The Aftermath of a Crisis
The credit market crunch that started in August 2007 has had a widespread impact on the treasury community’s liquidity management practices. Unlike in any previous market downturns, this credit market crisis started with a popular cash investment vehicle, asset-backed commercial paper, and continued with a system-wide shutdown of another, auction rate securities. Treasury managers are now retooling their cash investment practices to cope with a new back-to-basics paradigm. Such changes have included closer scrutiny of existing investments, re-evaluation of investment policies, increased concentration in money market funds and Treasury securities, and curtailing investments in less liquid securities1. During this paradigm shift, there has likely been increased focus on the suitability of the broker cash management model. In efforts to strengthen their fiduciary control over cash investment practices, corporations that outsourced these functions to brokerage outfits may now be reassessing the advantages and potential drawbacks of this decision.
What, then, is the broker model? Has the model served the treasury community well? Did it perform well during the current crisis? If not, can it be repaired? What does the future hold? These are some of the questions that first come to mind. Although the “fee vs. no-fee” debate has been ever-present among outsourced investment options, the credit crisis and the new paradigm shift may help practitioners refocus their attention on the risk control aspect of these relationships. In shedding light on this subject, we hope that treasury executives and audit committees can come to their own conclusions on the validity of the model. Also, in the interest of full disclosure, the author of this article is employed by a registered investment advisor which competes with the brokerage community for cash investment businesses.
The Broker Model – A Crossover
In a typical treasury organization, there are generally a handful of options for investing excess cash: a) money market funds, b) direct purchases of Treasury bills, commercial paper, or bank certificates of deposit, and c) outsourced solutions. The broker model most often attempts to combine the latter two options.
In a typical direct purchase relationship, a treasury organization has a dedicated investment staff making purchases from a number of brokerage firms through brokers who facilitate trade execution and make certain trade recommendations. The internal treasury staff monitors liquidity needs, makes investment decisions, initiates trades, and ensures compliance. In an outsourced solution with an advisor, the investor hires one or more outside managers to oversee the cash account on its behalf. With a set of investment guidelines, the advisors make “discretionary” investment decisions without the investor’s daily intervention. It is also common for an investor to have both direct purchase and outsourced relationships.
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