—–For general audience—-–
The fact that the role of Corporate Treasury evolves over time is nothing new. Technology, business requirements and the economy in general are textbook drivers. But regardless of these drivers, several key functions and processes that Corporate Treasury focuses on, always remain. The fundamental task of Corporate Treasury is to ensure a company’s financial health. Examples of instruments to carry out this task are Cash Management, Foreign Exchange, Risk Management, Regulation, Investment & Funding, Financial Supply Chain and Technology.
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By Jiaxin Huang and By Norbert Braspenning
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The consequences of the corona pandemic have affected these instruments and put Corporate Treasury’s fundamental task (ensure a company’s financial health) in a different perspective. The world’s economic output will be significantly reduced as a result of a severe supply shock, followed by a demand shock (during an economic downturn the public will spend less). Potentially there will be several more waves when regions get re-infected, as lockdown measures are relaxed (travel between countries and continents permitted), or when the contagion returns this autumn or in spring next year.
Cash is king
The importance of Cash Management is not to be understated. Cash is the lifeblood of any business. Cash is King. By generating enough cash, a business can meet its everyday business needs and avoid taking on debt. This may seem straightforward, but a lot of resources are put into ensuring the right amount of cash is available at exactly the right time, in the right (geographical) location and in the right currency. Difficult at the best of times, even more challenging during corona.
So, if taking on debt can be avoided by generating enough cash, what happens if corona makes generating cash very difficult or even impossible?
- An obvious response would be to take on (more) debt. However, a major impediment is that the corporate debt market is likely to implode due to the shape it is in;
- Another reaction is quite similarly to how we saw the general public respond. Hoard. In long supermarket queues, buying large quantities of canned food with a long shelf life (and of course toilet paper) many prepared for “bad times. Businesses, also in preparation for bad times, try to stockpile liquidity. Where empty shelves in supermarkets illustrate a mismatch between supply and demand, similarly, for businesses, liquidity dries up. Whatever is available is priced through the roof.
An isolated case versus a global negative shock
If, in an isolated case, a business experiences a severe negative shock (through no fault of its own), it will be able to obtain financing in order to continue. But if most firms are all suffering shocks at the same time, and the outcome looks as uncertain as it does now, it’s a different story. Financing is suddenly not readily available. There are two main reasons. Firstly, the way the corporate debt markets react to a global shock is impeding business from access to funding. Secondly, due to the fact that all counterparties of a business are affected, the flow of cash will be severely impacted. Payment terms may get renegotiated. Outstanding invoices may not get paid on time, or ever worse, not at all. Nevertheless, regardless of not receiving cash from account receivable (debtors) as forecasted, payment obligations towards account payable (creditors) still need to be honoured. Let’s look at both reasons in more detail.
The corporate debt market’s reaction
During times of crisis the Financial Institutions’ commercial and risk appetite changes. Market risk is avoided. Internal hurdles and sanity checks are up. Why? Lately the ratings agencies have been downgrading corporate debt at a rapid pace. Bank loans to businesses are considered riskier. Financial institutions are therefore less interested in granting loans. This is making things worse. And even if Central Banks step in to provide low cost funding, recently introduced regulations (Basel 3 and onwards) will impede banks from making balance sheet available. Meeting the capital maintenance ratios requirements is very costly if banks take on more debt. Especially if ratings are downgraded. As insurance against companies defaulting on their debts, financial institutions can use – so called – credit default swaps (CDS). However, the price of these swaps is back at the levels of the financial crisis after the Lehman shock. This is not helping. Hence, the cost of borrowing for businesses is considerably higher than before the crisis. This will be putting pressure on many companies that are already struggling to cope.
Cash flows and working capital
If suddenly the inflow from account receivable is less than forecasted, alternative sources need to be tapped into. In order to continue to meet obligations (accounts payable), there is an immediate need to borrow to bridge the gap. What are the options? Let’s take a European subsidiary of an Asian headquartered multinational company (MNC) as illustrative example.
