What kind of trends are you seeing in the treasury space today?
Over the last four or five years, the market segment of treasury has been evolving, maturing and expanding, and that’s a direct result of the financial crisis in 2008. Pre-crisis, there was little to no focus on treasury in the buy-side and hedge fund community—it was all handled by their counterparties. For instance, unencumbered free cash that was held at, say, a prime broker, would have been earning interest on par with what they would get elsewhere, so no one cared much.
Prime brokers were happy to accumulate cash balances from their clients. Additionally, there were very few details on fee transparency, and clients were not very focused on optimising fees across their prime brokers, opting to focus on generating higher returns from their portfolios. Finally, no one had much concern about counterparty exposure—who would have ever imagined that having Lehman Brothers as a counterparty was too risky?
Fast forward to 2008 and beyond, and suddenly counterparty exposure and the health of the counterparty is now paramount for every fund manager and its investors. Questions around how a manager monitors counterparty exposure and keeps track of credit are now standard in due diligence, and managers must have a good response or they won’t get any funding.
Additionally, with new regulations such as the Dodd-Frank Act, the European Markets Infrastructure Regulation and Basel III, balance sheet consumption has been a focus for all banks. As a result, prime brokers are telling clients to take their cash elsewhere—for small funds, they’re imposing minimum monthly fees, or telling them to take their business elsewhere altogether.
What are the additional drivers of change, aside from regulation?
There are multiple catalysts driving this. There is the regulatory side to it, but also average hedge fund performance is not keeping pace with what we have been accustomed to seeing in the past, ranging from negative 4 percent to highs of 1 to 1.5 percent.
Managers are looking for any opportunity to reduce their cost structure, reduce the cost of borrowing and funding, and to generate any kind of yield they can. Whereas previously there wasn’t a specific need for this, now it’s important to add basis points (bps) wherever possible.
However, when yields are at 0 percent or even negative across the board, and prime brokers want that excess cash out of the account, for fund managers, moving the cash around is just an operational headache with no reward. We’re starting to see more of a focused effort on managing cash—starting with managers aggregating cash balances with the respective rates across all accounts globally, optimising debits and credits, hedging foreign exchange exposure, and ultimately sweeping excess cash out of prime broker accounts into custodian and money market funds, which aligns with prime brokers’ demands.
The key objectives of any treasurer managing cash are: safety, liquidity and, to a lesser extent, yield. In an ideal world, a treasurer can have the tools to effectively manage cash, optimise all cash usage, then easily sweep unencumbered free cash to safe and liquid providers, like money market funds.
Today, this could add 20 to 30 bps of additional yield, while keeping prime brokers happy. But, in a rising interest rate environment, this could yield much higher return.
In addition to cash management, collateral management is another focus area for most treasurers. With the low interest rates we have today, cash is the main form of collateral. When a fund is dealing with a billion dollars of collateral across multiple positions it could be over-collateralised at any given time. Typically, their counterparties don’t report excess collateral, indicating they can recall it, and historically this didn’t matter too much. But today, treasurers are looking to closely track collateral and to recall any excess collateral so they can deploy it elsewhere, which could also easily yield another 20 to 30 bps with a basic cash sweep.
Additionally, fund managers want to understand the cost of funding and deconstruct their cost of borrowing, as well as understand any potential revenue opportunities that may exist in their long books. As such, with a tight treasury function, fund managers can effectively manage their counterparties when it comes to borrowing costs and the lending of their own portfolios.
One important note is that treasurers aren’t necessarily looking to optimise and save every penny they can from their counterparty—doing so would only negatively impact their overall relationship with their prime brokers. Instead, they want to understand their overall costs so they can better manage the overall relationship.
Finally, investors are getting more diligent about understanding every aspect of their managers’ operations, which includes effective cash management and controls, cost of funding, and counterparty exposure metrics. Over time, we expect to see investors demanding regular treasury reports with key metrics around managing this function.
Where does cash movement come into the treasury management function?
Physical cash movement is a big part of it—how do we actually move cash from one bank account to another or to a payee of some sort? This is particularly relevant at the moment because of the concerns around cybersecurity.
Multi-billion dollar funds that have accounts in different countries can easily have hundreds of accounts. For each of these, every time a fund manager wants to access a bank’s secure online portal, they have to use a token to log on to that account. Someone—a CFO or COO—has to keep track of those tokens.
At the same time, if you have to move a large sum of money from one account to another, they have to get internal approvals from multiple (typically two, but often three or four) people, who each have to manage their tokens as well.
All of this makes cash movement a big operational problem, and the COOs and CFOs in charge of the tokens face significant challenges tracking and managing tokens along with password expirations.
Hazeltree has integrated these security and audit trails into a centralised cash management platform, aggregating all of the tokens into one secure interface with all the counterparties, meaning each fund manager only needs one token.
Having one integrated platform for moving money around provides the same level of security but without having to log in to various different portals. With due diligence around physical cash movements and the focus on cyber security, this is emerging as a key interest. Everyone wants to have tight cyber defences, but if the process is too cumbersome, they just won’t deal with it.
Do the challenges differ, depending on jurisdiction?
It’s a tough environment for everybody. We have clients in New York and around the US generally, in Europe—predominantly London, but also Zurich and Geneva, as well as in Hong Kong and Singapore.
If there is any difference, it’s around the size of fund managers. Those that are of size and scale have a much tighter focus on treasury management, while smaller funds, even if their counterparties are pushing them a little bit, don’t necessarily have the flexibility to push back.
In general, the bigger the fund, the more focus on treasury management and the more return on investment they’re likely to get. The US market typically has large funds, followed by London and then Switzerland. About 40 percent of our clients are US-based, 35 percent are in Europe and the rest are in Asia, where there aren’t many big funds.
Still, regulations are more or less consistent globally. Some regulators may have enforced certain parts of it earlier than others, but we see everything converging to pretty much the same landscape.