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Treasury & Capital Markets
Preaching to the preachers
Treasury is no longer a mere sideshow that investment banks pay lip service to. As regulation kicks in to mitigate the kind of crisis that enveloped the world in 2008, the treasury function at banks and brokers is gaining as much credence now as it has been with the corporate clients they serve.
Daniel Yu 5 Aug 2014

Treasury is no longer a mere sideshow that investment banks pay lip service to. As regulation kicks in to mitigate the kind of crisis that enveloped the world in 2008, the treasury function at banks and brokers is gaining as much credence now as it has been with the corporate clients they serve.

 

"This is the topic that is dominating investment banks' working agenda this year," says Barnaby Nelson, regional segment head for Northeast Asia and Greater China, investors and intermediaries, transaction banking at Standard Chartered. "Primarily, it is because of Dodd-Frank and EMIR (European Market Infrastructure Regulation) as well as Basel III."

 

These regulations require banks and their broker-dealers to maintain a transparent, real-time view of their credit exposures. "When added to the general need for greater optimization of liquidity and capital due to the credit crunch, the pressure is on for banks and brokers to put in place the infrastructure that really helps them to maintain a razor-sharp view of their liquidity in a way that has never been seen before," he adds.

 

Investment banks and brokers have been under the regulatory spotlight as the origins of the 2008 financial crisis have much to do with the failure to adequately manage funding and liquidity risk. This is especially in the face of the extraordinary credit events at the time. One lesson that stood out was the over-reliance on short-term funding to finance longer-term assets.

 

To a corporate treasurer, of course, that lesson is but part of Treasury 101. In Asia, that was also hammered home somewhat painfully during the Asian financial crisis in 1997 and which led to the development of the bond markets as companies termed out their funding.

 

While a number of banks and their brokers have since stepped away from the over-reliance on very short-term funding and started to manage the maturity profile of their liabilities, not all enjoy the level of visibility that some of the most sophisticated corporate treasury centres have.

 

As Nelson sees it, the challenges are two-fold. One is that most banks and brokers currently fund their books through undisclosed credit lines - which are, by definition, impossible to quantify or rely on. "As a result, brokers have to seek out and pay for committed facilities, which they can depend on and for which they can track their consumption," he says. "This is a major change for most brokers - but one that they acknowledge to be positive overall despite the increased cost of funding."

 

The second challenge is the measurement of exposures, which historically has been done by function and by activity within the bank and therefore is in a fragmented way. "This now needs to change to an integral and overall view of exposures, which requires organizational and structural re-engineering to revamp the way credit consumption is monitored and reported on," he believes. "At the most basic level, it requires a strong convergence of operational and treasury teams as a first step."

 

In some ways, the challenges facing treasury at a bank and a corporate are not too dissimilar. Yet, banks and brokers do face unique issues given the nature of the business. Regulatory agencies such as FINRA (Financial Industry Regulatory Authority) in the US in their regulatory updates for example identifies a number of red flags of potential funding and liquidity problems banks and broker-dealers face such as:

 

· Significant increases in the cost of funding operations, including those that are firm specific and those based on changes in the interest rate environment;

 

· Unexpected increases in exposure to certain asset classes, markets and counterparties;

 

· Elevated costs of holding particular asset classes;

 

· Sudden difficulty in entering into longer-term funding arrangements;

 

· Significant increases in the proportion of the broker-dealer's longer-term assets funded through shorter-term markets, such as the overnight repo market;

 

· Downgrades or announcements of potential downgrades of the credit ratings assigned to the public debt of the broker-dealer or its parent;

 

· Downgrades or announcements of potential downgrades of the credit ratings assigned to collateral pledged by the broker-dealer;

 

· Negative publicity or rumours targeted at the broker-dealer or parent that could reduce its perceived credit worthiness;

 

· Widening spreads in the credit default swap market that suggest concerns about the credit worthiness of the broker-dealer or its parent;

 

· Significantly widened credit spreads for the public debt of the broker-dealer or its parent;

 

· Significant decline in earnings or projected earnings for the broker-dealer or its parent;

 

· Increases in demands for funding by affiliates, as this may negatively affect the parent's ability to fund the broker-dealer;

 

· Cancellation of external funding sources and non-renewal of maturing debt (such asuncommitted repo or revolving credit facilities);

 

· Imposition of increased collateral requirements and wider haircuts by counterparties, carrying broker-dealers and clearing organizations;

 

· Excessive reliance on customer assets (cash and securities held in margin accounts) to help fund operations;

 

· Significant reductions in the market value of certain asset classes held in inventory;

 

· Breaches of pre-established risk limits;

 

· Difficulty in timely monetizing the broker-dealer's assets in an excess liquidity pool;

 

· Significant decline in the amount of excess liquidity available;

 

· Unexpected demands for cash arising from contingent liabilities (e.g.,pending lawsuit);

 

· Notable increases in collateral disputes with counterparties;

 

· Assets returning to the balance sheet from customers with explicit or implicit puts that require immediate unanticipated funding; and

 

· Deterioration in the financial condition of the broker-dealer or its parent that may trigger loan covenants or other credit events.

 

Nelson says the heightened focus on liquidity and credit exposure by the banks and brokers is the first evidence of the convergence between operations and treasury from an organizational perspective. "It is forcing us to take a fresh look at how operational solutions can drive treasury benefits," he suggests. For example, the growth of outsourced clearing is inevitable, Nelson argues, as service providers start to offer the efficiencies of cross-margining by taking on brokers' risks across multiple markets and asset classes.

 

Banks and brokers will find that a lot of what's behind best practice on funding and liquidity are not unlike how corporates have been advised to organize their treasury function. Indeed, some service providers are reaching out to corporate treasury to find the talent to advise banks and brokers as to what works best.

 

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