THE CLASH FOR CASH ATTRACTING CORPORATE LIQUIDITY IN ASIA PACIFIC WITHOUT A TRANSACTION BANKING FRANCHISE

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1 Financial Services THE CLASH FOR CASH ATTRACTING CORPORATE LIQUIDITY IN ASIA PACIFIC WITHOUT A TRANSACTION BANKING FRANCHISE AUTHORS Christian Edelmann, Partner, Head of Asia-Pacific Region Ben Quinlan, Manager, Corporate and Investment Banking Practice

2 INTRODUCTION A decade-long run of bumper profits, coupled with reduced capital spending in response to uncertain macroeconomic conditions, has seen corporates in Asia Pacific amass record cash reserves in recent years. Listed regional corporates alone held US$2.3 TN in cash at the end of With banks continuing to deleverage and on-going economic uncertainty, these cash holdings are likely to remain elevated in the medium-term. With so much excess corporate cash in the market, banks have entered a battle for corporate liquidity. This battle has been intensified by the Net Stable Funding Ratio (NSFR) requirement of Basel III, which will create sizeable shortfalls in deposit funding for many institutions. It is widely believed that only banks with strong transaction banking capabilities can effectively compete for corporate cash. We disagree. While transaction banks will continue to remain dominant players in managing operational corporate cash, there is an untapped opportunity for banks with no or subscale transaction banking offerings to compete for excess cash. These players can use their corporate advisory relationships to introduce structured deposit products or asset management capabilities to corporates sitting on sizeable cash stockpiles. This applies primarily to the traditional investment banks but also a range of Asian banks without meaningful transaction banking capabilities. The current dynamics of subdued core investment banking revenues, significant excess cash on corporates balance sheets and a low yield environment creates an ideal opportunity for advisory teams to engage corporate treasurers in such cash management dialogue. Additionally, as strategic financial advisers to corporations, advisory bankers can talk about corporate cash reserves as part of a broader balance sheet structuring discussion. Oliver Wyman has helped several banks to pursue this opportunity. The more successful of them have achieved additional funding of between US$5 10 BN and recurring revenues of US$20 50 MM p.a. In the new normal environment, this is an opportunity too important to ignore. Copyright 2013 Oliver Wyman 2

3 1. OVERVIEW OF THE CORPORATE CASH MARKET IN ASIA PACIFIC As Asian economies continue to grow rapidly, Asian listed corporates are performing well. Since 2007 their revenues have increased by more than 25% per annum. Rather than dispersing profits to shareholders or making new investments, however, Asian corporates are building up large stock piles of cash for three reasons. Firstly, the global financial crisis (GFC) encouraged many companies to accumulate cash reserves as a shield against a slowdown in consumer spending and the threat of an economic meltdown in the US and Europe. Secondly, they sought to reduce their dependence on funding from banks, whose post-crisis deleveraging caused them to restrict their lending to corporates. Thirdly, technological advances have reduced production and delivery times and allowed corporates to adopt just-in-time production models. The cash that once financed stock piling of inventories now instead sits in transaction banking accounts. Advances in technology have also seen companies move from labour-intensive production processes (requiring continuous cash outlays to meet wage demands) to capital-intensive production processes, which have lower operating cash requirements. Research & Development (R&D) investments have also increased in recent decades, with lower asset tangibility and higher external funding constraints requiring companies to hold larger cash buffers to offset cash flow disruptions associated with their R&D spend. From , cash and cash equivalents held by listed companies in Asia Pacific grew at a compound annual growth rate of 17%, totalling nearly US$2.3 TN by the end of 2012 (see Exhibit 1). While worldwide cash reserves have also grown at a considerable pace over the same period, Asia Pacific corporates have led this charge and now hold over 46% of corporate cash globally (up from 36% in 2007). Emerging markets contributed the lion s share of this growth, with cash holdings soaring by 26% per annum since Companies in mature Asian markets hold a lower but fairly stable 9% of their assets in cash (though still above the 7% held by their European and American counterparts), whereas emerging market multinational companies (MNCs) hold cash allocations closer to 14% of total assets. Copyright 2013 Oliver Wyman 3

