The phrase ‘unintended consequences’ perfectly encapsulates the frustrations of many treasurers dealing with the fallout of financial regulation. Not only are they having to rethink aspects of cash and liquidity management, but they are also adjusting their funding strategy accordingly.
Europe’s CRD IV package, which implements Basel III across the continent, is a case in point. As the liquidity coverage ratio (LCR), net stable funding ratio (NSFR) and leverage ratio become entrenched in Europe’s banks, financial institutions’ appetite for taking short-dated deposits is waning.
LVNAV funds may be forced to move away from a stable unit value pricing to a variable unit value pricing
“A combination of regulation and the ratings environment has led to many banks losing interest in very short-term deposits,” confirms Pedro Madeira, treasurer at Thames Tideway Tunnel. “While one or two banks are still happy to accept deposits, others only accept them as a gesture of goodwill and as part of an ongoing relationship with the company,” he notes.
The impact of CRD IV on deposit-taking is being exacerbated by quantitative easing, which has flooded the banking system with liquidity, combined with the extremely low interest rate environment. Many treasurers are therefore seeking alternative solutions for their short-dated cash. But regulatory initiatives like money market fund (MMF) reform in Europe are further narrowing the field.
While the US has already enacted MMF reforms, a political agreement on new European rules was only reached in December 2016. Full implementation is therefore more than 18 months away, but one of the more significant changes is the introduction of a new type of MMF, the low volatility net asset value (LVNAV) fund.
Although the experience for end users will be relatively unchanged from that of constant net asset value (CNAV) funds, a few factors will be very different. In certain scenarios, LVNAV funds may be forced to move away from a stable unit value pricing to a variable unit value pricing. They will also have potential liquidity fees or redemption gates applied to them in extreme stress scenarios.
EMIR is an ongoing frustration. We self-report and it has become a bit more complicated of late, but we’re fortunate not to have too many reportable trades
As a result, some treasurers are starting to rethink their use of MMFs. However, Alastair Sewell, head of the EMEA and APAC FAM group at Fitch Ratings, believes that while there are new features of LVNAV funds that treasurers will need to get used to, European MMFs will remain fairly robust. “Indeed, investors we have surveyed see LVNAV funds as a workable alternative to the existing product range,” he notes.
Robert Scriven, group treasurer and planning manager at Cairn Energy, falls into that camp. “Although I was concerned about the introduction of LVNAV funds originally, I feel more relaxed now about the changes,” he says.
“Some of the main concerns, such as the impact on ratings, have dropped away and the nuances of the new rules are now becoming much clearer. As long as we get appropriate accounting guidance, we should still be able to count these funds as cash or cash equivalents and we will still continue to use them.”
Alongside MMFs, Scriven also uses repos as an alternative to bank deposits. “Our experience of using triparty repos is that you can achieve at least as good as, if not better, rates than you’ll get on deposits and you get security – so it’s a no-brainer from our perspective,”
he says.
For those smaller corporates who are unable to access repos, short-dated securities such as treasury bills may be a viable alternative to bank deposits and MMFs. The challenge is that they yield very little, or in the case of Europe, have a negative yield.
Aside from narrowing treasurers’ short-term investment options, the structures and technologies that corporates use to manage their cash and liquidity are also under threat from financial regulation.
One of the main consequences of the CRD IV leverage ratio, for example, is that banks must effectively attribute capital against the gross positions in notional pooling structures.
Ian Tyler, MD at Alvarez & Marsal Financial Industry Advisory Services, comments that, “We have therefore seen some banks aggressively exiting that business, and others have looked to significantly reprice these arrangements, which is encouraging the move to physical netting of balances.”
In addition, MiFID II, effective January 2018, means that some corporates are not only finding themselves impacted by increased transaction reporting requirements, but must also trade through automated systems – which, while second nature to larger treasury functions, may be painful for smaller companies.
Corporates’ funding mix is also changing because of financial regulation. As Nick Burge, MD, head of strategic liquidity, at Lloyds Bank explains: “Under CRD IV, the amount of capital that banks must hold against credit risk is now 2-2.5x higher than it was pre-crisis. Given this increase in the raw material cost of manufacturing loans, lending has naturally become a more expensive process.”
And although the average corporate treasurer of an investment-grade company would likely say that the current cost of borrowing has never been lower, there are factors coming down the line that may cause treasurers to think again about bank borrowing.
IFRS 9, Financial Instruments, the new IAS 39, is a prime example. In simplified terms, IFRS 9 requires banking books to be mark-to-market. This can lead to more volatility in the bank balance sheet, which then requires more capital to be held.
Burge believes it is too early to make a direct read across to the impact that IFRS 9 is having on banks’ capacity to lend and the cost of borrowing, largely because banks are still modelling IFRS 9 and aren’t implementing it yet.
