represents one of the greatest challenges for European liquidity management because of continuing uncertainty over the form it will ultimately take: ‘hard’, ‘soft’ or somewhere in between. At present there is no sense of linear progression to a predictable outcome, which makes planning future liquidity structures near impossible, especially in the context of rules relating to cross border transfer payments in Euros.

For example, there may be implications for treasuries regarding the creation of intercompany positions and the movement of funds in relation to their corporate tax positions. At present, whether or not the bank account is resident or non- resident is largely immaterial and the movement of funds is straightforward. This may no longer be the case post-Brexit.

The tax implications for a particular liquidity structure, or the consequences of an entity moving funds to another entity, or to the same entity in another jurisdiction, remain unknown.

Some more advanced corporate and other client treasuries are already undertaking considerable scenario scoping to devise strategies that have the flexibility to cover the broadest possible array of Brexit outcomes. Much depends on the size, complexity and location of operations. For instance, a corporate that is mostly European-focused with minimal UK operations, but with a UK-based liquidity structure, may have more at stake in terms of Brexit outcomes than one with mostly UK-based operations.

A key consideration in Brexit preparations is that a treasury’s banking partners will be able to support the broadest range of possible contingencies if changes of bank account domicile and/or ownership are needed. Those banking partners will therefore need to be able demonstrate both network range as well as depth, plus a consultative relationship approach to devising the optimal post-Brexit liquidity strategy and structures. Furthermore, they must also be able to offer the necessary tools for corporate treasuries to have maximum visibility and mobility of their liquidity both within Europe, as well as globally.

There is one very important upside to the very considerable demands of post-Brexit liquidity preparations. Many of the other changes due to affect the European liquidity landscape over the next few years are much more definite in their outcome than Brexit. Therefore, developing processes, systems and structures that are sufficiently flexible to cope with the broad range of post-Brexit outcomes will also implicitly deliver a more general competitive edge that will be of value in tackling these other challenges.


Ring fencing

As from January 2019, major UK banks have to ring fence core retail banking from investment banking. This represents a fundamental change that affects large corporates’ liquidity management. Historically, UK banks have used the funding raised from small/mid-sized business and retail customers to fund their loan books, with large corporates being major consumers of this loan capacity. After ring fencing, that pool of deposits may no longer be available to fund this lending.

This has two significant implications: the cost of large corporates’ borrowing will increase, but so will the value of their deposits, possibly quite considerably. These pricing implications are already becoming apparent in the market place and this trend is likely to become more pronounced as January 2019 approaches.

As regards deposit rates, an important distinction is whether large corporate deposits are being placed with a ring fenced or non ring fenced banking entity and the credit rating of that entity[1]. A non ring fenced entity may be perceived as higher risk and have a lower credit rating and so will have to pay higher rates to attract deposits. However, it may be content to do this if it can deploy the resulting deposits at a better return. Therefore corporates’ treasury investment policies will need re-examining to determine what is or is not acceptable in terms of risk/reward when choosing whether to place deposits with ring fenced or non ring fenced bank entities, or a mixture of both.

The ring fencing rules are likely to drive some notable shifts in banks’ liquidity positions and therefore the rates they are prepared to pay to attract deposits. Some that were previously flush with liquidity may have to compete aggressively in the corporate deposit market to retain it and vice versa. One area likely to see appreciable change is the large corporate Euro deposit market. Previously many banks have avoided accepting Euro deposits because of the negative credit interest rates involved. However, post ring fencing, some banks may feel they are nevertheless worth attracting as it may now be possible to use the Euro deposits as a source of funding and redeploy them profitably.

From a practical perspective, this fluid situation will place a premium upon the ability to (re)deploy surplus liquidity without incurring a large additional manual workload for treasury.

Therefore, tools that provide a single automated interface where liquidity investment/divestment can be accomplished across on/off balance sheet instruments and ring fenced or non ring fenced entities adds appreciable value.

 

Notes
1 Unlike small/mid-sized businesses and retail customers, the ring fencing rules do not specify whether large corporate deposits should be inside or outside a ring fence: https://blogs.treasurers.org/what-do-treasurers-need-to-know-about-bank-ring-fencing/

 

 

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