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Cash is King: The role of cash management in the search for yield
Cash is King: The role of cash management in the search for yield
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Cash is King: The role of cash management in the search for yield

17/09/2019

Sean Moran

Sean Moran

Head of Sales and Relationship Managers

BNP Paribas Securities Services

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In an evolving and increasingly volatile market, this Dear COO article looks at how cash management is emerging as a not-so-new tool in a hedge fund's arsenal on their quest for yield.

Dear COO

In the past, cash management has been treated by some hedge fund managers on a passive basis. Today, it’s earned the right to be treated as its own asset within a fund’s portfolio.

Why? As the constantly evolving regulatory framework impacts financial institutions’ appetite and ability to hold liabilities in various ways – and economic conditions as well as central bank policy have resulted in higher interest rate volatility – cash management has become an increasingly important tool in a hedge fund’s search for yield, and could ultimately prove the difference between producing a flat and positive return. 

Indeed, liquidity optimisation deals have proven a win-win solution for both our clients, and BNP Paribas. Where we are able to reduce intraday liquidity extension and improve liquidity and capital ratios, clients holding liquidity positions as little as $20 million or as large as $1 billion have been able to improve their overall cash yield – in some case by as much as 50 basis points – while often also reducing operational requirements and risk[1].

Following a couple of years of rate hikes from the Federal Reserve, the trend was inverted in July this year when rates were cut for the first time in a decade. The market is now fully pricing in at least one further cut in 2019. On the flip side, many economies are still experiencing a negative interest rate environment and whereas for some we have seen a shift away from historic stimulus measures (see the Swedish Riksbank surprise hike in December 2018), for others conditions seem to be far from improving. More stimulus measures are now expected for EUR with a rate cut largely priced in following ECB President, Mario Draghi’s comments in June and market participants expecting further quantitative easing, according to a Reuters poll. Driven by this global landscape, further hikes are unlikely for the other large economies currently experiencing negative interest rates (JPY and CHF).  In this increasingly volatile environment, a review of counterparties and trading partners, as well as a move towards more active cash management, represents an opportunity for hedge funds to earn additional yield or reduce their costs for negative interest rate markets.

New playing field

It is important to note that a number of regulatory changes over recent years have radically changed financial institutions’ treatment of cash held on their balance sheet, and the products and rates they have been able to offer as a consequence.  In particular, the introduction of Basel III (specifically the Liquidity Coverage Ratio), G-SIB (Global Systemically Important Banks), and the SLR (Supplementary Leverage Ratio) have resulted in significant capital and liquidity charges, forcing many banks to reassess their funding models, liquidity metrics and treasury operations globally. And while the guidelines are the same for all, they have impacted banks and their internal divisions in varying ways, with the market response to different client segments proving to be radically different in many cases.

The implications have been particularly evident for many hedge funds using prime brokers, some of which have been turning away unencumbered cash balances from their hedge fund clients. This in turn has created an opportunity for well-positioned custodian banks who can offer liquidity solutions in addition to other core custody or administration services. It has been evident too within the custodian bank industry where appetite for liquidity has varied significantly, also driven by currency movements. In some cases it has even been evident within organisations, where different pockets of cash may find better ‘homes’ amongst the various divisions (i.e. securities services vs. corporate and retail arms).

New uncleared margin rules (UMR) for OTC derivatives, currently being phased in under EMIR, may result in greater levels of cash being positioned with custodians and an additional avenue for yield optimisation. The regulation defines some strict boundaries in terms of what can be posted and received as collateral, mainly cash and liquid/non-risky securities, access to which from banks has been made more expensive due to their need to comply with Basel III’s liquidity ratios.

Things to consider

Faced with a shifting landscape, a COO/CFO on the hunt for yield and cash optimisation should consider the following:

  1. Replace passive cash management with active cash management, starting with a review of your counterparties and market opportunities
  2. Be aware of the counterparty risk where you hold your cash
  3. Term profile your liquidity, remaining aware of the various risks of holding on-call cash vs. term cash and cash equivalent products (such as money market funds and other short term securities such as government bonds)

In addition to the above, the following questions are also worth keeping in mind:

  • How can I improve cash management efficiency?
  • How can I maintain cash or cash equivalents without penalising the portfolio yields?
  • Does my counterparty want my cash and what services and alternatives can they offer?

A final word

Spurred on by evolving regulations, and a macro environment that has proven challenging for the hedge fund industry, cash management is quickly emerging as a not-so-new tool available in the fund manager’s arsenal on the quest for yield. The landscape for providers of active cash management has seen an unprecedented shake-up, with some incumbents exiting the space completely, or being forced to pass on increased compliance and operational expenses to hedge fund clients, and therefore pricing themselves out of the market. Custodians with robust balance sheets, who are able to take on cash deposits as part of a broader relationship, will be the likely beneficiaries of the new playing field, as hedge funds seek to streamline counterparties and consolidate wallet share. 

What we offer

As a best-in-class[2] custodian with over $11 trillion assets and one of the largest and most capitalised banks in the world, our strength as a counterparty offers clients premier safety for their cash deposits. We have a vast payments network (with over 90,000 client cash accounts and 15 million high value payments annually covering 75 currencies) and are one of the world’s largest Euro clearers. We have 100+ dedicated product and operations professionals in our treasury team and offer a number of potential solutions to hedge fund managers for cash management supported by our core hedge fund administration business. We look to structure optimal liquidity solutions for our clients, including:

  1. Interest Bearing Accounts – available for operational and/or collection accounts with no minimum balances required, rates are transparent based on published benchmarks and cash is available on demand.
  2. Cash Sweep – automated cash reinvestment tool executed with same day value, access to leading triple-A rated money market funds both proprietary and third party (pre-approved list available upon request).
  3. Cash Pooling – a domestic and cross-border solution available across 5 regions:  Europe, Asia, the Middle East, North America and Africa.
  4. Money Market Deposit – an investment which permits the client to receive a return based on pre-agreed interest rates at a pre-defined maturity date. Deposits are customised to pre-defined conditions; cash balances, fixed or variable rate and maturity.
  5. Term Deposits – cash is placed on deposit for a pre-agreed interest rate for a pre-defined maturity date, subject to term and currency appetite.
  6. Government securities – custody of treasury positions is part of our DNA.

We strive to offer the most attractive cash conditions, in particular on operational stable credit balances tied to our custody services. If you would like to discuss our cash deposits in more detail please do not hesitate to contact us.

For more information on our full service offering for hedge fund managers, please download our brochure:

 

[1] BNP Paribas data

[2] Custody Risk

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