4 Exhibit 1: CORPORATE CASH HOLDINGS OF LISTED COMPANIES BY REGION AND INDUSTRY CORPORATE CASH HOLDINGS YEAR END CASH HOLDINGS*, US$BN APAC Share % % APAC 5-Year CAGR: 17% % % % ,149 1,283 1, % ASIAN CASH HOLDINGS BY SECTOR 2011 Consumer staples 7% Materials 11% Other 16% IT 16% Industrials 30% Consumer discretionary 20% Africa/Middle East Latin America Europe North America APAC mature** APAC emerging * Cash and cash equivalent items including all short-term investments with three months to maturity Other (includes telecommunication, energy, healthcare and utilities); consumer staples (food and beverages); consumer discretionary (apparels, textiles, durables) APAC emerging: China, India, Indonesia, Philippines, Thailand, Vietnam ** APAC mature: Australia, Hong Kong, Japan, Singapore, South Korea, Thailand Source: Capital IQ, Oliver Wyman analysis China, while difficult for foreign players to access, has been the driving force behind much of the growth in corporate liquidity, with cash balances of listed Chinese companies totalling US$729 BN in 2012, up 250% from 2007 levels. Japan, the largest hub of corporate liquidity in the region, saw more modest growth over this period, with cash positions of listed Japanese corporates rising by 14% per annum to US$863 BN. While much smaller, the cash holdings of Southeast Asian corporates also grew strongly, up 16% per annum since 2007, with Indonesia a standout performer (up 22% per annum from ). Many of the region s biggest holders of cash are domiciled in Japan and China, though a growing number of cash-rich corporates can be found in other countries across the region. In Southeast Asia especially, we see an increasing number of companies with cash holdings at levels similar to more mature Asian markets (see Exhibit 2). Copyright 2013 Oliver Wyman 4

5 Exhibit 2: APAC CORPORATE CASH POOL BY MARKET (LISTED COMPANIES) Wilmar 8.6 Tokyo Electric 21.2 Singapore Airlines 4.0 Toyota 15.8 Genting Bhd 6.0 Petronas Chem. 3.0 Indofood 1.4 Korea 110 5% Japan % Samsung 16.9 Hyundai 6.7 Astra Int. 1.3 Infosys 2.7 TCS 1.2 PTT Public 4.5 Banpu 0.7 SE Asia % HK 156 8% China % Taiwan % Hon Hai 19.3 Quanta Computer 11.0 Hutchison 12.3 PetroChina 16.8 China Mobile 15.2 Rio Tinto 7.1 BHP Billiton % China State Constr. Eng US$BN Year CAGR Source: Capital IQ, latest available of FY2012 and Sep 2012, Oliver Wyman analysis There is also a substantial pool of cash sitting on the balance sheets of unlisted corporations across the globe. Estimates of total cash positions held by non-financial companies range as high as US$18.5 TN globally (more than 3x the US$5 TN listed cash pool), of which ~US$8 TN (41%) is held in Asia Pacific. 1 However, most of the cash in the unlisted space is held by small to medium enterprises, middle market enterprises and smaller private companies which cannot be effectively covered by large global banks. Whether listed or unlisted, it is important to note that only a small fraction of the cash pool in Asia is held as operational cash (i.e. cash used to manage day-to-day operations of a company and often tied up in demand deposits or transaction accounts). The remainder, which we estimate to be 70-85% of total cash positions, 2 is held as excess cash, which is considerably less sticky and presents the core opportunity for non-transaction banks to compete in the emerging clash for cash. 1. Economist Intelligence Unit estimates (EIU) 2. According to the FDIC, ~88% of corporate cash in the United States is considered excess cash (see Oliver Wyman report Attracting and Managing Corporate Deposits, 2012) Copyright 2013 Oliver Wyman 5

