Liquidity Management: Asia’s Road to Self-Funding
Between them, Sridhar Kanthadai and Victor Penna have a combined four decades of experience in transaction banking at Citi and JPMorgan. They now bring their expertise and experience to Standard Chartered Bank’s transaction banking practice – Kanthadai as Managing Director and Regional Head, North Asia, and Penna as Managing Director and Head of Treasury Solutions.
Mindful of the new lending environment being ushered in by Basel III and rising interest rates as the global economic recovery gathers steam, both Kanthadai and Penna urge CFOs and senior treasurers to take a long hard look at self-funding versus bank borrowing.
“Self-funding becomes more important when the market tightens around credit lines or the cost of credit lines,” says Penna. They spoke to CFO Innovation’s Cesar Bacani. Edited excerpts:
The Basel III regulations that are coming into effect can possibly raise the cost of borrowing for many companies, even as central banks seem poised to raise interest rates as the US unwinds its quantitative easing measures. What can CFOs and treasurers do about this?
Sridhar Kanthadai: I think [it presents an opportunity] for companies to sweat their balance sheet more, to sweat their process more, and for banks to be much more part of the equation.
[Basel III] gives more opportunity for both companies and banks to really understand cash flows and liquidity flows. If you go back and look at every treasury survey, you’ll find that cash flow forecasting is the No. 1 issue that most companies have.
Have they looked at their own balance sheet and how much self-funding they can do? The balance sheet now becomes a significantly better source [of liquidity]. It’s obviously within the company, it’s cheaper, it’s more guaranteed . . . Can you look at the supply chain, for example, to try and create a source of liquidity?
Victor Penna: Self-funding becomes more important when the market tightens around credit lines or the cost of credit lines.
A similar thing happened a couple of years ago when we used to talk about how European banks were reducing their lending in Asia. If anything, the net result was that it just basically was another reason why the region focused on self-funding.
If you actually look at the general shift in the market since the global financial crisis [in 2008], it’s been more and more towards building the liquidity structures that increase the level of self-funding in the corporate. And I think this [Basel III and other new regulations] just increases that general trend.
Asian companies are sitting on a lot of cash, but CFOs will need to calculate whether it makes more sense to self-fund rather than borrow. How much in savings can companies realize from self-funding?
Victor Penna: I’ve done some work with some very large companies and I’ve seen anything from savings of a couple of millions to more than $50 million, depending on the size of balance sheet and how much debt there is versus how much cash there is.
Sridhar Kanthadai: The rule of thumb that I’ve seen in some cases is a percentage of your total cash position. If you think about your overall cash position across your operations, let say it’s $400 million in Asia, you can retire a certain amount of debt that is equivalent to a percentage of this. So let’s say it’s 20% of this, so effectively you have $80 million of debt that you can take out.
One of it is the cost of debt compared with the return on your deposit. But more importantly, what is the impact on your leverage ratio, because taking out debt also changes the leverage. So that has a reinforcing impact.
Are there actual companies that have done this?
Sridhar Kanthadai: There’s a case study done by INSEAD on Tyco Electronics, and they have retired something like US$400 million of excess liquidity.
What [should] interest CFOs is not so much the debit-credit savings. The hidden secret is really what [self-funding] does in terms of capital. Does it cover the cost of capital and more? That conversation is probably more appealing to the CFO and senior treasurers.
Otherwise it just becomes 50 basis points versus 1.5, and then you say, Oh I can get a loan for 1.25.
Victor Penna: [Self-funding] has three financial impacts. One is it actually increases the level of net profits. Two, it increases the return on assets, because you have less assets and liabilities as your cash comes down and your loans come down.
The third impact is, because of the increased earnings, there’s a high return on equity.
It’s really about taking down both sides of the balance sheet so you have an earnings impact and you have a balance sheet impact.
So why isn’t everyone with excess cash doing self-funding? According to S&P Capital IQ, Asia’s 17,000 listed companies had US$2.3 trillion in cash as of December 2012.
Victor Penna: There is some complexity because regulations come into it. The ability to move cash, particularly cross-border when you’re dealing with multi-currencies, is often restricted by the FX and capital controls of different countries.
How much you can do is dependent partly on your own flows and where your businesses are based, partly on the regulations and partly on the type of structures that you are trying to create.
Obviously different companies operate at different levels of sophistication and have different footprints. So if you are a business that’s present in many countries, you’ve got a lot of operating subsidiaries and a lot of bank accounts. It can be quite complex because you have to aggregate all the cash at the local level.
That might be across seven or eight operating businesses and 50 accounts. And that’s just the local level. And then you’ve got to get [the excess cash] out into some sort of regional structure.
A regional structure being a regional treasury center or a cash pooling structure?
Sridhar Kanthadai: RTCs can do many more things; they can also manage the pool.
We’re seeing significantly more interest with Chinese multinationals. As they expand further, their sources of liquidity that they need to use to fund overseas expansion, the needs are there. Secondly, they have pools of liquidity in all these new markets that they are in which they need to manage.
We see Malaysian companies, we see Indian MNCs, all embarking on the same process. The treasury agenda is very alive and kicking, especially for fast-growing Asian companies where access to the bond markets is not as easy as for Western MNCs.
