Building a Treasury Policy: Cash Investment, Counterparty Risk and Controls

The Purpose of a Treasury Policy

A common misunderstanding at board level is that the purpose of a treasury policy is to maximise the yield on cash deposits. It is not. The Association of Corporate Treasurers (ACT) is unambiguous on the priority ordering: safety first, liquidity second, yield third. These three objectives must be considered in that order, and any investment decision that improves yield at the cost of safety or liquidity is contrary to good treasury practice.

Safety means preserving the nominal value of the company's cash. A growth-stage company's cash balance is not investment capital; it is the operational runway that funds the business until profitability or the next funding round. Losing any portion of that cash through a bank failure, a counterparty default or an illiquid investment is categorically different from a disappointing yield: the former can threaten the business's existence.

Liquidity means ensuring that the company has access to sufficient cash to meet its operating obligations as they fall due. This requires matching investment tenors to the company's anticipated cash requirements. A company with four months of operational runway should not hold cash in a 95-day notice account without being certain that the notice period will not conflict with a cash trough. The treasury policy must reflect the 13-week cash flow forecast and ensure that the investment portfolio does not constrain day-to-day operational liquidity.

Yield is a legitimate objective, but only once safety and liquidity have been fully addressed. In a rising interest rate environment, the yield differential between a current account (earning close to base rate) and a diversified portfolio of notice accounts and money market funds can be meaningful for a company holding several million pounds in cash. However, the pursuit of marginal additional yield should never compromise the first two objectives.

What the Policy Must Cover

A complete treasury policy addresses the following areas. Each section should be specific to the company rather than generic: a policy that could apply to any business is a policy that has not been properly designed for any business.

• Investment objectives and priority order: explicit statement that safety, then liquidity, then yield is the governing framework, with any company-specific constraints noted.
• Permitted investment instruments and their limits: the specific instruments the company is permitted to use (e.g. instant-access current accounts, notice accounts, money market funds, short-term gilts), with any concentration limits by instrument type.
• Counterparty limits by institution: the maximum cash the company may hold with any single bank or institution. Typically expressed as an absolute amount and as a percentage of total cash.
• Minimum counterparty credit rating: the minimum credit rating (e.g. A-/A3 from S&P/Moody's) required for any institution with which the company deposits cash. Unrated banks are generally excluded for amounts above the FSCS threshold.
• Tenor limits: the maximum maturity of any investment. For a growth-stage company, a maximum tenor of 90 or 95 days is typical. Longer tenors require explicit board approval.
• Currency policy: which currencies the company may hold cash in, and whether it may hold cash in currencies other than its functional currency without hedging.
• Approval authorities for transactions: who is authorised to open new bank accounts, move cash above specified thresholds, or make investments in new counterparties. Clear segregation between those who initiate transactions and those who authorise them.
• Review frequency: the policy should be reviewed by the board at least annually, and following any material change to the company's cash position or business model.

Investment Options for Corporate Cash

The range of instruments available to a UK corporate treasurer for short-term cash investment is broader than most finance teams appreciate. Understanding the relative merits of each instrument is essential for building a proportionate treasury strategy.

Understanding FSCS Protection

The Financial Services Compensation Scheme (FSCS) protects eligible deposits at UK-authorised banks and building societies up to £85,000 per institution per depositor. For corporate depositors, this protection applies to companies that meet the definition of a "small company" under the Companies Act (broadly: turnover below £10.2m, balance sheet below £5.1m, fewer than 50 employees). Most venture-backed fintechs in their early years will qualify.

The FSCS limit of £85,000 has a straightforward implication for treasury management: any cash above £85,000 held at a single bank is outside FSCS protection and represents an unsecured claim on that institution. For a company holding £5m in a single current account, £4,915,000 is entirely unprotected in the event of bank failure. This is not a theoretical risk: the Silicon Valley Bank UK failure in March 2023 demonstrated clearly that bank failures can and do affect technology companies, and that the exposure for companies with concentrated cash positions can be severe.

Managing Counterparty Risk

Counterparty risk management is the section of the treasury policy that most frequently requires active maintenance. The key parameters are: the minimum credit rating required for counterparties, the maximum exposure to any single counterparty, and the process for reviewing and updating the approved counterparty list.

Credit rating requirements should be set by the board at a level that reflects the company's risk appetite. A minimum long-term rating of A-/A3 from at least one of S&P, Moody's or Fitch is a reasonable starting point for uninsured deposits. Counterparties rated below this threshold should only hold deposits up to the FSCS limit. Unrated banks and challenger banks should be restricted to amounts fully covered by FSCS unless a specific board exception is granted.

Concentration limits prevent the scenario of a single bank failure materially impairing the company's cash position. A limit of no more than 30% of total cash with any single counterparty is a common starting point. This means a company with £10m in cash must spread it across at least four institutions to comply with the limit. Some policies set different limits for different credit quality tiers: for example, up to 40% with AAA-rated institutions, 30% with AA-rated, and 20% with A-rated.

Presenting the Policy to the Board

The treasury policy must be formally adopted by the board. The presentation should cover the following points, each addressed concisely and without jargon.

1. Current position: how much cash the company holds and where it is currently held. If concentrated in a single institution, state the FSCS exposure.
2. Proposed policy objectives: safety, liquidity and yield in that order. Confirm that the policy is not intended to generate investment income as a material revenue source.
3. Permitted instruments: what the company will and will not invest in. Current accounts, notice accounts, MMFs and short-term gilts are typically permitted; corporate bonds, equities and cryptocurrencies are typically excluded.
4. Counterparty limits: the specific limits proposed, with a table showing how the current cash position would be allocated under the policy.
5. Approval authorities: who can move cash and open new accounts, and what segregation of duties applies.
6. Review cadence: the policy will be reviewed annually and following any material change in cash position or business model.

Key Takeaways

• A treasury policy is a board-approved governance document, not an investment strategy. Its primary purpose is to define the rules under which the CFO manages corporate cash.
• The correct priority order is safety first, liquidity second, yield third. Any departure from this order requires explicit board approval.
• FSCS protection is limited to £85,000 per institution for eligible depositors. Above this threshold, the company takes unsecured credit risk on the counterparty. The Silicon Valley Bank UK failure in 2023 is the most recent demonstration of why this matters.
• Money market funds (LVNAV type) offer same-day or next-day liquidity, broad diversification, and competitive yields. They are not FSCS protected, but the diversification of the underlying portfolio provides a different form of safety.
• A concentration limit of no more than 30% of total cash with any single counterparty is a practical starting point. This must be actively maintained as cash balances change.
• The treasury policy must be formally adopted by the board and reviewed at least annually. For most growth-stage companies, this is a one-day piece of work to draft and a one-meeting item to approve.