Deep relationships and regulation

As long-awaited regulatory changes begin to come into effect, their impact on banks and corporates is becoming clearer, says Greg Kavanaugh.

In today’s regulatory environment, it is important that the effects of change are clear to both banks and corporations. Banks are well placed to help clients navigate these changes, whether understanding the impacts of global financial regulatory reform, or the potential benefits resulting from the internationalisation of the renminbi, or the myriad of other regulatory changes occurring around the globe.

One of the new regulations, Basel III, is intended to strengthen the global financial system. Key components include the new capital adequacy measures for certain global banks under the Supplementary Leverage Ratio (SLR), and coverage of cash outflows that may be withdrawn in a crisis stipulated by the Liquidity Coverage Ratio (LCR). The combined impact of these is expected to increase banks’ costs of holding High Quality Liquid Assets (HQLA), which are required for certain types of deposits under LCR.

As a result, corporations that leverage banks for single transactions, such as a deposit or credit facility, may find these transactions could be re-priced – although the deepest corporate-bank relationships should feel little to no impact. Over time, corporations may begin to reduce the number of banking relationships they maintain to achieve the most favorable pricing.

While LCR will make certain deposits less desirable, pending regulatory reform is also set to affect corporate demand for money market funds (MMFs) – long considered a critical alternative for deposit balances. MMF reform coming into effect in the U.S. stipulates that the stable $1.00 per share Net Asset Value (NAV) will be replaced with a floating NAV over the next couple of years – a development which is expected to reduce corporate demand. While MMF reform has stalled in the EU, it is likely that similar changes will follow in due course.

In order to support their clients in this evolving climate, banks are likely to develop new products that are more favorable under LCR and are, therefore, appealing to both corporates and banks. At the same time, some corporates may opt to invest in securities on their own, or use an investment professional to work on solutions such as separately managed accounts (SMAs). Others may simply accept lower returns. In speaking with treasurers, their foremost goal is return of capital rather than return on capital, so it is critical for them to work with investment professionals when updating their investment policies and balancing risk with reward. In this context, treasurers should also be managing their working capital and cash flow more closely.

Cash management is particularly challenging given the confluence of the changing regulatory environment and the low or negative interest rate environment. For banks, these conditions make it difficult to price in enough spread to offset the cost of deposits, while for corporates, gaining a robust return on cash is difficult. The European Central Bank is unlikely to raise rates while tough economic conditions continue in Europe. In the meantime, treasurers would be well advised to revisit their cash forecasting routines and investigate the use of banking tools such as sweeping and pooling to facilitate cash optimisation.

Such tools are not available in all countries, but the landscape continues to evolve. In China, for example, the State Administration of Foreign Exchange (SAFE) has recently introduced new opportunities for companies to engage in cross-border sweeping and two-way sweeping. This can enable companies to achieve greater working capital flexibility, while also resulting in lower borrowing and FX costs. Corporations doing business in China may benefit from revisiting their regional cash structures in light of these opportunities.

A further aspect of regulatory compliance is the trend towards more stringent sanctions and targeted currency controls, which are increasingly being viewed as the most effective tools in the management of geopolitical tensions. Financial institutions must comply with sanctions as well as anti-money laundering and anti-corruption measures – and inevitably this has an impact on their corporate clients as well. In order to implement an effective compliance policy around these measures, corporates first need a full understanding of the relevant requirements. Banks are well-positioned to discuss such matters.

In light of all these changes, the client-bank relationship is shifting in a number of ways. Organisations know they have to do their homework around regulation, but the changes are driving a more consultative bank approach. Banks have a wealth of information to share and will spend a lot of time being the ‘value-added’ provider, just as organisations work with different banks around the world and may also share their experiences. In a changing regulatory environment, where deeper client-bank relationships have been forged, it is easier to navigate that changing environment.

Greg Kavanaugh is a managing director and head of Global Liquidity Investment Solutions and Revenue Management for Bank of America Merrill Lynch Global Transaction Services. Kavanaugh joined Bank of America in May of 2007 to lead the Treasury Services Revenue Management group and added Global Liquidity responsibilities in early 2008. Before joining the firm, Kavanaugh was head of Liquidity and Investment Products, Commercial Client Solutions for JPMorgan Chase.