Written By: Susan Smithfield – Corporate Finance
In a context in which interest rates are low in developed countries, treasurers are facing the delicate issue of optimizing their treasury placements. Near-zero or negative interest-rate policies have created a situation in which no inflation growth has been produced, and spending and investment have not grown as expected. Hence, many companies may face a situation in which cash is available, but investment perspectives are still low.
The situation is not always like Apple’s, which is still increasing its cash balance year after year, despite distributing dividends and buying back its own shares (see cash return in the graph below).
However, treasury placement has become a strategical issue for boards and chief financial officers (CFOs), as they have faced the double need to optimize their operational and risk management worldwide and also to optimize and diversify their placements.
Implementation of work-flow platforms and financial-risk systems is a prerequisite.
Today, letting cash into a bank account can represent a real cost, and treasurers have been obliged to create platforms and work-flow systems to strengthen their visibility in the lifecycle of the treasury. They not only have had to create good forecasting systems on outgoing payments but also on incoming payments. As letting cash into bank accounts can now incur bank charges (through fees, if not negative interest rates), treasurers need real cash-resources planning systems, integrated with purchase and sales systems.
They have to achieve instant visibility of their bank accounts’ situations, as well as the most accurate forecasting—if possible with SWIFT integration that will allow them to process the payments as fast as possible and redirect the cash if needed. They need to also optimise their currency positions and “hedgings”, as deposits in most “strong” currencies may cost them, and hedging positions in each of those currencies also represent a cost. And finally, they may want to take more risks to place their treasury, but while doing so they will have to set the proper financial risk-management system as a prerequisite.
Now let’s look at the recent evolution in the nature of treasury placements.
Treasurers may use various traditional deposits or bonds, but on different maturities and conditions.
Depending on their investment perspectives, they may choose longer maturity placements, either through long-term deposits or monetary funds. Treasurers can roll their treasury placements over several months and years, rather than several days or weeks. They may also negotiate loyalty premiums for longer-term placements, and for placements with a pre-notice period to withdraw the deposit. Those are less costly for their banks and hence better remunerated (due to banks’ regulations toward liquidity and capital-adequacy ratios).
Then treasurers also have to diversify their placements according to the rate—for instance, Euribor (Euro Interbank Offered Rate) will bring them a better return than shorter-term Eonia (Euro OverNight Index Average) rates. Those placements bear a low and acceptable risk for a treasurer. Even if still simple, those products oblige the treasurer to be able to manage forecasts over longer periods. For instance, the pre-notice period can be more than 30 days to end a deposit.
Treasurers may implement a new currency approach regarding hedging FX risk.
CFOs who are managing revenues and expenses in foreign currencies face a dilemma of whether to hedge each exposure, and if so, how much of it. And markets in strong currencies often propose hedging instruments for each currency at high costs. Managing the total foreign-exchange (FX) exposure of their currency portfolios has become a top-priority question. If the treasurer is hedging partially or totally each currency position separately, the company will face higher costs for hedging. But if a treasurer has developed a risk system to measure Value at Risk at a global level on the total currencies’ portfolio, he will probably minimize the costs by hedging its total FX exposure at a global level. Instead of bearing the hedging costs in each currency, the treasurer will take the opportunity of inverse trends between currencies and hedge the residual risk.
The share of treasury placed overseas is quite high today. For instance, Moody’s Analytics revealed in 2016 that the cash on balance sheets of the US companies rated by Moody’s was somewhere around $1.7 trillion. And the total treasury when including cash held overseas was closer to $3 trillion. The companies’ interests in transferring and exchanging overseas foreign currencies are not always proven.
Treasurers may be tempted by moderate-risk products.
Some stocks of top-rated companies performed well in 2016, but non-European sovereign bonds may have been interesting as well, even in foreign currencies. However, capital-guaranteed products will be preferred by CFOs. That’s why they will also consider some structured products (from insurers or banks).
Treasurers are increasing their levels of risk appetite.
Having a static portfolio strategy in today’s low-return environment is not going to meet the return goals of most companies. When investors lose that long-term clarity, they look for a more diversified strategy that selects the right mix of assets for that environment. They target a consistent and precise volatility range each year, and a consistent minimum annual return. Provided they are well-equipped in market-risk limit monitoring, CFOs will certainly look for a partial allocation of their placements in more complex products.
Hence, some CFOs have accepted products such as Auto Callable plans or credit linked notes (CLNs) from the biggest investment banks. Auto Callable plans provide a predetermined annual return, but they only pay out if the chosen stock market index has exceeded a set level on a set date. The biggest banks have now automatized their infrastructures to give to small investors access to those structured products. Hence, in a balanced-risk approach, placing a share of the total portfolio is not without sense for CFOs. In credit linked notes, the underlying asset may be a European sovereign bond, still easily accepted in terms of counterparty risk.
In conclusion, treasurers are definitely challenged in this exceptionally cash-rich situation, either with implementation of new risks and processing systems, or when choosing the most appropriate ways to place their cash. But, depending on their risk appetites and expectations of return on placements, boards of companies will also have to define, as Apple did, the growing trend in distributing dividends to shareholders, and maybe buy-back plans for their own shares. One can also expect some big movements to come in mergers and acquisitions.