To organisations headquartered outside the region, Asia often appears a liquidity headache. Multiple jurisdictions with complex and restrictive legislation seem certain to obstruct efficient liquidity management. However, while the region is more regulated than the US or Europe, the effect of regulation is by no means as severe as it superficially appears. Therefore, corporations that might otherwise shrug their shoulders and write off Asia in liquidity management terms are missing a considerable opportunity. Furthermore, in addition to the perception/reality gap on the general liquidity environment, Asian trends in economic growth and the supply chain also make this a particularly apposite moment to review liquidity strategies in the region.
While Asia has been affected by the global economic malaise, its resilience when compared to Europe and the US is already apparent. Certain countries, namely China, India, and Indonesia, maintained GDP growth in 2009 and the indications are that this will also apply to the rest of Asia in 2010 (see Figure 1).
The importance of exports to regional economies saw many Asian governments moving quickly to support regional and domestic consumption in 2009 by negotiating intra-regional trade agreements. In addition to the economic benefits, these free trade agreements have also offered treasuries the opportunity to optimise cash flow management between legal entities and jurisdictions.
The Asian economic recovery also presents opportunities around currency management. Most Asian currencies are likely to strengthen against the US dollar in the short and medium term, which has obvious implications for liquidity strategy. All other things being equal, collecting and retaining surpluses in local currencies, while paying liabilities or assuming debt in dollars appears the most logical course of action for early 2010.
Supply Chain Squeeze
A number of developments in the supply chain have had the overall effect of releasing additional liquidity. An obvious example has been the resurgence of letter of credit (LC) usage since early 2009 (see Figure 2). This has been primarily driven by a desire to mitigate counterparty risk, but other factors – such as the inability of smaller Asian suppliers to raise finance for open account trade against their balance sheets – have also played a part.
Another tool that is releasing additional liquidity into the trade ecosystem is supply chain finance. Given an ‘anchor’ buyer of sufficient credit status, this also typically delivers bank liquidity to smaller trading counterparties at a price considerably lower than they could achieve independently.
A further broader trend also starting to increase liquidity availability is tighter management of the financial supply chain (FSC). While many corporations have made huge efficiency gains in their physical supply chains in recent years, FSC management has often lagged. In some cases this relates to continued use of physical documentation, in others it is inherent inefficiency of process – such as delays in raising invoices extending the working capital cycle. As corporations start to grapple with this sort of situation, liquidity starts to circulate more rapidly within the supply chain, as sales of goods and services are more rapidly converted to cash. This has become particularly valuable over the past two years or so, as corporations have come to appreciate that optimising liquidity in a squeezed FSC environment improves profitability and business scalability, and in extreme situations also ensures survival.
Facts Versus Mythology
While these factors either already or will soon increase corporate liquidity levels, many companies may be unaware of just how much can be achieved in terms of optimising that liquidity in Asia. As mentioned earlier, there is a prevalent assumption that Asia is effectively a no-go zone for efficient liquidity management, with currency controls and onerous regulation the obvious stumbling blocks. Upon closer inspection, it becomes apparent that many of these perceived limitations either do not apply at all or apply to a much lesser extent than assumed.
To begin with, certain countries have no restrictions at all; in this respect, those such as Australia, New Zealand, Singapore and Hong Kong are in liquidity terms functionally the same as any western European country. Elsewhere, such constraints as do exist are often far less onerous than commonly assumed. A case in point is Malaysia, which is widely regarded as problematic when it comes to cash concentration across legal entities. However, there are significant exceptions to its regulations; for example, Islamic banking products (popular with insurance companies) are exempt. There also exceptions for certain industries; automotive companies are subject to much looser restrictions, while for airlines and shipping companies the restrictions often do not apply at all.
To the casual observer, China appears to forbid pretty much any structure or strategy relating to efficient liquidity management. Again, this is a false impression; in practice, a great deal can be achieved by requesting an authorisation from the appropriate regulator. It should be emphasised that such dispensations have to be formally applied for, not assumed as of right. It is also important to note that the success of any application for an exception is influenced by the corporation’s standing. If a company is perceived as a ‘good corporate citizen’ and also works with a bank that has an impeccable regulatory track record, then much can be achieved. For example, on an authorised exception basis, Citi actually had multi-entity sweeps functioning in China before Japan. Other standard liquidity management practices are also available in China via specific mechanisms. For example, subject to regulatory approval, cross entity funding is permitted via entrustment loans.
Apart from the gulf that often exists between regulatory perception and reality, many imagined constraints and concerns are in any case rendered irrelevant by the current environment. In the case of China, companies may complain that they receive poor onshore rates on renminbi (RMB) balances, but in reality they have minimal motivation to convert those balances to US dollars anyway. The implicit assumption is that the RMB will continue to appreciate against the US dollar, which represents a considerably greater potential return than a few basis points of interest. In any case, with the appropriate approval, qualified foreign institutional investors are now permitted to invest their cash outside China in approved money market funds (MMFs).
Similarly, the commonplace complaint of trapped cash in China currently is not entirely convincing. Corporates headquartered in certain countries have little real desire to repatriate cash because their home countries will tax the deemed dividend, which is hardly a fault that can reasonably be laid at China’s door. Finally, there is the simple economic argument for keeping cash in China anyway because of the plethora of business investment opportunities available.
It’s Consolidated, Now What?
Liquidity misconceptions do not end with the aggregation of cash; received wisdom on treasuries’ current investment strategies is similarly wide of the mark. The popular notion is that risk reduction and reducing tenors are the top priorities, with yield very much an afterthought. Citi’s first hand observations contradict this rather simplistic view. Firstly this is seen in the timeline – two years ago some 80% of our portfolio of excess cash investment products had a tenor of between overnight and one week; today some 50% of it has a tenor of three months. As regards counterparty risk, there is no question that corporate treasuries are far more cautious than in the past and are rigorously enforcing individual allocation limits. However, in terms of practical effect, corporate risk diversification has resulted in remarkably little net change. For example, Citi’s share of demand deposits in Asia (excluding China and Japan) has risen from around 3.5% to 4% in 2009.
Finally, corporate demand for yield is definitely still very strong. In fact, this has been a primary factor in the launch and huge popularity of money market deposit accounts, which in Citi’s case have attracted more than US$6bn this year. Unlike MMFs, these accounts allow immediate access to cash, but on the understanding that the monthly average balance will be substantial and stable. As a result, these accounts offer rates akin to one-month LIBOR for cash that is instantaneously available.
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