Tyler, however, cautions that the way the regulators respond to this new accounting development in terms of core tier 1 thresholds “could yet have a significant impact on banks’ risk appetite for term lending”.
An initiative intended to provide greater access to alternative sources of funding is the EU’s Capital Markets Union (CMU) plan. Despite suffering some setbacks, the CMU is still a significant focus for Brussels. The plan introduces a raft of different measures aimed at developing and deepening the market, but may not be straightforward to implement.
One such initiative for treasurers to be aware of, for example, is the revision of the Prospectus Directive. Shortening a prospectus summary to six sides of A4 paper, yet making the content more prescriptive, will be tough for even the most seasoned professionals.
Elsewhere, EMIR continues to dog many treasurers. The rules governing the mandatory posting of collateral for uncleared derivatives came into force on 4 January 2017 and, as of 1 March 2017, all in-scope counterparties must post variation margin.
There is a phased-in implementation for initial margin from 1 September 2017-2020. While this change will only impact the largest non-financial corporates, it is widely seen as an inconvenience – and a step that the market simply isn’t ready for.
“EMIR is an ongoing frustration,” confirms Scriven. “We self-report and it has become a bit more complicated of late, but we’re fortunate not to have too many reportable trades.”
We have been asked by one bank to use Markit’s KYC.com and we could see, if more widely adopted, that this would help us all
Madeira, meanwhile, always has an eye on derivatives regulation because of the impact it may have on the banks’ ability to offer long-dated derivatives in an affordable way. “We are already seeing that some long-dated derivatives are becoming more expensive,” he says.
“The challenge is that too much regulation on the banks might end up leaving corporates unable to afford hedging solutions and sitting on the risk, which surely cannot be what the regulators truly intend.”
Another concern, he says, is the ring-fencing of UK banks. “We wonder whether derivatives might end up in the so-called ‘bad bank’ and what impact that will have on charges.”
Despite the clear rationale, banks’ ever-more detailed KYC requirements are yet another headache for treasurers, who frequently provide the same detailed information to different banks, or different departments within the same bank. One ray of light is the emergence of KYC utilities, which essentially act as a secure repository for corporate KYC information that only authorised banks can access.
This means, in theory, that treasurers need to upload and update just one set of KYC information. “We have been asked by one bank to use Markit’s KYC.com and we could see, if more widely adopted, that this would help us all. It does seem to be a way forward for the industry, but it is early days,” says Scriven.
Finally, while individual regulations may put additional strain on treasury resources, the real challenge is managing the combined impact of these regulations and staying one step ahead of future changes.
To that end, the ACT will continue to keep members updated on the latest regulatory developments – including potential deregulation in the US. Although, for now, that falls squarely under the heading ‘watch this space’.
Alongside financial regulation, treasurers should also be aware of two new market codes due to be published shortly: the Global FX Code and the UK Money Markets Code.
Both are voluntary codes of conduct designed to ‘improve’ behaviour in unregulated financial markets.
The codes set out best practice principles for users of these markets covering: ethics, governance, risk management, information sharing, execution, confirmation and settlement, and as such are helpful to corporates looking to understand how they and their counterparties should act when transacting in these markets.
The Foreign Exchange Working Group of the Bank for International Settlements released the first phase of the Global FX Code in May 2016, together with principles for adherence to the new standards. The complete global code and the adherence mechanisms will be released in May 2017 and will replace the FX component of the current Non-Investment Products (NIPs) Code in the UK.
The UK Money Markets Code, which is due to be published on 26 April 2017, will cover the executions of transactions in the UK in unsecured deposits, repos and securities lending markets. It was developed by a joint subcommittee of the Bank of England’s Money Market Liaison Committee and the Securities Lending and Repo Committee.
It will incorporate revised relevant sections of the NIPs Code, as well as revisions and updates to the Gilt Repo Code and Securities Borrowing and Lending Code. It is expected to come into force as of 1 January 2018.
While the Global FX Code is expected to apply to all market participants who are active in the market as a regular part of their business, the UK Money Markets Code only applies to those corporates defined as professional eligible counterparties by the Financial Conduct Authority (which broadly means firms with net assets above £5m), and who are regularly active in the wholesale unsecured deposit market.
From a corporate perspective, while the codes provide best practice guidance, the ACT, among others, lobbied to ensure that proportionality is a fundamental principle in both codes in recognition of the differing level of exposure and complexity among the various market participants.
To help treasurers better understand the impact of these codes, the ACT will shortly publish guidance for corporates. “Once the codes are issued, treasurers should familiarise themselves with the details of each code, determine the extent to which it applies to them and make a judgement call as to whether they adhere to the suggested policies and procedures on a proportional basis,” advises ACT associate policy and technical director Michelle Price.
Eleanor Hill is a freelance corporate treasury writer.
This article was taken from the April 2017 issue of The Treasurer magazine. For more great insights, log in to view the full issue or sign up for eAffiliate membership