The recent turmoil in the banking and financial system with the collapse of three U.S. regional banks – Silvergate Bank, Signature Bank, Silicon Valley Bank (SVB) and 167-year-old Credit Suisse in Europe, suggests now would be as good a time as any for businesses to review their approach to perfecting the pillars of cash management – diversification, liquidity, and yield.
Each year that goes by has proven to provide us with unprecedented unpredictability, each causing a fresh bout of challenges. While businesses have started to become accustomed to the significantly higher levels of volatility, there’s nothing like bank failures and the effects felt from the fallout to remind us of the importance of a prudent cash management strategy.
While businesses remain concerned and vigilant for any further signs of contagion, all of this comes at a time when central banks have thrown the proverbial ‘everything but the kitchen sink’ to combat the soaring inflation that came after we were over the worst of the coronavirus pandemic. This has ultimately caused any business holding excess to lose the value of their cash in real-money terms.
After the global financial crisis that started in 2007, businesses in advanced economies have been operating in a prolonged period of ultra-low interest rates, and in some countries, negative rates. In response to the coronavirus pandemic, central banks looked to ease monetary policy further while also provide liquidity to markets and maintained the flow of credit. More recently, in response to rapidly growing and stubbornly high inflation well in excess of its targets, central banks around the world have tightened monetary policy by increasing interest rates to their highest level since 2008.
With the impact of bank failures felt on the day-to-day operations of businesses holding excess cash, Finance Directors, Treasurers and CFOs are now putting cash management to the top of their priority list to actively diversify their bank deposits and in doing so, achieve better returns. There are potentially other benefits less recognised for them to also consider, such as ESG.
Interest rates are at their highest level since 2008 and businesses can diversify their cash across many different instruments, from bank deposits to money market funds. With traditional voice brokers, such as FXD Capital, at the epicentre of information flow, traders at banks are trusting and increasingly relying on brokers as key conduits of information. For businesses holding excess cash in search of diversification and yield, there is a plethora of solutions as well as many hidden opportunities that are not so easy to identify.
Stable NAV money market funds invest in a diverse range of highly rated and highly liquid money market securities. They are considered an alternative to holding cash balances in bank deposits, designed to protect capital and maintain liquidity while providing competitive returns. There is currently $5.8 trillion invested in the global money market fund industry which is at its highest level since April 2020 after record inflows of more than $286 billion in March 2023 because of investors concerned about the safety of their bank deposits.
With markets now torn on whether interest rates have peaked, or if we will get more rate hikes in May 2023, businesses can still benefit from active portfolio management – whether that be to generate yield improvement through the remainder of the rate hiking cycle or to start to think about protecting their returns from a potentially falling rates market.
With over 350 deposit taking banks in the UK – this includes the most recognised banks as well as many less well-known possibilities, all of which give rise to additional considerations beyond just credit rating to consider- such as the capital and liquidity of the bank. With only one of the largest 10 global banks in the world (by assets) being based in the UK, many of these are UK branches and subsidiaries of larger overseas banks. This leaves additional factors to consider – such as sovereignty and the level of risk in the investment and loan activities the bank undertakes.
Businesses may feel that identifying new banks and opening deposit accounts is an onerous and futile exercise, one that for many is a daunting task often bypassed due to the perception that the benefit doesn’t warrant the effort. Or that, with only a handful of banks appearing accessible and others not making their rates, products or even appetite for cash known, the range of rates for a depositor remain limited relative to the wider market, leading businesses to compromise on their ‘ideal’ treasury policy in a need to diversify bank risk.
For businesses to understand what the deposit rate should be, they must first obtain rates from comparable banks for the same duration. Only then can they truly understand their opportunity cost of using banks offering inferior rates and which, in many cases are deemed a higher credit risk by the major credit rating agencies.
The key challenges are clear and at times overwhelming. Risk assessing the current banks beyond standard credit ratings, which are updated periodically and often do not address the near-term risks. Devising a robust investment mandate, continually monitoring existing bank names, identifying new banks, opening and maintaining deposit accounts as well as negotiating competitive rates, all pose a challenge and increase bureaucracy for those tasked with overseeing it.
FXD Capital is a brokerage that specialises in cash deposits and money markets. The firm was founded in 2018 with a mission to provide all depositors of size and sophistication with access to the same opportunities that the largest, most knowledgeable businesses have come to expect.
To learn more about how FXD Capital can help your business better manage its excess cash, please get in touch with the team by emailing enquiries@fxdcapital.com or calling +44(0)2030360520.
