18 May 2015
Making sure we can pay our bills - the mysteries of Group Treasury revealed
Group Treasury’s role is to ensure that Legal & General has sufficient liquidity to meet all our commitments as they fall due. Put very simply, we make sure that we can pay all our bills, on time, all of the time.
It’s worth highlighting at this point that I’m talking about our own money. We actually look after £709 billion of customer funds. Our regulators have set out a very robust framework, which means we protect our customer money separately from our own corporate money.
Corporate liquidity management can sound very complex. You’ll hear me talking about liquidity requirements, liquidity resources, cash flow analysis, liquidity coverage ratios, liquidity stress tests etc. But it’s really very straightforward and very similar to what we do as individuals in running our own personal or household finances.
We invest our surplus assets in a range of investments including equities, bonds and property. This isn’t that different to the average UK household which may have equities or bonds in a pension or ISA or might even own residential property.
This is the process where we set out how much we need to pay our day to day bills. This includes salaries, interest on our debt, dividends, paying suppliers, utility bills, taxes etc. As you can see, this is the same process for households when they plan what they need to pay for food, mortgages, utilities bills, taxes etc.
Group Treasury then calculate how much money we’ve coming in. This could be internal dividends arising from the profits of the group’s businesses, money from the debt that we raise in the market, return from our investments. Again individuals and households do the same thing: calculating how much they receive from wages, savings etc.
Cash Flow Forecasting
Every day we forecast our cash flow, ensuring we know when there are large payments due. We might need to sell some of our investments or to take out a short term loan to make sure we’ve enough cash to meet a particularly large payment. The more detailed the cash flow forecast, the more accurate it will be. In turn, this allows us to manage our cash more efficiently giving us a better return. We invest our surplus cash taking account of when it may be needed in the future. Our cash flow forecasts take into account our liquidity resources and our liquidity requirements.
Typically, our cash flow forecasts look forward for three months. Our weekly or monthly cash flow forecasts look at one year in the future.
Liquidity Coverage Ratios
Liquidity coverage ratios (LCRs) are a very simply way of comparing our liquidity resources to our liquidity requirements.
Typically the LCR is the liquidity requirements divided by the liquidity resources.
We manage the business and our cash to ensure that this is above a specified level. We always want it to be more than 100%! Depending upon the regulatory environment that any given company operates in, there may be specific regulations setting out how theLCR is calculated. We also calculate theLCR over a number of periods, say 1 week, 3 months and 1 year to ensure that we have sufficient liquidity to cover cash requirements, which are not in the immediate future.
Individual and household may not do very detailed calculations but we often think about whether we have enough money to pay the annual car insurance or the annual family holiday in 6 months’ time. This is just another form of cash flow forecasting and liquidity coverage ratios.
Liquidity Stress Tests
As well as looking at whether we have sufficient money to pay our bills in the normal course of events, we also consider what happens if we are in a time of stress. Or put simply, do we have enough cash if things get really bad?
In one of the liquidity stress tests we consider what happens we can no longer borrow any external money for say three or 12 months. We then calculate whether we’ve enough internal resources to pay our bills. We take all our internal resources into account including cash in the bank, money on short term deposits and long term investments in the form of equities and bonds.
There are certain longer term investments that we would prefer not to sell, that may be difficult to sell or can only be sold at a knock down price. We factor all these into the equation. A liquidity stress is similar to thinking about what would happen if we were to lose our job. We would consider what cash we have and whether we got enough money to see us through until we get a new job. Similarly, we would consider what savings we have and which items we would sell first.
Liquidity stress testing is a very important tool in managing our business. And depending upon the regulatory environment that any given company operates in, there may be specific regulations setting out how we carry out the liquidity stress test.
So you see, we take liquidity very seriously at Legal & General. We’ve developed detailed processes to measure and forecast our liquidity both in normal conditions and also in stress conditions.