The future of liquidity management: New opportunities in a shifting landscape

Liquidity management is not a static discipline; internal and external factors dictate that today's optimum liquidity management solutions and strategies will in the future require adjustment, upgrade or perhaps even complete replacement.

Specific internal factors will obviously vary from corporate to corporate, and will therefore play a significant role in determining the future path of these individual liquidity management solutions and strategies. However, it is possible to extrapolate some of the likely future external factors and their probable influence. More specifically, it is also possible to do this in the context of the corporation's access to (and infrastructure for managing) any information that has a bearing on the liquidity management process.

User typology and requirements

Corporates' information management capabilities can be broadly divided into two groups, though corporations may of course display different group characteristics in different parts of their business.

Information-led corporates

The first of these two groups is probably best described as "information-led". Companies in this group will have their data management supported by the appropriate infrastructure, including personnel, processes and systems. This type of corporation will have robust control of its cash flow information and is therefore able to predict future cash flow patterns with a reasonable degree of accuracy. While some younger technology-driven companies tend to fall naturally into this category, other corporates are also migrating in this direction. In part, this movement is being facilitated by the boardroom's increased focus on working capital management and associated value chain efficiency initiatives in the past few years, and more recently to the re-appraisal of treasury's mission-critical liquidity role during the financial crisis.

This information profile means that when choosing a liquidity management solution a company in this category will regard operating transparency, technology flexibility and proven service resilience as high priorities. These companies are more likely to favour hybrid techniques that will ensure the routing of funds follows pre-determined paths. They will, of course, require timely and complete reporting data, but this will primarily be for reconciliation purposes (matching anticipated versus actual outcomes). Their need for information access will be secondary, in the sense that they perform a higher level of internal processing, consolidation, netting and re-routing of transactions in accordance with their own predetermined rules. As a result, they already possess transactional information that is more complete and timely than their banks can deliver to them.

These companies often initiate financing or investment transactions in advance of any rebalancing conducted by the liquidity management techniques being used, so will also require suitable credit arrangements to facilitate and support these processes. Finally, companies in this group will typically want access to multiple funding and investment options that they can effectively benchmark and actively manage as needed. In short, corporates in this category will be more interested in the mechanics and basic features of a liquidity management technique than the attractions of the ancillary services available.

Service-dependent corporates

The second group of corporates are organisations that have less developed infrastructure and so are generally more dependent on the information made available to them by external sources, such as banking partners. As a result, this type of corporate tends to be a consumer of value-added banking solutions, as opposed to developing those solutions in-house or in conjunction with a third-party supplier. This is not to imply that there is anything intrinsically "wrong" with this approach; a corporation may operate in this fashion for any one of a variety of reasons, including long-standing practices due to company longevity, rapid acquisitive growth or simply because the cost/benefit justification for switching to an information-led model is absent.

Corporates in this group require providers that are able to offer wide and consistent coverage across all locations in which the company operates. Their decision-making process relating to liquidity management is also dependent upon providers being able to deliver timely access to information and comprehensive reporting.

Such corporates will typically favour more passive techniques that can provide overall cash position information in the most automated manner. Their approach to currency management is also consistent with this low-touch approach; they will favour the extension of techniques to multi-currency structures in order to minimise currency management overheads as much as possible. On the investment side, they have a preference for end-to-end solutions that minimise the process interruption between transactions clearing and the utilisation of any net liquidity that arises, including passive investment products.

Service needs

Corporate needs for liquidity management services can be categorised into three service groups of varying product/solution maturity and availability.

  • Core services: These encompass a range of established physical and notional liquidity management techniques with traditional features and their associated in-depth reporting.
  • Value-added features that complement the core services: These cover a number of ancillary functionalities that enrich the core services proposition and enhance the user experience.
  • Service extensions: These include tools that automate or improve complete liquidity management disciplines, such as cash flow forecasting and investment management.