6 2. THE CLASH FOR CASH IN ASIA PACIFIC The battle to attract corporate cash reserves in Asia has been intensified by three key drivers. Firstly, Basel III regulations require banks to meet a long-term Net Stable Funding Ratio (NSFR). The NSFR stipulates that a bank s liabilities should be at least as stable as its assets: that is, that the expected maturity of the liabilities should be at least equal to the maturity of the assets. NSFR requirements will create a large shortfall of stable funding that will need to be addressed by 1 January Because deposits are the cheapest and most stable source of funding, they are in high demand to fill this funding gap. 4 Secondly, evidence of capital-flight from Asia following the GFC, coupled with persistent macroeconomic uncertainty, prompted some local regulators to protect depositors from exogenous shocks by ring-fencing domestic liquidity. In line with their early adoption of Basel III, several Asian countries have requested foreign subsidiaries build an increasingly self-sufficient domestic deposit base rather than rely on their parent company for funding support. This has put foreign banks in Asia under particular pressure to raise local funding. To make matters worse, many emerging markets in the region have also sought to protect domestic banks from increased competition by imposing regulatory burdens on foreign banks. For example, foreign banks in China face quotas on foreign debt and restrictions on their choice of branch location. 3. Asian countries are at the forefront of enacting these new liquidity rules. Most have already published a draft set of implementation rules, and Singapore and Japan are set for implementation in Short-term operating cash is considered most valuable to banks under Basel III, given 95% of the deposit balance is considered stable Copyright 2013 Oliver Wyman 6

7 Thirdly, recent years have witnessed loan issuance outpace deposit growth across several Asian markets, further intensifying competition to attract deposits. This is especially the case in Hong Kong, Singapore and Indonesia, where loan-to-deposit ratios (LDRs) increased post-gfc (see Exhibit 3). Exhibit 3: LOAN-TO-DEPOSIT RATIO % Hong Kong Singapore Indonesia Source: HKMA, MAS, Bank Indonesia, Oliver Wyman analysis Copyright 2013 Oliver Wyman 7

8 3. COMPETING FOR CORPORATE LIQUIDITY WITHOUT A TRANSACTION BANKING FRANCHISE Corporate deposits are captured primarily by large corporate and transaction banks on the basis of the superior cash management services they offer clients. Many of these banks promote their cross-border and domestic sweeping capabilities, as well as their notional pooling and aggregation services (combining the information and balances on multiple accounts into a single account), as a mechanism to increase returns on idle cash. Most of the larger regional banks market their complete set of transaction banking services, as well as their market intelligence and liquidity investment strategies. By offering a one-stop-shop transaction banking service, these banks position themselves to capture all of their clients cash. Nevertheless, banks with limited capabilities in transaction banking now have an opportunity to capture corporates excess cash. Low interest rates and resulting global inflationary pressures are eroding real returns on cash. This presents an opportunity for players with advisory capabilities to sell structured products or asset management services to corporates seeking to enhance yields on parts of their excess cash. The one-stop-shop cash management proposition makes sense for operational cash. For excess cash, yield is another issue. Moreover, Asian corporates may be unusually open to pitches from rivals to their main transaction bank, with about 80% of Asian MNCs maintaining over 10 different banking relationships, compared to only 40% of North American and European MNCs. Asian treasurers are also becoming increasingly sophisticated in their use of financial products. Continued economic uncertainty is deterring many companies from making acquisitions or other large investments plans. A large number of deals are still on hold. This gives advisory bankers the opportunity to offer alternative, annuity-style revenue products, and thereby remain relevant to client C-suites. As strategic financial advisers to corporations, advisory bankers can provide advice on excess corporate cash holdings as part of a wider discussion on balance sheet management. Copyright 2013 Oliver Wyman 8

