Staying Ahead of the Curve

Liquidity Management Innovation

Faced with a new macroeconomic era, corporates are understandably prioritising effective cash and liquidity management. Here, three industry experts highlight the key issues and innovations for treasurers to consider when looking to optimise the use of excess cash, maximise yield, and manage risks in these testing times.

Efficient liquidity management is vital for corporates at the best of times – without a proper handle on it even the most profitable company can go under. And in periods of high market volatility, economic turmoil, and uncertainty, as we are seeing now, its importance is magnified.

Walter Cegarra, CEO of FNZ Q-Hub, a specialist team within wealth management platform provider FNZ, is clear about just how challenging the environment for managing liquidity has become on the back of Covid-19, geopolitical tensions, and the Russian invasion of Ukraine. This recent period, he reminds us, contrasts sharply with the previous decade, which was characterised by a relatively benign, super-low-rate environment and virtually zero yield on cash. However, the rapid hike in inflation and rates globally over the past year (although tapering is on the cards), have necessitated a sharp revision of corporate liquidity and investment strategies.

Cegarra says: “The much-altered rate environment has significant implications for cash investment. Treasurers must now consider cash as an asset that can be used to generate a reasonable return to compensate the increased inflationary pressures impacting all corporates. But it is also important to recognise that such an investment bears significant risk. The recent woes in the banking sector, for example the collapse of Silicon Valley Bank [SVB] in the US and Credit Suisse in Europe, demonstrate that even global banks can be risky institutions for cash. Certainly, our conversations with corporate treasurers suggest they are rethinking their short-term investment strategies in light of the new environment.”

Research from TMI’s 2023 Liquidity Survey in partnership with Northern Trust Asset Management backs this up. Among the 217 corporate treasurers surveyed, 41% cite interest rates as their top concern, with 15% selecting inflation. And many are tweaking their investment duration as a result (see Chart 1).

Chart 1:  In what way is your view on interest rate hikes impacting your investment strategy

_{Source: TMI and NTAM Liquidity Survey 2023}

Bucketing cash

Against this backdrop, Cegarra highlights the renewed importance of cash laddering – also known as segmentation (see figure 1). The decade of super-low rates ensured minimal importance being attached to cash investment in aid of cash flow management, but those days are over. Treasurers, he says, now have to think much harder about cash on their balance sheets and recognise that the deliberate planning of investments in support of cash flow requirements has become critical again.

Fig 1: Suggested parameters for cash segmentation buckets

_{Source: TMI and NTAM Liquidity Survey 2023}

In this new environment, treasurers must try to determine how much of their cash they need for the immediate, short, and medium-term. Cegarra continues: “We see treasurers expending considerable effort to define those three buckets in the new environment and their relative benefits versus cash flow needs. The good news is that there are now plenty of tools to help them with that process and develop innovative strategies that offer a powerful alternative to the playbook paths of old. There has been significant progress over the last decade in manipulating data and forecasting and making those advances available through technology.”

While no tools or strategies can ensure delivery of the perfect solution, they can, says Cegarra, offer up a series of potential solutions that account for yield, liquidity and risk, which can then be mapped onto specific requirements of the corporate. “In this context, cash laddering can play a vital role for creating liquidity for immediate cash needs at a predetermined time that matches a desired risk profile.

“At FNZ we still believe, as it stands, bank deposits and very conservative money market funds remain part of the solution. But that’s only for the immediate cash needs, which typically tends to be just a small, but overestimated, portion of the consideration. Corporates still need solutions for short-and-medium-term cash requirements, where higher yielding opportunities can be found, balanced against associated risks.”

Pulling different levers

When considering the type of solution currently being adopted by treasurers, FNZ is seeing three key factors or levers coming into play, says Cegarra. The first is duration risk. “It is absolutely fine to be exposed to some controlled duration and the accompanying risk, but what is not acceptable is duration mismatch. SVB’s collapse, for instance, was largely due to duration mismatch – the bank failed to match the duration of deposits with the duration of assets.

“Investors should avoid investing in an instrument that is supposed to be liquid but is backed by an asset that is not liquid. Because there will likely come a day when they need the liquidity – and it is simply not there. Being comfortable with terming out to six months to a year is fine, as long as the investments underlying are six months to a year. But terming out to six months and using 1 to 5-year instruments on the back of it to get to higher yields, well, we think that is a problem.”

The second consideration is credit quality: moving from investment grade to, for instance, crossover credit or even high yield, are valid measures to take, as long as it is recognised that they come with their own risks and liquidity issues. Cegarra expands: “We have also seen some offering short-to-medium-term products where there is a direct or indirect exposure to the equity market as a way to generate a higher yield on their investments. This may be appropriate for treasurers as long as they properly understand and can absorb the risks, including duration, credit and market risks.”

