‘A turn in the road is not the end of the road, unless you fail to make the turn’ - Anonymous
Household pets have been covering their ears. During the first calendar quarter, once reticent finance executives, and finance-engaged CEOs, of B.C. and ON credit unions may have been raging expletives. It’s been a frustrating, challenging and unfamiliar period. Financial instruments once wholly alien to small Canadian credit unions, perhaps large ones too, are now commonplace. A whole new lexicon of investment terminology has been explored, digested and applied. Stakeholder reporting may have underwhelmed expectations. New journal entries may have being imagined from first principles. Financial reports and risk oversight may require a refresh. BCFSA has a new guideline and a new regulatory report (and several consultations). And your prudential supervisor Relationship Manager has requested a touch-base video conference call, again.
Note: A formatted, graphical PDF version of this article is available at https://www.bitly.com/rm-hqla
Almost two years ago, FICOM issued a decree. The ‘mandatory liquidity pool’ structure was dead. It had been used for decades to execute credit union compliance with Liquidity Requirement Regulation of the B.C. Financial institution Act and equivalent ON legislation, and as a contingent funding source. Jumping to 2021, substantially all B.C. and ON credit unions likely now have portfolios of fixed income securities, held in legally ring-fenced trust accounts, on their balance sheets. Forget proportionality. Regulatory changes impacted the largest and smallest credit unions alike. Identical regulatory reporting requirements and frequency. Hopefully Canadian consumers can sleep a lot more easily each night, safe in the knowledge that their cooperative financial institution has lower systemic liquidity risk due to it directly holding a ring-fenced portfolio of high quality liquid assets. Or not. Retail banking, it seems, is a whole lot more complex than it used to be.
‘Forget proportionality. Regulatory changes impacted the largest and smallest credit unions alike. Identical regulatory reporting requirements and frequency. ’ - Ross McDonald
Credit unions should reflect on unpleasant realities. Fixed income securities, once the domain of second-tier entities and wholesale banks, are new to substantially all credit unions and executives. Regulatory guidelines, prudential supervisory expectations, and regulatory reporting in regards liquidity management have escalated to a level unimaginable only a few years ago. This new world seems a permanent, irreversible change. It may contribute to collaboration, amalgamation or other strategic discussions. Any credit union that fails to duly adapt is likely to experience the relentless intervention wrath of its financial regulator.
In the spirit of cooperative values and wiser together, below are several treasury tactic ideas that smaller credit unions may consider in regards statutory liquidity deposits.
First, consider radical simplification. In January 2021, Central 1 Credit Union terminated legacy term deposits and migrated equivalent portfolio of fixed income securities. This provided member credit unions with duly equivalent exposure. Credit unions may continue in this way. But there is no such compulsion. Central 1 Credit Union, and its peers, are now service providers to be duly instructed. Credit unions have discretion in selection of asset manager and in the establishment of related investment strategy. Academic research highlights the ‘cost of complexity’. Were it so inclined then a credit union could consciously instruct its asset manager to discard all fixed income securities and hold familiar bank deposits, provided that they satisfy HQLA criteria. Perhaps lesser yields may result. But the potentially material simplification of accounting journals, risk management and/or resourcing costs could make such an approach attractive. This approach aligns with strategic practice of choosing ‘where-to-play’. Perhaps treasury, for some smaller credit unions, is somewhere not-to-play. K.I.S.S. is a timeliness axiom for a reason.
‘a credit union could instruct its asset manager to discard all fixed income securities and hold familiar bank deposits, provided that they satisfy HQLA criteria’ - Ross McDonald
Second, constrain portfolio scope. Many types of securities qualify as High Quality Liquid Assets. A regulator may recommend, or require, that an Investment and Lending Policy provide detailed criteria of securities attributes (e.g. credit rating) for each security type. For example, if ILP states that corporate bonds are acceptable as a security type then it may need to state which issuers, industries, credit ratings or other attributes are acceptable or unacceptable. A credit union may determine that some potential HQLA security types are undesirable. Maybe the credit rating specification is unfamiliar. Or perhaps the accounting journals are troublesome. A credit union may direct its asset manager not to hold corporate bonds, mortgage backed securities or another type of HQLA. This approach may align with the concept of competitive advantage. Perhaps being good-enough at treasury management is just that - good enough.
