The COVID-19 pandemic continues to have severe effects on the US economy, with historically low interest rates driving businesses to reconsider their cash management strategies. In this volatile liquidity landscape, how can businesses successfully navigate their operating cash goals? T om Meiman, Product Line Manager for Liquidity Balances and Demand Deposit Account Services, BNY Mellon Treasury Services, and Sam Schwartzman, Head of the IMG Cash Solutions Group, BNY Mellon Markets, explore.
Over the past decade, US liquidity has been significantly affected by short-term low interest rates, imposed following the 2008 global financial crisis. In 2015, the US dollar strengthened against other major world currencies and rates began to increase slowly through 2018, followed by some modest reductions in 2019.
The current unprecedented environment caused by the pandemic has placed further pressure on these short-term USD rates. As uncertainty rose in March, over US$1 trillion was moved into Government and Treasury money market funds (MMFs) over approximately a six-week period. The massive increase in demand, occurring in such a short time frame, temporarily pushed T-bill and overnight Treasury repo rates below zero at times. Elsewhere, LIBOR rates were greatly affected in March, with credit spreads widening.
Although T-bills and overnight Treasury repo rates are now positive (albeit T-bills have begun declining again of late) and LIBOR rates are leveling out, businesses are still waiting to see the long-term effects of the pandemic – with the added threat of a second or third wave. So, as banks look to successfully navigate the uncertain and turbulent liquidity landscape, how can they optimise their excess operating cash?
With the markets reaching new levels of instability in March and April, swift regulatory and legislative measures were introduced. For example, the Fed has so far delivered an unprecedented $3 trillion in additional liquidity to the US market.
To ensure that credit continued to flow to businesses and households, and so that the financial system did not amplify the shocks to the economy, the Coronavirus Aid, Relief and Economic Security (CARES) Act was passed. The $2.2 trillion stimulus bill – the largest emergency aid package in U.S. history – provided a much-needed injection of liquidity in the market.
The Fed also eliminated banks’ reserve requirement—the percentage of deposits that banks must hold as reserves to meet cash demands. Although banks generally hold far more than the required reserves, this unprecedented move has freed up additional liquidity for banks to use to lend to individuals and businesses.
The Fed has also temporarily – until March 31, 2021 – eased its supplemental leverage ratio rule (SLR), a non-risk weighted capital that affects large banks. This has allowed bank holding companies to exclude cash and Treasury securities from calculating their total assets –effectively reducing the amount of capital they are required to hold. This approach was particularly valuable at the height of the market crisis, as it ensured banks were not constrained by the influx of deposits that would have significantly affected their SLRs, thereby freeing up their balance sheets and providing further liquidity to the market.
There are numerous other programs that have been enacted by the Fed to secure additional liquidity – with some of the most prominent measures including the Money Market Mutual Fund Liquidity Facility (MMLF), the Primary Dealer Credit Facility (PDCF), the Primary Market Corporate Credit Facility (PMCCF), the Municipal Liquidity Facility (MLF) and the Term Asset-Backed Securities Loan Facility (TALF). With more initiatives in the pipeline, it is expected that the Fed’s balance sheet will continue to expand.
The short-term market rates forecast
Although the regulatory actions have provided valuable relief, market participants face considerable challenges, with the forecast for short-term market rates remaining uncertain.
Following the initial phase of the crisis, T-bill rates were steadily rising, but have since flattened and have even
begun to decline. If T-bill rates trend upwards again, and banks begin to move deposits away from the Fed into the T-bill market in search of yield, a near term cap could be put on these rates.
Elsewhere, LIBOR rates have been somewhat flat of late after blowing out in March and April and then coming back down to (in some cases) historically low levels. We do expect them to remain relatively flat going forward, assuming a resurgence of the market volatility seen in March and April does not occur.
MMF yields are still on a downward trajectory, and have generally not bottomed out yet, because the funds are somewhat benefitting from holding securities purchased in March – prior to when the two Fed interest rate cuts took effect. This lag effect will run its course shortly.
Fed funds’ rates are predicted to remain close to zero for the foreseeable future, largely due to continued weakness in economic activity and actions taken by the Federal Reserve. That said, assuming rate predictions hold, rates are currently not expected to go negative.
Utilising excess operating cash
What tools can cash managers employ to effectively optimise their excess operating cash during these volatile times? Due to the recent turbulence in the market, there has been an influx of cash into the short-term market space, with a focus on bank deposits through several different options.