While core services are already widely used, the other two service groups may include tools that will enhance the liquidity management process in the future, but may not necessarily be commonly available today. Where there is currently still an element of differentiation on the provision of core services, over time these will inevitably become commoditised and undifferentiated. The competition over service differentiation is already shifting to the other two categories.

Value-added features

One example of the value-added features intended to complement core services' real-time online liquidity management reporting is event-triggered notifications, allowing a tailored configuration of user-defined events to generate alerts. Among other things, this has the obvious benefit of allowing more efficient use of available internal liquidity, even when unexpected transactions arise.

More sophisticated examples include interactive tools that facilitate controlling and monitoring of the outcomes arising from a liquidity management technique and algorithms that respond automatically to initiate the next event. For example, a structure may have an algorithm applied that specifies an established path by which an overdrawn entity/account in the structure can automatically draw funding. However, this could also interact with another algorithm that deals with minimising any tax impact or intermediation costs arising from the funding path. (In other words, funding drawn up to a certain value might follow Route A, but above that threshold the second tax/cost algorithm would switch the funding to Route B.)

Another value-added possibility is a solution that allows the corporate to monitor and adjust some components of the liquidity management structure on a real-time, self-service basis. If this includes the ability to control inter-company flows, the corporate could establish a range of internal limits relating to debt-to-equity ratios, internal credit exposure or internal funding control.

Benchmarking is often required by corporate treasurers, but historically the focus here has been on interest rate performance. However, there is no reason why benchmarking cannot be extended further. As regards internal benchmarking, providers could deliver data that would allow corporates to see the current effective rate of return that their heterogeneous liquidity management structures were delivering, which could also be used to monitor period-on-period performance. In due course, the logical extension of this is for providers to also offer corporate clients anonymous peer group data on liquidity performance to allow external benchmarking.

Service extensions

When it comes to service extensions, the perennial bugbear of cash flow forecasting is an obvious candidate. Some of the tools offered by banks in this area are already offering much of the functionality available in full-blown treasury management systems. These tools include the ability to access and consolidate data from multiple underlying sources. They also contain a range of analytics such as period-to-period comparisons for tracking the historical deviation between projected and actual cash levels. In addition to providing general guidance on how forecasting can be improved, these tools also allow the users to drill down into individual components of forecasts (at business-unit level) to track the quality of forecasting on a more granular scale.

Nevertheless, however fully featured these tools may be, the quality of the forecasting is ultimately determined by the quality of the underlying data. In this regard, it is important to look beyond the bank-focused definition of cash flow forecasting that is predominantly based on data that the bank is able to provide. That alone is insufficient; the complete picture also depends upon data residing in enterprise resource planning, accounting or treasury management systems that only the corporate has access to.

Two other promising areas for service extension are simulation and work flow management tools. In a sense, both these tool sets build upon the benchmarking services mentioned above. Simulation tools allow the treasurer to run a series of "What if?" scenarios based upon a range of putative actions, and then compare the results with existing benchmark data in order to determine the optimal course of action. In the case of work flow management tools, in addition to the event notifications previously mentioned, these are intended to present the user with a consolidated view of all the relevant data at any process stage for which a decision or instruction is necessary. At this point, they would also offer the user a selection of appropriate actions for the next process step(s).

Such tools will mean that informed and timely decisions can then made by manual intervention or by an automated routine with pre-determined selection criteria. They also enable the corporation to bridge the gap between liquidity management structure monitoring and funding/investment transaction execution, regardless of whether the user opts for a single or multiple bank relationship model. As long as the data upon which the decision criteria depend are available in a structured electronic format, the process can be automated.

The liquidity management landscape

A wide range of factors will drive the future evolution of the liquidity management landscape and, by implication, also the liquidity management services and solutions that corporates require.

Dimensionality and other participants

In conjunction with other factors outlined below, the dimensions of the liquidity management process look set to expand. With the acceleration of initiatives driving data/process standardisation, system interoperability and open platforms, the financial services value chain will inevitably become more accessible and competitive. After a period of bank relationship rationalisation, corporations will continue to maintain counterparty and service provider diversification as part of their risk management strategy. In combination, these two factors will result in a rationalising but increasingly competitive market for service providers.