Third, evolve oversight. Finance & Risk reporting should include Liquidity Adequacy Ratio. Prudential supervisors appear to have sharpened their liquidity compliance. The legacy broadly defined Statutory Liquidity Ratio has been effectively replaced by a more restrictive Liquidity Adequacy Ratio. Most liquidity held by a credit union outside of the in-trust account(s) does not count towards its compliance with legislative requirements. As part of ‘Quality of Risk Management’, assessment prudential supervisors may be re-reviewing executive expertise and board oversight of liquidity management. This approach may align with measuring what matters. Your friendly regulator may have said that LAR% now matters.
‘As part of Quality of Risk Management assessment, prudential supervisors may be re-reviewing executive expertise and board oversight of liquidity management.’ - Ross McDonald
Fourth, expectation management. Despite commendable enthusiasm, executive/board committees and boards may be content to receive limited reporting on key finance & risk topics. At least for an initial period. Reporting from an asset manager, custodian or other service provider may well be evolving in its rigour, scope or timeliness. Trailblazing credit union executives may have already designed comprehensive internal reporting. Smaller credit unions likely have not. Patience can be a virtue, and may save duplicated effort. Whether as part of mandated work scope; a response to industry feedback; or to mitigate threats from circling competitors then asset manager and/or other service providers have every incentive to provide appropriate reporting at their earliest convenience.
Fifth, professional development. Treasury competences are now cool in credit unions. Who’d have ever guessed that! Executive Asset & Liability Committees and board Investment & Lending Committees may find unfamiliar and elevated stakeholder attention. Some finance executives may need to brush up on technical knowledge of financial instruments. Or to initiate accelerated training. Scary times perhaps. Finance executives with a growth mindset may view HQLA as a wonderful opportunity to expand product knowledge; to extend functional maturity; and to better serve the business and membership. Executives with a curious mindset may ask ‘dumb’ questions about how liquidity, risk, return and cashflows impact their organization. This approach may align with functional maturity. Given changes in external environment, some credit unions may re-evaluate their current and target levels of functional maturity for Finance or treasury. Financial regulator(s) may have moved the goalposts. Time to recalibrate.
‘internal stakeholders may be content to receive limited reporting on key finance & risk topics in regards HQLA, at least for an initial period.’ - Ross McDonald
Lastly, seek help. Sometimes we all need a little help from our friends. As appropriate, reach out to peer credit unions for advice. Or seek a paid contractor relationship with a credit union that has relevant expertise. B.C. credit unions may request the assistance of Stabilization Central Credit Union. Or explore support from service provider(s).
Make no mistake, prudential supervisors may well dispense some unpleasant letters. Remediation from a regulatory intervention is a thoroughly unpleasant place. Credit unions may mitigate regulatory risk through proactive adaptation of liquidity management practices, rather than naively hoping for the best.
During the pandemic, many executives and staff have been working from home. The presence of domestic pets may provide welcomed comfort and companionship. A wagging dog tail; a purring cat; a chirping bird; or otherwise may bring joy and smiles. Such selfish pleasures may be repaid through fewer expletives from their owners.
DISCLAIMER & COPYRIGHT
This article reflects the personal opinions of the author, Ross McDonald. This article does not represent the views of any financial cooperative, corporate organization, regulatory body, government ministry or other organization. All content is wholly based on information that is in the public domain. Where relevant, sources have been identified and referenced.
Although the author has made significant effort to ensure that the information in this submission was accurate at the date of completion then the author does not assume any liability to any party for any loss, damage, or disruption caused by errors or omissions, whether such errors or omissions result from negligence, accident, or any other cause.