Demand deposit accounts have been a cash management staple for decades. Popular due to their non-interest-bearing nature, they do not have any direct tax obligations. They are used to offset expenses, making them the ultimate transaction account – flexible and safe, with cash available on demand. Other instruments being utilised to maximise operating cash include sweeps, intraday investments, interest bearing accounts, hybrid accounts and netting and pooling – each with their own distinct advantages.
Off-balance sheet investment options may be equally viable for some cash managers and can prove valuable to different clients at different times. Another popular option is the Fixed Income Clearing Corporation (FICC) SMP repo program, which has been heavily utilised in recent years. This is because the traditional intermediary role that many banks and broker dealers played in the repo market has been reduced due to regulations restricting how they can participate in that market from a capital perspective. It is expected that the increase in FICC repo popularity will continue to grow.
A negative USD rate
Over the past 10 years, the US liquidity landscape has been faced with near zero interest rates. In this unique time of disruption, businesses face further challenges when it comes to navigating the volatile landscape – including the possibility of moving towards a negative rate.
The US has the advantage of being able to learn from the experience of other currencies and markets that have gone down the negative rate route. The Euro and the Japanese Yen have both dropped below zero in recent years, which proved less of a setback than it was once thought to be. That said, one big differentiator that would need to be considered is the size of the money market fund industry in these currencies compared to the US.
Although the Fed has made it clear that it will do all it can do avoid a negative rate and BNY Mellon is currently not projecting a negative environment, market participants must plan for a host of different eventualities. Clients need to be informed, understand their options and plan for an array of scenarios. What’s more, organisations need to be mindful of the potential impact of using such tools if rates did drop below zero.
It is up to banks to help ensure their clients are prepared with the knowledge of the short-term liquidity tools available to them, and the potential consequences of various market shifts on those solutions, to enable them to successfully navigate the shifting landscape.
The views expressed herein are those of the authors only and may not reflect the views of BNY Mellon. This does not constitute Treasury Services advice, or any other business or legal advice, and it should not be relied upon as such.
 Crane Data
What to Know Before You Expand Across Borders
By Sean King, Director of International Tax at McGuire Sponsel
The American retail giant, Target Corporation, has a market cap of $64 billion and access to seemingly limitless resources and advisors. So, when the company engaged in its first global expansion, how could anything possibly go wrong?
Less than two years after opening its first Canadian store in 2013, Target shut down all133 Canadian locations and terminated more than 17,000 Canadian employees.
Expansion of an operation to another country can create unique challenges that may impact the financial viability of the entire enterprise. If Target Corporation can colossally fail in its expansion to Canada, how might Mom ‘N’ Pop LLC fare when expanding into Switzerland, Singapore, or Australia?
Successful global expansion requires an understanding of multilayered taxes, regulatory hurdles, employment laws, and cultural nuances. Fortunately, with the right guidance, global expansion can be both possible and profitable for businesses of any size.
Any company with global ambitions must first consider whether the company’s expansion outside of the U.S. will give rise to a taxable presence in the local country. In the cross-border context, a “permanent establishment” can be created in a local country when the enterprise reaches a certain level of activity, which is problematic because it exposes the U.S. multinational to taxation in the foreign country.
Foreign entity incorporation
To avoid permanent establishment risk, many U.S. multinationals choose to operate overseas through a formal corporate subsidiary, which reduces the company’s foreign income tax exposure, though it may result in an additional level of foreign income tax on the subsidiary’s earnings. In most jurisdictions, multinationals can operate their business in the foreign country as a branch, a pass through (e.g., partnership,) or a corporation.
As a branch, the U.S. multinational does not create a subsidiary in the foreign country. It holds assets, employees, and bank accounts under its own name. With a pass through, the U.S. multinational creates a separate entity in the foreign country that is treated as a partnership under the tax law of the foreign country but not necessarily as a partnership under U.S. tax law.
U.S. multinationals can also create corporate subsidiaries in the foreign country treated as corporations under the tax law of both the foreign country and the U.S., with possibly two levels of income taxation in the foreign country plus U.S. income taxation of earnings repatriated to the U.S. as dividends.
Under U.S. entity classification rules, certain types of entities can “check the box” to elect their classification to be taxed as a corporation with two levels of tax, a partnership with pass-through taxation, or even be disregarded for U.S. federal income tax purposes. The check the box election allows U.S. multinationals to engage in more effective global tax planning.