- The subsidiary can turn to its local bank to arrange a loan in Euro. This will take time (a few days at least). Time the subsidiary does not have. The local bank most likely will not be eager to extend a loan, and if it does, the cost will be considerable;
- The subsidiary may wish to utilize its Uncommitted Overdraft Facility at a local bank. Regardless of extremely high cost, the nature of the facility (uncommitted), may have led the local bank to terminate unilateral, in light of the economic crisis. Furthermore, Uncommitted Overdraft Facilities are usually aimed at bridging a cash flow mismatch for a very limited time span (few days), and cannot be relied upon for an extended period like a crisis;
- The subsidiary can turn to the head office to request funding, assuming the head office has sufficient liquidity or adequate access to funding though one of its relationship banks. But as timing is of the essence, a few bottlenecks immerge;
- Borrowing will most likely not be in Euros. If it is, cost will be high. The Lehman shock as well as the burst of bubble economies has shown that in those circumstances, Asian banks will face difficulties sourcing foreign currency. Consequently, very high premiums for foreign currency will be passed on to clients. (This bottleneck also applies in case the head office does not have sufficient liquidity itself);
- Assuming borrowing will be in local currency, it will need to be swapped into Euros. This will take additional time. It also introduces a foreign exchange exposure. Depending on term of the exposure and the respective policies, this potentially needs to be hedged;
- As Intercompany lending will need to be at arm’s length and properly documented and administrated, this is a cumbersome, intensive and therefore lengthy process.
Can a simple liquidity management tool come to the rescue?
Yes it can. Some MNCs have learned from previous crises and opted for implementing one without even using. Keeping it ready in case it needs to be relied upon. We are talking about Cash Pools. A Cash Pool can facilitate all the funding needs, same day, globally at reasonable cost. But only the right one.
Here is what to look for:
- Multi-Currency. Supporting as many currencies as possible (35+). Otherwise you’re still stuck with managing (swapping) currencies individually. This would also apply to a DIY (Do It Yourself) in-house bank;
- Global and flexible. Applying the follow the sun principle. Liquidity between all continents and regions can be bridged within the timespan of one single day. Japan deposits and the US withdraws, all valued same day;
- Multi-Entity. Subsidiaries globally (Foreign Exchange Controls permitting) participate.
- True Notional. Meaning:
- No sweeps to a master account (no Intercompany Loans triggered);
- No gross guarantees or cross indemnities (no Intercompany Loans triggered);
- No foreign exchange, no swapping, currencies remain as is (no foreign exchange risk);
- One single interest rate per currency (so spread between depositing and borrowing).
Here is what to be aware of:
- Cash Pools centralize assets and liabilities. The most secure way to place funds is to select a bank that provides offset of debit and credit balances. The same bank with different legal entities, for example one in New York and one in Singapore, likely do not permit offset;
- How Basel affects the Cash Pool;
- Overall (hidden) cost and how negative interest on selected currencies is charged.
Conclusion
The down side is that you can’t implement a Cash Pool overnight. So it won’t help you right now, but it may be good to consider, in order to help you prepare for the next crisis. For the time being apply the following simple principles:
- In a perfect world, bank account rationalization is great for cost cutting. Not in times of crisis. In preparation always have at least 2 banks;
- Make sure one of these is local bank, especially if this is the one where most of the cash is located or for very specific local business;
- Continue maintaining a transparent relationship with your banks (only knocking on their doors only in need is not a good idea).
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Featured image: Gif-sur_Yvette (near Paris). Image of the morning sun hitting the treetops, but a storm is imminent. The sun representing the fact that everything seems calm in the confined space we operate in. The storm indicates that if we look at the broader (financial) picture, things may be quite different ahead. (Photo: Doan Nguyen).
The views in this post solely reflect the opinions of the author and not necessarily those of the institutions with which he/she is affiliated.
In the posts the author(s) express(es) personal insights, expert views, and opinions with respect to the topic(s) discussed. Due to differences in interpretation, insights may (and will) differ.
Editor: Norbert Braspenning
TREASURY INSIGHTS & CURRENT TOPICS 