In the liquidity management industry alone, the range and number of third parties involved have continued to expand. Banks, information technology (IT) vendors, business process outsourcing (BPO) providers and asset management companies are all competing for a piece of the corporate pie. A further complication in this crowded market place is that some of these participants have started to move beyond their core competency into other areas. As mentioned, some banks are now offering banking solutions that offer functionality that has a significant overlap with treasury management systems, while some IT vendors are expanding into the BPO space. From a treasury perspective, while this has the potential to simplify choices (one provider can cover more bases), it also raises the due-diligence threshold when it comes to ensuring that a provider claiming to cover multiple bases can actually do so to a core competence level.

In this future landscape, every actor, either buyer or provider, will have to look at the value chain continuum, from the point when a transaction becomes a source or use of liquidity, to the point when funds are invested or sourced. However, the process still remains granular throughout in terms of its sub-components, such as clearing, mobilisation and consolidation of cash, and determining how best to deploy that cash. As a result, all those involved in this financial value/process chain as service providers will have to make sure their organisation remains competitive in the piece of the continuum they decide to compete in.

This approach also throws up interesting opportunities from an informational perspective. While the idea of a treasury dashboard is not new, in terms of being able to compare and choose from a panel of banks, it has only really taken off in areas such as foreign exchange and money market funds. If these dashboards continue to evolve to their next application to the liquidity management space, it should eventually be possible to define rules relating to counterparty limits and other pricing criteria for ranking bids, filter the raw results based on these criteria and actually action any resulting borrowing/lending decision immediately, making use of automated work flow management tools.

Influencing factors

A variety of other environmental factors will affect what is feasible in liquidity management in the future (some of which are dealt with in more detail below). The pace and extent of deregulation on both capital mobility and currency convertibility are cases in point. Countries such as China (with its Pudong Nine initiative and gradual moves towards renminbi convertibility) are prominent examples. As this sort of deregulation gathers momentum, it will eventually throw up numerous new opportunities to boost the effectiveness of existing corporate liquidity management structures.

A similar situation applies with regard to local clearing practices. As existing restrictions - such as those relating to foreign-sourced low-value transactions - are relaxed, there will be considerable scope for streamlining bank account structures and reducing costs. Another potential efficiency-driver is the establishment of larger common economic/currency areas, such as further expansion of the eurozone, or the emergence of an Asian regional common trade currency. Finally, a long-standing potential issue on the fringes of liquidity management has been intra-day liquidity charges. As part of their operations on behalf of corporate clients, banks offer daylight overdrafts or intra-day payment settlement lines at nil cost, even though there is a cost in terms of regulatory capital or central bank charges for themselves. If banks start to charge clients for these intra-day facilities, this will require significant adjustment to liquidity management structures both in terms of improved treasury transaction visibility as well as timing of flows.

Deregulation

As mentioned, deregulation could have a major beneficial effect on the future evolution of liquidity management. The potential here is particularly significant because the top international cash management banks have already invested (and continue to invest) in global platforms. In HSBC's case a multi-year investment plan is in place to deploy a technical platform and a new operating infrastructure capable of supporting regional and global liquidity management structure requirements. Under the banner of Global Liquidity Solutions (GLS), both physical and notional techniques are today available on a multi-location and multi-currency basis, setting the foundation for the development of the next-generation ancillary services to complement the core product offering. The crucial point is that the primary limitations on what is currently possible are not technological, but regulatory. Therefore, as regulatory barriers drop, the move to far more effective liquidity management will be swift.

A related opportunity concerns treatment of bank balance sheets. If banks are permitted to take a more global view of their balance sheets and their treatment (from a net reporting perspective), this will open the door to far larger-scale and more efficient implementation of cross-border notional pooling.