Toll charges, transfer pricing and treaties
When establishing a foreign corporate subsidiary, the U.S. multinational will likely need to transfer certain assets to the new entity to make it fully operational. However, in many cases, the U.S. multinational cannot perform the transfer without recognizing taxable income. In the international context, the IRS imposes certain outbound “toll charges” on the transfer of appreciated property to a foreign entity, which are usually provided for in IRC Section 367 and subject to various exceptions and nuances.
Instead, the U.S. multinational may prefer to license intellectual property to the foreign subsidiary for a fee rather than transfer the property outright. However, licensing requires the company and foreign subsidiary to adhere to transfer pricing rules, as dictated by IRC Section 482. The U.S. multinational and the foreign subsidiary must interact in an arms-length manner regarding pricing and economic terms. Furthermore, any such arrangement may attract withholding taxes when royalties are paid across a border.
Are you GILTI?
Certain U.S. multinationals opt to focus on deferring the income recognition at the U.S. level. In doing so, they simply leave overseas profits overseas and delay repatriating any of the earnings to the U.S.
Despite the general merits of this form of planning, U.S. multinationals will be subject to certain IRS anti-deferral mechanisms, commonly known as “Subpart F” and GILTI. Essentially, U.S. shareholders of certain foreign corporations are forced to recognize their pro rata share of certain types of income generated by these foreign entities at the time the income is earned instead of waiting until the foreign entity formally repatriates the income to the U.S.
The end goal
Essentially, all effective international tax planning boils down to treasury management. Effective and early tax planning can properly allow a company to better achieve its initial goal: profitability.
If global expansion is on the horizon for your company, consult a licensed professional for advice concerning your specific situation.
Pandemic risks eclipse treasury priorities as businesses diversify investments to mitigate impact
The Covid-19 pandemic has shunted aside existing challenges to sit atop treasurers’ priority lists, according to “The resilient treasury: Optimising strategy in the face of covid-19”, a survey run by the Economist Intelligence Unit (EIU) and sponsored by Deutsche Bank.
The results show that treasurers are looking to diversify their investments in a bid to mitigate the pandemic impacts, including heightened liquidity, foreign-exchange and interest-rate risk. As many as 55% plan to increase investments in long-term instruments, with 48% increasing investments in bank deposits, another 48% in local investment products, and 47% in money-market funds.
“The Covid-19 pandemic has drastically altered business plans in 2020. It has placed a certain level of strain on treasury processes, but the challenge it presents has been managed by traditional treasury skills. It is clear that pandemic risk will be on the treasury checklist for years to come, but it is one of many risks the department faces and will continue to manage,” says Melanie Noronha, the EIU editor of the report.
Despite Covid-19 looming large, other challenges wait in the wings. Notably, the replacement of the London Interbank Offered Rate was identified by 38% of respondents as the main challenge of their function.
Technology, meanwhile, continues to be a pressing issue, with treasury teams becoming increasingly reliant on IT solutions. Here, data quality is rising up the list of concerns. Already highlighted as very or somewhat concerning in 2019 by 69% of respondents, the figure rose to 78% in 2020. Acquiring the necessary skill sets to realise the full benefits of this data and technology is also a continuing priority – with some progress registered from last year. In 2020, 30% of respondents say they have all the skills they need to manage technological change, up from 22% in 2018.
“Treasury’s focus on technology is not only helping teams operate more efficiently in a remote-working environment, it has long played – and continues to play – a key role in realising their long-term priorities,” notes Ole Matthiessen, Head of Cash Management, Corporate Bank, Deutsche Bank. The survey shows that
Release 1 | 2 managing relationships with banks and suppliers (highlighted by 32% of respondents) and collaborating with other functions of the business (also 32%) remain top of the agenda – and seamless digital systems will help give treasurers the bandwidth and insight to be more effective partners for both internal and external stakeholders.
Based on a global survey of 300 treasury executives, conducted between April and May, the survey explores stakeholders’ attitudes among corporate treasurers towards the drivers of strategic change in the treasury function – from the pandemic through to regulation and technology – and their priorities for the next five years.
Digital collaboration: Shaping the Future of Finance
By Ryan Lester, Senior Director of Customer Experience Technologies at LogMeIn
With heightened economic uncertainty and increased customer expectation becoming the norm in the banking industry, it is understandable that the sector is struggling to keep afloat. Due to its precarious nature, banking institutions are trying their best to ensure they remain relevant in the competitive landscape and guarantee that their customers continue to be a priority.
