Trapped Liquidity Optimisation – Solutions for Asia

Regulators in the region are introducing ever-tighter rules on the movement of cash and assets for which firms need to find innovative solutions.

Connectivity has for some time been a cornerstone of both international business and modern financial markets, with a view to seamlessly connecting markets, participants and different regions around the world. However regulators increasingly seeking to prevent capital flight through ever more restrictive regimes on the transfer of cash and securities offshore. We need to face the liquidity regulations are coming to Asia.

The challenge is that while currency convertibility and asset/cash transfer-ability are essential to optimising balance sheet management and capital/liquidity regulations such as LCR (liquidity coverage ratio), it will be followed with an increase in opportunity costs and can be difficult to achieve without strong, fundamental knowledge of local rules, conventions or regulators.

The current situation

Cash pooling and transferability

Cash pooling and interest optimisation are common solutions developed over the years by banks with a large network and deep knowledge of evolving regulations. But, the relaxation of several countries’ rules on transferability, withholding tax and capital requirements requires constant surveillance of local rules for any potential change in eligibility, quotas and reporting, such as China RMB/FCY cross-border lending scheme.

Physical and notional cash pooling offer various degrees of flexibility, with the first one adding transparency but also taxes and higher transaction costs; notional pooling presents a decentralised approach but increases capital requirements and cross-guarantees. The current PBOC (People’s Bank of China) and SAFE (State Administration of Foreign Exchange) circulars for cross-border cash movements offer optimisations for bank’s group LCR, but are subject to change at any time.

An estimated 55 percent of companies based outside China are now using RMB cash pooling optimisation, with 45 percent still considering it.  Solutions outside the Shanghai Free Trade Zone are building up, such as cross-border pooling venture between banks and corporates. Cash pooling cuts costs in half, and optimises interests.

Interest optimisation

Global interest optimisation enables cash trapped onshore to be aggregated for improved rates across internal accounts, without account ownership centralisation. One of the solutions to improving interest optimisation is reducing the number of operating accounts across jurisdictions. This offers more visibility, optimisation of earnings and no interest reallocation (limiting transfer pricing requirements). In one instance, it reduced to total interests by 40 percent over one year for a bank across its Asian operations, with more visibility for cash management.

Discussion with regulators

Engaging with local authorities is another option taken by several longstanding/reputable foreign banks locally to negotiate bilateral agreements for trapped liquidity relief, via physical/notional cash pooling or temporary repatriation of cash to head office. This has been seen not only in small emerging countries, but also major ones, such as China, Japan and South Korea. For instance, there have been agreements on temporary repatriation of cash/HQLA (high-quality liquid assets) to head office, with caps, in exchange for firms’ North-Asian headquarters being installed in the country.

To support this effort, treasury teams must have an in-depth knowledge of local market rules for solutions and regulatory compliance, in coordination with a bank’s business strategy in the country and the region. With the above solutions already tested, several challenges remain, including cash projections with positive and negative scenarios on local rules.  There are three opportunities to strengthen cash repatriation for improved USD and major currency LCRs during benign/crisis periods.

Opportunity 1 – Review the legal entity structure of APAC entities

This enables further liquidity repatriation from US GAAP consolidated subsidiaries, with or without physical transfer; limits dependence on local regulatory requirements and potential rule changes limiting cross-border lending schemes; and ensures other internal and regulatory metrics are not negatively impacted for the group (capital, liquidity, concentration risk).

Opportunity 2 – Use “bridge subsidiaries”

Leveraging on bilateral/regional country relationships to transfer liquidity, in the event there is no direct agreement with head-office jurisdiction, and requires construction of a liquidity pass-through between a counterpart and your entity with a clear map of regulatory relations across the ASEAN+3 countries, but counterparty credit risk must be within accepted limits, and legal contracts should be robust.

It comes with a proviso that some regulations may be preventing the structure, with potential fines/freeze of liquidity onshore. Firms should therefore confirm cross-border transfer scheme rules, their degree of stability, eligibility, reporting, and quotas for the countries involved in the structure

Opportunity 3 – Build a scaling plan with local regulators

This allows for 2-way cash transfer, including caps/floors and scenarios for repatriation by cash type (operating, excess, other). It requires stress-tests on head-office LCR and other metrics in the case of delayed transferability, as well as further negotiations with local regulators, and institutions should rank the consistency and stability levels of bilateral agreements to further optimize and ensure scalability of freed liquidity.

Other impactful solutions – from transferability to asset exchange

The value of HQLAs lies in their lighter haircut (0 percent) versus demand/term deposits (3-5 percent) and level 2a (15 percent) and operational deposits (25 percent)

In parallel, transferring liabilities, such as direct deposits from counterparts, may face additional limitations from local regulators.

The key method of moving HQLA is free-transferability, including clearance from ringfencing measures (such as excess HQLA definition), unencumbrance checks, non-convertibility of local currency, FX controls and local rules such as Sharia.

Separately, demand/term deposits from corporations are considered stable and may be transferred to regional/global head office for LCR improvement if there is no restriction under Rule 171 of BCBS 238.

There are various key models for measuring excess operating deposits under LCR, including granular deposit forecasting which can include projections of operating/excess cash levels and volatility by currency and client type, based on historical stickiness and local as well as regional macro-economic impacts.

A trending approach is now the use of liquidity diffusion models for rates behaviour estimates, including non-linear approaches for benign/crisis periods; assessment of outflow and inflow speed differences to review skewness due to the 75 percent limitation for inflow calculation; and assessment of off-balance sheet impacts, with cash in/outflow probability for standby purchase agreements and liquidity lines.

Local LCR; flexibility assessments

These include assessment of excess HQLA and percent of excess cash in stable deposits by currency, including G20 and non-deliverables, as well as reviewing encumbrance and transferability of cash and HQLA, based on their currency and liquidity degree in the markets during good and challenging market situations.

LCR improvements, HQLA currency switch

Reviews of time gaps for LCR production at group, regional and local levels, amid daily and monthly calculation requirements, create an opportunity to rebalance operating cash and HQLA between offices based on reporting timing rules, at different HQLA categories and deposit types including demand/term, operational, and excess cash.

Liquidity trapped in regulated and un-regulated countries can also find outlets in further technical reviews of US Fed and BCBS LCR rules. This might include the ability to transform HQLAs from local to G3/G10 currencies, offering further flexibility for temporary repatriation due to their liquidity.

Adapting cash types definition for transferability or accounting aggregation is an opportunity for LCR improvement at regional or group-level.

Capital flight and increased liquidity regulations are expected to remain of keen interest to regulators in the region. As they continue to tighten already restrictive regimes, unlocking trapped liquidity will be a challenge for firms. The most successful market participants will have the knowledge, confidence and local relationships to critically assess, bridge and partner with regulators to build scaling plans for the future.

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