Cegarra explains that when FNZ develops solutions for treasurers, it does so mitigating duration, credit and market risk, and focussing on what is important for treasurers: good returns earned on the basis of controlled risk and liquidity.

There are no miraculous solutions

One of the upsides to the advances in technology, data manipulation and forecasting is that investors now have access to more granular offerings, with providers even breaking down their products as a way to better communicate their characteristics with their investors. Indeed, this is a development to which FNZ itself attaches great importance, says Cegarra. He points to the MMF space as an example of this trend, noting that historically MMFs have been a single label for one large family of funds, with often big differences between constituent funds.

 “Now, we have labels that break down MMFs into short term, very conservative to medium term, less conservative, and maybe more creative ones with wider investment guidelines. We think it’s a good way to communicate to investors where they should go because the more granular the offering, the better the communication of what to expect from it, and that can only be good. It is a progressive move by providers. Having said that, we are still seeing proposals for magic solutions, and false expectations being created. We don’t believe in miraculous solutions at FNZ.”

Still, Cegarra believes that, as investors on behalf of their companies, treasurers are becoming better at identifying their objectives and constraints, and mapping solutions to needs to identify the one that best suits their goals. “They don’t see themselves as just managers of a commodity, cash, but also as a source of return for the organisation, not just a cost centre. We are now very much in an era where cash has become an asset that needs to be worked hard, maximised and optimised. And treasurers have a key role to play in this mission. For me, that’s really indicative of where we are today and we have solutions to help them do exactly that.”

Coping with complexity

For Valentin Popescu, Head of Treasury, Risk and Insurance, OMV Petrom, managing all aspects of treasury operations has become altogether more challenging. As the largest integrated energy company in Southeast Europe, Romania-headquartered OMV Petro, like many corporates in the region, is at the sharp end of having to manage its operations against the backdrop of the war in Ukraine. Its focus on oil and gas heightens the challenges for the company.

Popescu says: “If you have geopolitical conflict nearby, and then you have inflation, the global economic turmoil, uncertainty, and developments such as more hybrid working then, clearly, it’s going to have huge, additional impacts on treasury operations. Complexity for us has increased significantly – certainly much more than I thought it would when the conflict began.”

An ongoing reorientation by the company, meanwhile, is adding yet another layer of complexity to OMV Petrom’s treasury operations. This strategic rethink aims to transform OMV Petrom from a pure oil and gas player into an energy company with significant exposure to low and zero carbon alternatives, including solar, green hyrdrogen and biofuels. 

With so much to contend with, efficient liquidity management and investment is crucial for OMV Petrom. Popescu reveals the company is currently cash rich and is in the process of actioning its latest strategy for investing cash.

He continues: “Being cash rich, financing is currently not a high priority for us. Much of our focus is on developing cash positions and working on the strategic redirection of the company. To support that, our treasury team’s efforts have centred on simplification, automation, liquidity planning, and preparing treasury for our changing business needs.

“Liquidity planning is always a major pain point for us, as I am sure it is for all treasurers, especially in this new operating environment we find ourselves in. Indeed, we recently launched a project to reassess our liquidity planning process and reshape it for the new circumstances.”

Focus on daily cash flow

The major rethink regarding liquidity planning began with a review of AP. Popescu admits that, normally, this would have been an easy first target for the review. However, the strategic redirection of the company that is in progress, coupled with the difficult operating environment, have made matters much more challenging. “It is more complicated for us now than it might have been, say, five years ago. We are now having to focus more on daily cash flow, much shorter than the one-to-three-month range we had in the past, with one month out as the current main target range.”

The operating conditions for the company mean much greater use of the direct cash flow method, which uses real cash inflows and outflows taken directly from company operations rather than accrual accounting, which recognises revenue as it’s earned, rather than when payment is received.

When it comes to AR, Popescu is looking to leverage AI or some form of algorithmic solution. “I do think this kind of technology is now vital to have – we cannot survive without it in such an unpredictable operating environment. Greater automation, simplification, and accuracy of analysis are essential. If you are lumbered with processes that are no longer fit for purpose then accuracy goes out of the window.”

The company implemented a new TMS two years ago but without a major focus on liquidity planning. That is now being remedied and Popescu is not keen on investing too much more in new software and technology. “We now just want to integrate our TMS and ERP. If we can do that successfully, all will be well. We have a provider helping us, of course, but some of my colleagues are extremely tech savvy, so if we can do something in-house, and faster, we will do. It’s cheaper as well.”