Payment system infrastructure

The ongoing evolution of domestic and international clearing systems has the potential to transform the possibilities of simple operating accounts in ways that will substantially benefit the liquidity management process. For example, there are restrictions today in certain countries that oblige corporates to hold accounts that are purely domestic in nature in order to access specific local clearing systems. This causes the proliferation of bank accounts, which in turn raises the overall cost and complexity of the liquidity management structure.

If this type of restriction is lifted, then the point of origination of a transaction immediately becomes less relevant. For example, a transaction could be initiated from Europe and it would be as efficiently processed as if it was initiated from an in-country account in Asia Pacific and would also be treated as domestic and low value for pricing and processing purposes. This would have major (and beneficial) implications; rather than building the liquidity management structure around the limitations of bank accounts in certain locations, it can instead be designed from the ground up with the sole objective of efficiently maximising liquidity. Constraints no longer dictate structure.

Taking this theme to its logical conclusion opens up even more opportunities. The end result could be the use of a single, multi-currency operating account that combines the functionality and benefits of a set of virtual single currency accounts with the ability to manage notional currency conversions and balance segregation as required. When necessary, and according to user-defined criteria, true currency conversions could be conducted automatically in conjunction with a conversion rule set that varies the transaction methodology based on factors such as transaction size and type.

In effect, accounts of this type would in themselves represent a condensed or collapsed liquidity management solution in a single account, while still offering all the features that a traditional structure offers, such as reconciliation services, inter-company loan administration, foreign exchange trade confirmation and execution, etc. This would radically alter the dynamics of liquidity management; all processes are simplified and all the dependencies on account structure design and reporting (as well as all the administrative workload relating to cross-border physical and notional compensation) disappear, because everything can take place instantaneously in a single account.

Service scope evolution

The combination of factors already outlined suggests that the future prospects for corporate liquidity management are likely to be bright. As constraints such as regulation and proprietary standards recede, both information-led and service-dependent corporates will be presented with a far broader scope of service possibilities than at present. The multiple customer-configurable options available in this new environment should ensure that the widest possible range of corporations should individually be able to come far closer to their ideal liquidity management solution than is currently possible.

This situation will give treasuries far greater flexibility when determining their liquidity management strategy in the light of internal factors, such as finite resources. The ability to assemble multiple providers into a single chain using common standards means that both transformational and incremental approaches to liquidity management become readily accessible as strategic options.

Intriguingly, many of the positive factors in the new landscape also open the door to internal corporate transformation. For some companies, increasing use of common standards and decreasing cost of technology may make a move from a service-dependent to an information-led business model feasible, which obviously has implications for the future direction of their liquidity management strategies.

From the perspective of international cash management banks, this will result in a market that will increasingly demand and expect to have access to extensive, complete and globally consistent core liquidity management services. A major global player servicing corporate segments of all sizes and types (multinational corporations, emerging or established; local corporates, large or small; small and medium-size enterprises) will need to be able to offer such services to a greater portion of their customer base. At the same time, value-adding and ancillary service provision is where the differentiation and product development efforts will concentrate. 

Conclusion

In a sense, one can argue that the future of liquidity management represents the opportunity to create something that is greater as a whole than the sum of its parts. The closer integration of liquidity management techniques with investment products and financing sources generates new holistic benefits and efficiencies. Data from the whole end-to-end process becomes more readily visible so that liquidity decisions can be made on a more informed basis.

That, in turn, plays back into the two themes mentioned at the beginning of this article and throughout this guide; liquidity management is a process of continual improvement (not a static point) and is also unique to every organisation. The happy prognosis is that both the continual improvement and the fit of liquidity management strategy to individual organisations should be easier to accomplish in the future, even if the bar will lift in terms of the sophistication involved.

However, there is one final caveat; this benign scenario only applies if corporations work with the right providers. Key banking partners must have the capabilities and vision to support the corporation on its journey to improved liquidity management for this opportunity to be grasped.

First published in HSBC's Guide to Liquidity Management in Asia-Pacific. HSBC Bank. All rights reserved. Published with the kind permission of PPP Company Limited.

¬ Haymarket Media Limited. All rights reserved.