How to optimise company cash

Businesses that earn much of their income in foreign exchange now tend to look at a wider range of cash management options. PAUL MELLY speaks to Tim Jackson, an expert who knows what they are

How do you make the most of your company’s cash?

This is a challenge – but also an opportunity – that now confronts corporate treasurers across the Middle East, in businesses with large-scale international earnings.

Cash placed on simple “call-account” deposit generates a poor return in today’s low interest rate environment. And these conditions are likely to persist for some time to come, in the current troubled state of the world economy.

Yet in sectors such as petrochemicals, gas and oil, steel, logistics or air transport, today’s Middle East is home to companies with a global sales income and substantial cashflows in major currencies.

And for an increasing number of these sophisticated Middle Eastern businesses, cash is not just a reserve to be saved. It is also a commodity that can be invested.

Over recent years they have become keen to make their cash work – but, of course, through accessing diversified investment instruments that spread risk and protect core value.

Developments since the outbreak of the global financial crisis in 2008 have reinforced this trend.

In the present uncertain climate, where other business options may be limited, or carry too much risk, it makes sense for companies to ensure their cashflow is managed to the highest standards for safety, liquidity, yield and to diversify their cash in line with corporate strategy.

Traditionally, businesses in the Gulf have tended to entrust a high proportion of their liquid assets to their main house banks. This is particularly true for those with earnings mainly in local currencies – because the interest rates for these are higher than those for the US dollar, the euro or other major international currencies.

But those large businesses that earn much of their income in foreign exchange now tend to look at a wider range of cash management options.

Typically, they will continue to use banks, both local and international – which makes sense, as they also often have borrowing relationships with the banks concerned. But they will also place significant cash allocations into specialist liquidity products – available through their banks or increasingly, directly from specialist providers.

This is not just about maximising returns but also balancing security and liquidity requirements.

“A major corporate will typically set its own ‘counter-party’ limits – which place a ceiling on the amount of cash that it will place with any one counter-party. They will base these limits on their assessment of the credit quality – the financial strength – of each institution,” explains Tim Jackson, institutional product director at Invesco Asset Management Limited.

“This self-imposed risk control ensures that a company spreads its exposure and diversifies risk.

Once the counter-party limit for a particular bank has been reached, a corporate treasurer will need to tap into off-balance sheet options for depositing further funds.

“Normally access to off-balance sheet products will be provided by a bank;  but increasingly, companies are dealing  directly with independent asset management houses such as ours, which are specialists in liquidity management,” says Jackson.

“But whichever route is taken, the treasury team in a major corporate will usually aim to share its cash deposits among several banks and asset managers.”

Business strategies

A company with large volumes of cash to manage will generally need to balance a range of priorities.

Corporates tend to have several tiers of liquidity to manage. “The first layer is cash that is instantly available if required – which is generally placed in a facility that is equivalent to a ‘call account’ at a bank,” Jackson explains. “The second layer is general liquidity that the business can afford to set aside for slightly longer, 30 or 60 or 90 days, producing commensurately higher returns. The final layer is the management of longer-term reserves.”

To optimise the earnings from the different tiers of liquidity, a business will need to think in global terms about its liquidity and cashflows. And this is one area where the big international asset managers can complement the role played by a Middle Eastern company’s local house banks.

For example, a large Middle Eastern petrochemicals group could well have sales outlets in the Gulf itself, in Europe, in North America, and in the Far East, each generating income flows in those regions’ major currencies – euros, sterling or US dollars, or, these days, even Chinese renminbi. An airline might also have major income flows from Canada, Australia or South America.

The central treasury of such a group is likely to look at all these cash income flows worldwide, and set up arrangements to aggregate them, producing a combined cash balance for each major currency. In doing so, it can then monitor exposure to counter-parties in group terms, rather than looking at each local business as a small outfit on its own.

Creating a group-wide liquidity policy or corporate house standards in this way can optimise efficiencies. It ensures that, at a group level, counter-party risk and diversification (at a granular level) can be monitored effectively on a frequent basis.

“In assessing what is on offer from the asset manager, to achieve these goals, a corporate treasurer will look at two key measures. One key question is the connectivity and the technical efficiency of trading and flow of funds – Straight Through Processing (STP) is what many aspire to. In other words: will it actually work?” says Jackson

“The second key criterion is safety: how will the funds be committed, what instruments and investment options are being proposed, and do these offer sufficient diversification? The treasurer’s bottom line must be the preservation of their company’s cash or, to put it another way, preservation of principal; an attractive return is a plus, but the safety of the cash is fundamental.”

When a corporate treasurer is considering using liquidity products, be it with a bank or an independent asset manager, there are a number of considerations. The long-term standing of the financial institution and expertise in the liquidity management sector are key, combined with scale and infrastructure.

“At Invesco, we have been managing liquidity products for more than 30 years and have clients globally who invest in a range of currencies.  We have chosen to have our cash funds triple-A rated by all three of the major agencies,” says Jackson.

“When choosing a liquidity manager, public ratings are only an initial filter.  Beyond that, it is important to look at the infrastructure.  Invesco has its own credit research team that looks at the economic and financial factors shaping the market and the risks impacting on particular investment instruments.” n

 

Important information

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

Where Tim Jackson has expressed opinions, they are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

Issued by Invesco Asset Management Limited is based at Perpetual Park, Perpetual Park Drive, Henley-on-Thames, Oxfordshire RG9 1HH, UK. It is authorised and regulated by the Financial Services Authority.

 

Another article about cash management from Invesco will appear in the May/June issue of Cash&Trade.