Case Study – 1
Background
- Company A successfully raised £28m in a Series B from well-known institutional investors
- Their cash flow forecast meant £3m was considered ‘core cash’ with £25m considered ‘excess cash’, leaving a portion not needed for a reasonable length of time
- While there was no formal treasury policy in place, the FD and Board of Directors recognised a need to be more proactive with the excess cash and find a solution for the would strike a comfortable balance with diversifying their counterparty risk, ensuring sufficient accessibility of funds in line with their cash flow forecast and achieve better returns
- £25m was placed on a 30-Day Notice Account with Silicon Valley Bank earning 1.00%. The remaining £3m was on Instant Access earning nothing
Solution
- FXD Capital presented Company A with two carefully considered and globally recognised banks to further diversify their exposure from single bank risk, as well as a money market fund from one of the world’s largest money market fund providers
- The banks were assigned investment grade credit ratings with stable outlooks
- The money market fund was assigned AAA credit ratings from Moody’s, S&P and Fitch
- One bank was offering a 35-Day Notice Account at 1.59% and a 95-Day Notice Account at 1.74%. The other bank was offering a 45-Day Notice Account at 1.25%, 95-Day Notice Account at 1.40% and 185-Day Notice Account at 1.80%
- The money market fund was to be considered as an alternative to bank deposits given the objective of the fund is to preserve capital and generate income by investing in investment grade government and non-government money market securities. In doing so Company A’s cash would be instantly accessible and inherently diversified, while earning 1.16%
- The money market fund provided incremental yield improvement throughout the UK rate hiking cycle, with the deposit accounts also being variable rate and linked Base Rate to allow the client to benefit from future rate hikes without the need to re-negotiate the rate
Conclusion
By consulting with FXD Capital, Company A devised a robust investment strategy. They were presented with the optimum solutions based on their requirements and proceeded to place £20m shortly after the initial discussions took place. £17m in banks deposits and £3m in a money market fund. They not only had a prudent approach to diversifying counterparty risk, but they also staggered the maturities (from instant access through to six-months) in line with their expected cash flows to achieve better returns. At the time of placing the deals this generated £110k in additional interest income and throughout the remainder of 2022 and into 2023, this has generated hundreds of thousands more as they continue to benefit from the higher interest rates environment.
Case Study – 2
Background
- Company B raised £300m in a successful Bond Issuance
- While no formal treasury policy was in place, the Board had key criteria – to keep the cash short-dated (up to one-month) and also only consider systemically important banks
- They recognised a need to be more proactive with the excess cash to find a solution that would strike a comfortable balance with diversifying their counterparty risk, ensuring sufficient accessibility of funds and also achieve better returns. Any additional interest income would offset the cost of the debt issued
- Their bank, Barclays had been assigned credit ratings A1/A from S&P, A+/F1 from Fitch and A1/P-1 from Moody’s
- £300m was placed on Instant Access earning 0.15% and they were considering placing excess liquidity out on to one, two or three-month fixed term to earn 0.20%, 0.25% and 0.30% respectively
Solution
- FXD Capital presented Company B with a money market fund from one of the world’s largest money market fund providers as well as short-dated deposits from a couple of systemically important banks. For comparison we also showed other carefully considered and highly rated banks
- The banks were assigned investment grade credit ratings with stable outlooks
- The money market fund was assigned AAA credit ratings from Moody’s, S&P and Fitch
- The banks were offering a range of short-dated Notice Accounts that paid 0.40 – 0.84%
- The money market fund was to be considered an alternative to bank deposits given the objective of the fund is to preserve capital and generate income by investing in investment grade government and non-government money market securities. Company B’s cash would be instantly accessible and inherently diversified, earning 0.18%
- The money market fund provided incremental yield improvement during the UK rate hiking cycle, with the deposit accounts also being variable rate and linked to Base Rate to allow the client to benefit from future rate hikes without the need to re-negotiate the rate
Conclusion
By consulting with FXD Capital, Company B devised a robust investment strategy. They were presented with the optimum solutions based on their requirements and proceeded to place £170m, with £100m in banks deposits and £70m in a money market fund. They not only had a prudent approach to diversifying counterparty risk and maintaining liquidity but at the time of placing the deals this generated in excess of £800k in additional interest income and during 2022 and 2023 has generated millions of pounds more with the client continuing to benefit from the higher interest rate environment.
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