The only source of funding for them is either bank loans or their own self-funding. They don’t want to be leveraged so much. The bank loan market is very good, but I think they’re finding increasingly good ways of using their own liquidity to fund their balance sheet.
There are more than a dozen large Chinese companies that have pools with us, with other banks. There are many Malaysian companies, Thai companies, Indian companies that are in the picture. Japanese corporations have historically been slow, but they are now big-time into this.
Korean companies, especially the top chaebols, are already doing this, so I think this practice is going to be something that is going accelerate to the next level of clients as their access and their needs increase.
Victor Penna: Most liquidity structures five or six years ago were typically based in London, if it’s multi-currency, or if it’s dollars, New York. We’ve seen the rise of much more Asia-centric liquidity structures, so there are people setting up multi-currency pools in places like Singapore and Hong Kong, for example.
That’s a reflection of the fact that they want to increase the level of self-funding within this region, where there’s a lot of growth. So they want to fund more of their growth from their own cash resources.
That market has gone from virtually zero to now being an active market. On top of that, people are now including renminbi in their liquidity structures. That’s all reflective of the fact that corporates are really looking to increase the level of self-funding.
China is obviously one market with restrictions. Are there any others in Asia?
Victor Penna: Thailand and Vietnam. Indonesia and Malaysia, for the local currency but not for foreign currencies; there’s some flexibility around dollar flows. But local currency, very restrictive.
If you’re trading in dollars, those countries may not be as problematic for you as somebody else that’s trading in the local currency. If I had a business that’s largely ringgit-based in Malaysia or rupiah-based in Indonesia, it’s going to be difficult for me to utilize those excess balances in those countries.
However, if I’m a US-based company and I’m operating in those countries, I might very well be able to utilize some of those dollar balances in a regional liquidity structure.
Is there a case to be made for companies to charge in US dollars?
Victor Penna: Not really because normally the currency is determined by industry practice. There are certain industries like oil and gas that are dollar-based. There are some industries where you have some level of flexibility, where pricing happens in both currencies, and so treasuries that focus on these problems will often look at how they can move their billings to US dollars.
Sridhar Kanthadai: It comes in waves . . . Sometimes, the timing is not right and they have other priorities. One of the things that Victor and his team do is to help companies think through this journey [towards self-funding].
What does it mean? What does this journey look like? What are the complexities associated with it? It’s not all about multi-currency notional pooling; that is just one element of it. The thinking process around where you are located, what are the currencies you’re billing, what are your flows. Do you want to solve 100% of the problem or is 80% of the problem good enough?
I imagine a lot of CFOs are in a hurry to get to self-funding and so would like to have a multi-currency pooling structure in place quite fast. The holistic journey you are referencing may be something they don’t want to deal with at this time.
Victor Penna: No, I would say the vast majority of companies [understand the need for a holistic approach] because this is a fairly big move for them. Typically, before you put in place a cash pooling structure that has to involve the local businesses, you have to go through building a business case internally and also convincing the operating subsidiaries that this is for the good of the company.
There is a lot of work to be done. You have to have a vision of what you hope to achieve and the benefits to the company. You have to sell that vision internally. People do want to spend the time thinking that through, making sure whatever structure they do create is the right structure for them.
There also has to be some longevity in that structure. They don’t want to build something that they have to pull apart after a year or two because it wasn’t right.
How long does the process take, typically?
Victor Penna: When a company first starts to look at this kind of idea, it could be anywhere for a six- to 12-months process before they actually get to the point of saying, this is exactly what I want. Now, here’s the RFP, you banks come up with a proposal.
Sridhar Kanthadai: It depends on the scope. You might want to relocate your procurement process, you might want to relocate your credit process . . . There are many elements and angles. You can take the simple approach, you can take the most complex approach. I would say 6-12 months sounds about par for this.
Is it possible to start this journey on a smaller scale and move on from there?
Victor Penna: Some companies look at doing that for just one line of business or one region. They’ll build that first. These things tend to be evolutionary. A lot of big companies tend to start with one region and then they boot it up.
But when you talk to some of the big Asian corporations, it’s almost like they want to leapfrog. So what a Western multinational might have taken ten years to build, they say, I want one of those, how do I get there? They’ll work hard for 6-12 months and just implement a Big Bang [solution].
Sridhar Kanthadai: And that’s perfectly fine. When people have gone through the journey and there’s clarity around how you go there, you can skip steps. But you have to have a consensus around your own strategy. Skipping steps is not a function of technology or the market piece; everything is there. There are hundreds of companies that have done it. The question is, are you ready internally to do it?
It’s the culture of the company. Can they centralize the decision making and sell it internally? If you think about some of the advances in cash management and treasury management, my theory is that most of the companies that have been very successful in this are technology companies.
You didn’t have technology companies except IBM in the 1960s or 70s. Most of these companies were created in the 80s or 90s. So they never had legacy issues.
Some of the companies that have struggled with this are companies that are 150 years old. Because they have practices and procedures and policies and ways of working that are very old. And they’re much more localized in a hundred countries.
Technology companies are predominantly dollar based, there’s not a huge amount of retail outlets, you’re not collecting cash from a small companies . . . If you’re selling soda for 150 years, you’re collecting cash from mom and pop shops.
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