Thinking outside the box

The world of alternative investment is somewhat removed from corporate treasury, but when it comes to liquidity management, Jonathan Spirgel, Managing Director, Cash and Liquidity Management, Hazeltree, believes valuable insights can be gleaned from the treasurers’ experience in investment management firms. Hazeltree provides cloud-based treasury and liquidity solutions to investment managers and its clients include Ovata Capital, Bain Capital, and Northern Trust Asset Management.

Spirgel first draws some interesting comparisons between the challenges that confronted alternative investors at the height of the financial crisis in 2008 and now, especially with respect to the impact of issues across banking. He recalls: “Back then, it was hedge-fund clients that found themselves especially badly exposed. This year, we have seen another banking crisis emerge, led by SVB and First Republic Bank [FRB] in the US, and though nowhere near on the same scale as 2008, it has created turmoil for clients. This time, though, it’s more the private market side of the equation that has been impacted, private equity specifically.”

In the immediate wake of SVB and FRB’s woes emerging earlier this year, many of Hazeltree’s clients suddenly realised they needed to review and update cash investment policies. “It was no longer OK to look at the bank account on a periodic basis. Clients needed to know at a moment’s notice what their cash positions were, where funds were being held, and how accessible they were. And that was very helpful from our perspective because Hazeltree is especially focused on providing technology to aggregate balances and positions as well as carry out important treasury functions like making payments, investing cash balances, executing loan requests and payoffs to manage  portfolios on a daily basis,” says Spirgel.

“As in 2008, as indeed in 2020 when the full scale of the Covid challenge became clear, clients now need to know where their assets are, what the positions are, and ensure their assets are safe and accessible. Good treasury management, irrespective of industry, means understanding where your sources are, and the use being made of the cash at a moment’s notice.”

Another interesting development in the wake of the latest clutch of troubles has been a resurgence of interest in multi-banking to diversify risk, believes Spirgel. “The big question for many corporates and investment and insurance firms currently is whether they should have more than one bank. At Hazeltree, we’ve had many clients recently saying they want two banks for every account for every legal entity. No one wants to be in a position of having their money locked up in a potential SVB scenario and not be able to, for instance, make payroll. It’s been helpful for some of the very large banks because some people feel these institutions will have enough firepower to sustain whatever shock there is in the marketplace – we’ve seen clients migrate to some of them.”

Robust policies are essential

While considering advice for treasurers to ensure sound liquidity management, Spirgel is clear that robust investment policy and guidelines are critical. “It’s not just about how you invest. People should ask themselves a number of questions. Should I use an MMF? What type of MMF? Do I buy treasuries? Where do I keep my money? What type of bank? How do I gauge the soundness of that organisation? How often do I review it? What am I looking at on a daily basis to make sure that the places where cash is kept or used for investment remain within the guidelines?

“There must be robustness around those policies as well, the ‘furniture’ must be all present and correct. And don’t just put the policies and guidelines on the shelf, then assume all is good. Adhere to them, review them regularly – we see that being carried out typically every quarter among our clients.”

The aforementioned TMI and NTAM Survey found less proactivity around policy review, however (see chart 2). And treasurers are often too overstretched to manage frequent reassessments.

Chart 2: How often do you review your investment policy?

_{Source: TMI and NTAM Liquidity Survey 2023}

Interestingly, Hazeltree’s platform specifically addresses the needs of liquidity policy reviews with some helpful features. One of them involves generating reports for clients that aggregate all of their balances by bank. The report provides information on the health of the banks on the basis of a range of metrics including ratings. “Periodically, typically quarterly, the head of risk, the treasurer and CFO can jointly review those reports, and decide whether those banks are continuing to meet their needs or whether it’s time to engage in a new relationship. It can’t be just one person making those decisions, there have to be different perspectives,” advises Spirgel.

More broadly, Spirgel says much of the innovation being delivered by the Hazeltree platform is focused on supporting treasurers and CFOs with their all-important, repetitive, daily tasks such as scraping reports in aid of cash flow forecasting. “The real innovative part of the platform is that it supports and encourages you to constantly think about actions you need to take. What is the most relevant activity that you need to put in place from a risk perspective or from a functional perspective? Those are the elements that we’re constantly innovating on for our clients.”

To help treasurers manage complex workflows the platform leverages leading-edge technology including AI and ML, though with a degree of circumspection. Spirgel concludes: “While we love these new technologies, it’s important not to get too carried away by what they can do. At the forefront of our mind always is that real people need to make the financial decisions, often big ones, and getting that right is most critical, not just admiring how clever the technology is. We therefore spend a lot of time and effort testing the robustness around how we put these new technologies in place.”