When it comes to the first half of this year, the pandemic has shown how easy it is for industries to fail. Customers and companies alike had to get used to the new normal, as physical locations started to close. The banking industry felt this first hand, as banks were made to restructure how their business ran, with restricted opening hours and a wider push to motivate people to use online banking.
While some had already embraced digital options prior to the pandemic, this proved to be a stark contrast to the elderly population, who frequently visited branches to access their finances. Moving forward, banks have to adopt new methods to ensure customers get the most out of our their accounts, without their experience suffering.
Heightened Customer Expectations
When the pandemic reached its peak, people were encouraged to use online banking, as telephone contact was under strain with long waiting times and pressure mounting on contact centre agents. According to Fidelity National Information Services (FIS), which works with 50 of the world’s largest banks, there was a 200% jump in new mobile banking registrations in early April, while mobile banking traffic rose 85%.
With branches remaining closed, customers were continuously being urged to limit the amount of calls they made to the most urgent cases and consider whether they could solve their answers through mobile online banking or checking the company website. Although already being adopted in pockets of the industry, this was a real catalyst that spurred banks to up their game on digital channels and with self-service tools.
Banks are challenged with precariously balancing customer needs with the cost of personalised support. With the demographic of customers changing over the last few years, customers are becoming increasingly younger and more comfortable with technology. Influenced by the “Amazon Effect”, their expectations have raised to an all-time high, placing record strain on the sector
Customer experience isn’t just about support anymore, it’s about serving your customer at every point in the journey. Companies have an opportunity to elevate the experience they provide by moving beyond one-and-done interactions to create continuous engagements with their customers. It is starting to become a primary competitive differentiator in the market and one that doesn’t have a lot of variation. Deploying AI chatbot technology will be able to strategically help banks improve customer experience and raise the level of support that agents provide.
Digital collaboration: Working around the Clock
The benefits of adopting digital channels and self-service tools are second to none. By implementing chatbots, fuelled by conversational AI, banks will be able to help serve a wide range of customer queries and ensure they are protected from fraud and scams.
Conversational AI is exactly what it sounds like: a computer programme that engages in a conversation with a human. When it comes to service delivery, conversational AI can be deployed across multiple channels to engage with customers in ways that effectively address evolving customer needs. At a time defined by COVID-19, self-service tools such a conversational chatbots can work around the clock to solve customer queries in a concise and timely way. Of course, self-service tools won’t completely replace human agents in the banking industry, but they will help companies re-distribute customer traffic and workflows in ways that enhance customer experience. Self-service tools fuelled by conversational AI can also improve employee experience because service employees can handle fewer, but higher-level service tasks that chatbots might escalate to them.
Adopting new tools to help facilitate consistent and concise answers and help maintain customer experience is on the forefront of many industry minds. Banks such as the Natwest Group have seen this first-hand and are testament to the benefits that a good digital experience can provide. Simon Johnson, Capability Consultant, Digital at NatWest Group highlights NatWest’s use of digital tools during lockdown, “Over the last few months, we’ve learnt how to use digital tools to help our employees remotely. From a banking perspective, there have been a lot of changes including base rates, waive fees and the best ways of contacting our vulnerable customers, ensuring we keep them protected from frauds and scams.
“By introducing our Bold360 chatbot interface, Ella, we’ve been able to get relevant information out quickly, apply the best practice and ensure that our customer journeys are being developed correctly. Due to the volume of questions, some of our customers were finding themselves waiting longer than usual. So digital channels become essential to helping reduce the wait time. Using Bold360, we were able to mitigate issues and answer questions in a more timely way through our chatbot.
“Moving forward, as we open more digital services, we are analysing our data to see if customer will return back to their usual way of banking, now that they’ve seen what a good digital experience can provide. Either way, with Ella, we are ready.”
Chatbots and Humans: The Best Option for Customer Service
Over the last year, banking institutions have recognised the power that digital collaboration can have to their success. Delivering exceptional customer service and support is key for any business wanting to stay competitive in today’s market and banks are especially challenged with precariously balancing customer needs with the cost of personalised support. Leveraging the right technology, such as AI-powered chatbots, will enable the banking industry to provide better support and a more robust customer experience in the long term. Other institutions must follow suit, or risk becoming obsolete.
What to Know Before You Expand Across Borders
By Sean King, Director of International Tax at McGuire Sponsel The American retail giant, Target Corporation, has a market cap...
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