9 When non-transaction banks target corporates as potential cash clients, the size of their cash holdings should serve only as a starting point. The likelihood that this excess cash will find its way to investment products is just as important. A successful approach will involve: Start in the right places Target clients where the bank has deep C-suite advisory relationships as this will provide the best access point for any potential cash management dialogue. In most cases, this will be where the bank is regarded as a trusted M&A or capital markets advisor Focus on Treasurers and CFOs who have the requisite risk appetite and budgets that allow them to undertake structured product or fund investments. These are likely to include owner-managed and controlled companies, as well as larger unlisted firms. Opportunities should also arise from newly listed IPO clients Exhibit 4: CLIENT SELECTION BASED ON FINANCIAL RATIOS Company Cash US$BN Company1 * 11.1 ASSET COMPOSITION LIQUIDITY SOLVENCY OTHER Cash: current assets Current assets: total assets Current ratio Solvency ratio Interest cover Score Company Company Company Company Company Company Company Company Company Company Company Company Company Company Above industry average/attractive At industry average/ less attractive Below industry average/unattractive * Disguised corporate examples benchmarked against industry sector specific average. Cash figure is place holder An interest cover ratio of four and upwards is considered healthy and is the average benchmark applied to all industries in this table Copyright 2013 Oliver Wyman 9

10 Assess the client s capacity to invest Evaluate target clients cash profiles by using a number of readily-available financial ratios, which should help identify whether the client is holding too much cash. An example of our recent work with an Asian bank is shown in Exhibit 4 Use knowledge of the client s strategic agenda to evaluate their capacity to invest their excess cash holdings in managed funds or structured products: What are the company s ongoing working capital requirements? Does the company have any pending acquisition, divestiture, or share buyback plans? What is the company s forecast dividend pay out ratio for the coming financial year? Offer the right products Identify the client s risk appetite to determine the most appropriate product offering Leverage the bank s product capabilities/relative strengths (see Exhibit 5) Exhibit 5: APPROACHES FOR ATTRACTING CORPORATE CASH STRUCTURED PRODUCTS CAPABILITIES ASSET MANAGEMENT CAPABILITIES STRONG CREDIT RATING Leverage credit worthiness to attract clients with significant risk aversion (i.e. those with counterparty risk concerns) Suited to clients seeking highly tailored product/ geographic exposures offering capital protection Leverage strong investment track record and competitive pricing Suited to clients seeking more liquid investments with a strong aversion to sizeable single-name exposure (irrespective of credit rating) Structured products: best offered by banks with strong credit ratings and/or product manufacturing capabilities, with ability to offer capital protection, dual currency exposures or yield enhancement. Alternatively, banks with weaker credit ratings are well positioned to offer higher yielding products to clients with greater risk appetite. Lightly structured products represent a key opportunity for many banks in Asia, given their more basic manufacturing capabilities WEAKER CREDIT RATING Use high margin liability products (structured notes/longer-term repo agreements) to strengthen funding base and credit rating Suited to clients with an aggressive risk/return profile Leverage strong investment track record and competitive pricing Suited to clients seeking more liquid investments and sensitive to counterparty credit ratings Fund products: best offered by banks with weaker credit ratings and/or product manufacturing capabilities but with a strong investment track record and competitive pricing on money market products Copyright 2013 Oliver Wyman 10

11 4. REVENUE AND FUNDING BENEFITS Corporate cash represents a multi-billion dollar funding opportunity and sizeable revenue pool for non-transaction banking players in the region. A number of successful players have achieved wholesale funding benefits of between US$5-10 BN and recurring revenues of US$20-50 MM p.a. A sensitivity analysis highlights the potential revenues an individual bank can earn based on (i) the amount of excess cash captured and (ii) the margin on products sold (see Exhibit 6). Our analysis highlights that for every US$1 BN of excess cash captured, individual players stand to earn between US$1-10 MM p.a. with revenues heavily dependent on the products being sold. Exhibit 6: INDIVIDUAL BANK REVENUE POTENTIAL BASED ON EXCESS CASH CAPTURE AND PRODUCT MARGINS EXCESS CASH CAPTURE (US$MM)* Products (BPS margin) 2,000 4,000 6,000 8,000 10,000 12,000 BANK CAPABILITIES/CLIENT RISK APPETITE High Margin Low Margin Money market Fixed income Equity Alternatives Complex structured products Local/regional players Competitive pricing and basic product capabilities Attractive pricing and sophisticated products Regional/global players DEPTH AND SCALE OF CORPORATE/ADVISORY RELATIONSHIPS * Excess cash captured by sample investment banking client Source: Oliver Wyman proprietary data and analysis Copyright 2013 Oliver Wyman 11

