Liquid Assets

Many companies had previously seen treasury as simply a function of risk management best practice, with little added value. But as the credit markets have tightened, treasurers at blue chips and beyond are finding their skills are now in far greater demand for effectively managing cash reserves and preserving liquidity.

Holding strategy Malcolm Cooper is president of The Association of Corporate Treasurers and is in his seventh year as group tax and treasury director at National Grid. He is responsible for managing the treasury function of the UK’s largest utility. With earnings last year over £1.2 billion at home and in the US, it’s perhaps surprising to learn that the cash reserves under Cooper’s direct control are less than one might expect.

But National Grid’s small cash reserves are still greater than the levels of just a few years ago. As Cooper explains, the levels are a reflection of the changing times. ‘If we look at what we’re doing now compared with maybe two years ago, we’re holding a lot more cash,’ he says. ‘Our strategy back then was to hold the minimum amount of cash we could, which could be as low as £5 million in the UK – although that was higher in the US.’

So can Cooper operate comfortably with such small amounts on deposit in the UK, given National Grid’s size and the volatility of energy markets? Put simply: certainty of cashflow.

‘In the UK, our big customers are the power supply companies and generators,’ he explains. ‘That means we have a great certainty of revenue: I can give you an accurate forecast of our revenue on any given day for the next 12 months.’

All of which adds up to a situation where National Grid’s UK treasury team has been able to reduce the levels it has on deposit to a point below most of its peers. ‘You can manage quite easily on £5 million in the UK,’ says Cooper.

This is in contrast to Cooper’s strategy in the US, which requires greater funding. ‘In the US, we have direct exposure to the cashflows of the customers,’ he explains. ‘While our customers in the UK are the Centricas of this world, the US is all about individuals. That means we’re much more at the mercy of when they want to pay their bills. If they decide to pay the bill on a Thursday, then we get the cash on a Thursday.’

For Cooper, National Grid’s US business is a separate challenge. Unpredictable cashflows and differing regulations surrounding the energy market make far greater demands on the company’s cash reserves compared with the UK.

‘It means we tend to hold more cash in the US, perhaps a few hundred million, in order to deal with the volatility of cashflow there,’ he says. Meanwhile, times have changed in the UK. Two years ago Cooper could afford to let reserves run down to £5 million. Now, the emphasis is on strength in numbers. ‘The big difference today is that we’re sitting on a lot more cash,’ he says. ‘That’s largely because there is less certainty with issuance. Now, we’re still fairly comfortable with issuance and we’re confident we can fund. But in times like these you have to do it opportunistically and do it when the market looks at its most attractive. You need to spot the right windows in which to issue, which inevitably means we hold more cash than we would have had a few years ago.’

Credit ratings

The issue of where blue chips place their cash is one of growing interest for a range of stakeholders. There is also increasing pressure on boards to justify the use of credit ratings in the wake of the banking scandals kicked off by Northern Rock. But while Cooper accepts the ratings system sometimes fails – ask the Northern Rock shareholders – he’s also adamant that companies such as National Grid have little choice but to follow the established route of ratings use.

‘I know there have been criticisms of credit ratings recently, and I can understand that, but they are still the best tools available,’ he insists.

For the record, financial analysts Moody’s lost 16% of its share price in May 2008 after claims its research had misled US investors. But for Cooper, it’s a simple issue: the ratings may have flaws, but the alternative simply won’t fly.

‘In my view, the alternative is to have a team of 30 in-house analysts sitting within the company doing a very complicated series of credit analyses,’ he says. ‘For National Grid that is simply unsustainable. But we have to rely on something and until something better comes along we’ll have to use them.’

Energy influence

It’s fair to say that of all the sectors affected by inflationary pressure, energy has seen the most stark and contentious price increases. From the fuel pump to the domestic market, energy prices have been creeping skywards for more than a year. Despite consumer pressure, some energy suppliers have had to increase prices by around 40%.

Added to that, the markets in general have been unpredictable, with commodity prices on the rise as yields continue to fall. All this means that the treasury function in blue chips has risen further in its importance to overall risk management strategies, and so Cooper and his team are taking a more interventionist approach to their investments, aware that there is more likelihood of being required to justify certain investments in the event of losses.

‘The thing we do differently now, which is definitely a change, is taking more of an interest in what the money market funds are investing in,’ he says. This will usually involve Cooper’s team occasionally checking with a range of funds in order to ascertain what their exposure to various products is. ‘We need to be comfortable with their mandate before we put any money in, but once we have cash in there, we like to ask them for their asset allocation,’ Cooper says. ‘And we’ll look at where the money is invested and consider whether it’s doing the right thing.’

In Cooper’s view, what are the red flags for the treasury director to watch out for? ‘We’re interested in the mix across the board,’ he says. ‘But specifically if we see a situation where the fund might have invested in some highly structured products, that’s when we take notice. Most of the funds have some structured products in their mix of some description but when that gets too much, that’s when I get concerned.’

Given the skittishness of so many private large investors when it comes to risk management (and the inevitable reporting of it), the atmosphere among the money managers has come to reflect the need for reassurance among those investing. Cooper has seen this first hand. ‘The last year has seen that scrutiny increase,’ he says.

One step ahead

The credit crisis has created a much more risk-averse approach among the treasury community, according to Cooper. ‘Two years ago we would have been less interested in the underlying assets of the fund,’ he says.

‘We’d have simply gone for the fund and assumed that as a AAA it was fine. Now we’re much more interested in where we’re investing. The funds are used to that level of interest at the moment – they’re happy to give us their asset allocation analysis at the drop of a hat and you can make a judgement in the space of an hour or so.’

All this adds up to a more considered approach to risk within the National Grid treasury function. Fortunately for Cooper, the amounts on deposit mean the volatility currently affecting global markets has not significantly impacted National Grid and to date and it would appear that National Grid has found itself ahead of the curve on this issue.

It’s also worth noting that throughout the last year of market uncertainty Cooper has kept National Grid’s treasury strategy simple – and that includes technology.

‘We don’t have any sophisticated dashboards or bespoke software to help with liquidity management,’ he says. ‘As an organisation, if you compare us with a company such as GlaxoSmithKline, who might have cash scattered across 100 countries in various funds and operating companies, ours is much simpler.’