12 For a bank s asset management arm, corporate cash represents a largely untapped (and sizeable) source of net new money (NNM). Success depends on a bank s investment track record and its ability to price competitively (especially for money market products). A bank with sophisticated structured product capabilities can offer higher-margin products and operate in a less crowded space. While a client s risk appetite and financial sophistication will shortlist the range of structured products they are willing to invest in, a recent survey has identified liquidity, security and counterparty rating at the top of Asian corporate treasurers agendas when it comes to making investment decisions. 5 Selling structured products, including structured notes and medium-to-long-term repurchase agreements, will also allow non-transaction banks to tap into additional sources of funding, as well as remove excess risk concentrations off their balance sheets. These structured notes can provide principal protection and fit a client s investment profile by being linked to a spectrum of underlying assets, indices, interest rates, funds, commodities and foreign currencies. In the current low-interest-rate environment, a structured note paying initial coupons that exceed market interest rates is a potentially attractive proposition. Here, investment banks can market their strong product manufacturing capabilities, while a number of local and regional players will be able to leverage their strong credit ratings. Structured products, which may include vanilla credit-linked notes (CLNs), principalprotected notes (PPNs) and exchange-traded notes (ETNs), with maturities of 12 months or greater are well suited to addressing the Basel III long-term funding requirements. Basel III stipulates that liabilities with maturities exceeding one year will contribute 100% of their value to available stable funding. However, borrowings and liabilities with embedded options that would reduce the expected maturity to less than one year, or shorter-dated unsecured wholesale funding, contribute only 50% of their original value to the NSFR (see Exhibit 7). 6 The new funding regulations will come into force in 2018, at which point structured notes can be synthesised with incentives to increase lock-in periods. While structured products can be used to unlock the wholesale funding market, they can also be used in their own right as high-margin, revenue generating products. 5. Asia Pacific Corporate Treasury Benchmarking Survey 2011, Treasury Today/JP Morgan 6. Note that Basel III is yet to be finalised in several Asian countries, which may impact the funding benefits tied to certain structured products Copyright 2013 Oliver Wyman 12

13 A few non-transaction banks have already begun to market their asset management and structured product capabilities to cashed-up corporate clients, primarily through their corporate advisory departments. Not only has this helped them develop their advisory relationships through the provision of a broader, more holistic service offering, but it has proven to be a lucrative source of annuity income at a time when more traditional capital markets revenues have come under pressure. Exhibit 7: BASEL III AVAILABLE STABLE FUNDING (ASF) ASF FACTOR COMPONENTS OF ASF CATEGORY 100% The total amount of capital, including both Tier 1 and Tier 2 as defined in existing global capital standards issued by the Committee The total amount of any preferred stock not included in Tier 2 that has an effective remaining maturity of one year or greater taking into account any explicit or embedded options that would reduce the expected maturity to less than one year The total amount of secured and unsecured borrowings and liabilities (including term deposits) with effective remaining maturities of one year or greater excluding any instruments with explicit or embedded options that would reduce the expected maturity to less than one year. Such options include those exercisable at the investor s discretion within the one-year horizon 90% Stable non-maturity (demand) deposits and/or term deposits with residual maturities of less than one year provided by retail customers and small business customers 80% Less stable non-maturity (demand) deposits and/or term deposits with residual maturities of less than one year provided by retail and small business customers 50% Unsecured wholesale funding, non-maturity deposits and/or term deposits with a residual maturity of less than one year, provided by non-financial corporates, sovereigns, central banks, multilateral development banks and PSEs 0% All other liabilities and equity categories not included in the above categories Source: Basel III: International Framework for liquidity risk measurement, standards and monitoring Copyright 2013 Oliver Wyman 13

14 5. WHAT IS NEEDED TO MAKE THIS WORK? Players without transaction banking capabilities who nevertheless aim to tap into the corporate cash market will need some key enablers (see Exhibit 8). These fall into three categories; customer proposition, people proposition and business model. Exhibit 8: KEY ENABLERS CUSTOMER PROPOSITION PEOPLE PROPOSITION BUSINESS MODEL Selecting the right clients What clients offer the most attractive revenue/funding opportunities? Which of these clients do banks have the best relationships with? Of these, which has both the willingness and ability to invest their excess cash? Offering the right products To what extent are products differentiated from those offered by leading transaction banks? Are these products able to provide clients with appropriate risk/return trade-offs? Is there scope to tailor investment products better suited to corporate clientele? Providing appropriate incentives Are advisory bankers provided with incentives to make relevant introductions? Are these incentives appropriately calibrated for the relevant stakeholders? Is there commitment from senior management to build a more integrated business model? Educating internal stakeholders Are investment teams aware of broader, strategic objectives of the bank s corporate clients? Is there a way to promote cross-business success stories? Are investment bankers aware of the range of investment products on offer and do they understand the relative strengths/weaknesses of each of their clients? Ensuring sufficient resourcing Can the bank s existing resources be leveraged to effectively target this opportunity? Should coordination between departments be managed centrally or on an ad-hoc basis? Is there appropriate back and middle office support to cater for new business activity? Prioritising businesses Is there an appropriate balance between deal and non-deal related pitch/ execution activity? Is it clear which department will have veto rights on client coverage decisions? How should the conflict between long-term nature of AM revenues and lumpy nature of advisory revenues be addressed? Managing associated risks Can the bank effectively manage the risks associated with a larger structured products book? How will the bank manage the risks associated with poor product/ investment performance? How do these risks fit within the broader risk management and funding profile of the bank? Copyright 2013 Oliver Wyman 14

15 6. HOW WE CAN HELP Over the last year, Oliver Wyman has advised a number of non-transaction banks on how best to access the corporate cash space. Our client work typically involves a number of key work streams: Opportunity sizing Reviewing competitive landscape Defining target markets, industries and accessible cash pools (leveraging broader industry expertise) Establishing client selection framework and target accounts Identifying appropriate product offering based on client selection framework Quantifying potential funding pools and revenue streams Designing roadmap Identifying operational and organisational enablers Setting up appropriate incentive structures (e.g. revenue-sharing arrangement, KPIs) Establishing prioritisation framework between deal and non-deal related business Conducting deposit characterisation analysis to determine deposit volatility and stickiness Recommendations on enhancing risk management framework associated with structured products Streamlining product approval process Designing implementation blueprint Our approach has helped several clients increase the value of their investment banking relationships, as well as address broader funding concerns. Our most successful clients have been able to achieve additional funding of between US$5-10 BN and recurring revenues of US$20-50 MM p.a., a target we see as realistic for other banks looking to tap into this opportunity. Copyright 2013 Oliver Wyman 15

16 Oliver Wyman is a global leader in management consulting that combines deep industry knowledge with specialised expertise in strategy, operations, risk management, and organization transformation. For more information please contact the marketing department by at info-fs@oliverwyman.com or by phone at one of the following locations: ASIA PACIFIC AMERICAS EMEA Copyright 2013 Oliver Wyman All rights reserved. This report may not be reproduced or redistributed, in whole or in part, without the written permission of Oliver Wyman and Oliver Wyman accepts no liability whatsoever for the actions of third parties in this respect. The information and opinions in this report were prepared by Oliver Wyman. This report is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accountants, tax, legal or financial advisors. Oliver Wyman has made every effort to use reliable, up-to-date and comprehensive information and analysis, but all information is provided without warranty of any kind, express or implied. Oliver Wyman disclaims any responsibility to update the information or conclusions in this report. Oliver Wyman accepts no liability for any loss arising from any action taken or refrained from as a result of information contained in this report or any reports or sources of information referred to herein, or for any consequential, special or similar damages even if advised of the possibility of such damages. The report is not an offer to buy or sell securities or a solicitation of an offer to buy or sell securities. This report may not be sold without the written consent of Oliver Wyman.