At the annual Eurofinance International conference, key issues of treasury and finance were discussed in Barcelona while, in the rest of the world, global markets appeared to change from rollercoaster to bucking bronco.
To bailout or not to bailout? That was the question vexing the US Houses of Congress last week, with every twist and turn being followed by near-hysterical stock market peaks and troughs around the world. Meanwhile, the Irish government took the unprecedented move of stepping in to guarantee all deposits, bonds and debts in its six main banks for two years… unprecedented until other nations fell over themselves to offer similar guarantees for fear of losing billions in savings to countries that beat them to the punch. But as Irish savings now outnumber national GDP, how watertight can this guarantee be? (Read more in the commentary: Europe's Response to the Market Meltdown).
It was against this backdrop of extraordinary global financial turmoil that EuroFinance’s annual International Cash and Treasury Management conference took place in Barcelona. With such uncertainty and, in some cases, panic in the air, maybe it was to be expected that in the test of the interactive voting facility 12% of delegates listed their gender as ‘other’. And with the only possible example of interbank lending of the week seen when a number of delegates from one major bank had their wallets pick pocketed outside a party held by one of their rivals, what lessons can be learnt from the past 12 months and how can treasurers negotiate a path for their organisation through these turbulent times?
A Year in the Life of Liquidity and Risk
The financial panic felt in western markets was put into some perspective in the first session at the conference, which looked at risk and liquidity changes in the past 12 months and examined what regional differences there may be. Damian Glendinning, global treasurer at Lenovo, is based in Singapore and so was able to offer a perspective from Asia. He said that while it was difficult to judge the overall impact in Asia, there was not the same feeling of crisis there. This is perhaps borne out of the fact that Asian corporates are generally happy to accept higher risks in order to generate higher rewards. The Association of Corporate Treasurers in Singapore has tried to introduce more caution into its members risk management policies but, as Glendinning pointed out, maybe now is actually the time to be less conservative because of the opportunities presented by current market conditions For example, a conservative hedging policy doesn’t make the most out of volatile FX markets. Lenovo also has a negative working capital position, which means it looks for funding from suppliers, not banks. In the current climate, this looks like a very strong position to take.
Andrey Rostovsky, head of treasury at OAO Lukoil, gave a slightly different perspective from Russia, alluding to the huge drop in the share price that forced the government to make a serious move to inject cash into the system. He added that Lukoil had tried to move into commercial paper, but that was hard to do. So, it needs a good relationship with its partnership banks on working capital.
But what effect is the credit crisis having on the risk management profile of large US corporates? According to Brent Callinicos, vice president and treasurer of Google, the crisis has made his company change their risk policy in the short term, by bringing in an added focus on the preservation of capital. But in the long term, he explained that their risk management plans were not changing for the sake of it, although they are adding flexibility earlier into these policies, which will allow proactive risk management that can be tailored to the many possible fluctuations of the credit crisis.
Callinicos’s point about the changes in short-term risk management policy changes was supported by Andrés Garcia Peralbo, treasury director at Inditex, who said that his company is also focussed on preservation of capital. A banker sitting next to me in the auditorium commented that this is why people were turning to his bank, as they have a AAA rating. This of course offers some sort of security. But the banks themselves admit they aren’t 100% sure of the asset quality on their books and the ratings agencies are trying to keep up with every development in the banking industry. It is sensible for treasurers to adopt a cautious and methodical approach when assessing their bank relationships, so as to ensure that, if they feel they must transfer banking allegiances, that this truly is a ‘flight to quality’ and not simply a case of ‘out of the frying pan, into the fire’.
Members of the panel for this discussion seemed largely happy with their banking relationships at the time of speaking. Inditex’s Peralbo said that his company’s relationships had not changed as they were with bigger banks - although maybe they were talking more often with them. Rostovsky from Lukoil explained that they have long-term bank relationships and that, while there may be ups and downs, on the whole it was ok. Lenovo’s Glendinning gave a very upbeat assessment, saying that nothing has changed in his company’s bank relationships, adding that the banks had been unstinting in their support. The only cautionary note came from Google’s Callinicos, who said that he is hearing from banks on a daily basis saying that they’re ok. However, he added that even if you’re comfortable with a bank’s credit rating, you should be careful as it may be totally different tomorrow. (Read more about bank consolidation in Effective Risk Management Must Underpin Bank Consolidation.)
Not to be outdone by the panellists, delegates also had their chance to have their opinions heard, by voting on statements made about the key issues discussed. Sixty-seven per cent of delegates agreed that the credit crisis will effect companies investment programmes, 72% agreed that the credit crisis has prompted a flight to quality in investment portfolios, while 65% of delegates agreed that the credit crisis has prompted changes to FX hedging needs and management of counterparty risk. This echoes the sentiment of the panel and demonstrates some of the ways that the credit crisis is affecting corporates in their normal working procedures. However, 62% of delegates in the auditorium said that the credit crisis was not causing disruption in the financial supply chain (FSC). So, there is room for optimism, but again it is prudent to be vigilant, as there is a possibility that the effects of the credit crisis may take longer to be felt in some areas of the finance industry, such as FSC. Once again with this crisis, expect the unexpected.
The Voice of the Delegates
Once the experts had given their views on how the credit crisis is effecting liquidity and risk issues for treasurers, the delegates had their chance. Now, as the gender question mentioned earlier shows, you can get a few unexpected results when taking a poll of hordes of treasurers, but the results can give a good general insight into the themes and trends that are occupying the minds of treasury professionals.
Thinking about credit availability, 57% of the delegates in Barcelona said that there has been less availability of credit in the past three months. But when given the option of whether they were more concerned about credit availability, recession or inflation, credit availability only received 29% of the votes, comprehensively beaten by recession, which scored 64%. This was backed up by the fact that over a quarter of delegates (27%) thought that central banks around the world have handled the financial crisis badly. Sixty per cent thought the response had been ‘Ok’, but this was certainly not an overwhelming vote of support. Looking forward, 33% of delegates were ‘very worried’ about credit availability in the next six months, with a majority of 53% saying that they are ‘moderately worried’. And the air of caution was backed up by the fact that an overwhelming 85% of the audience rejected the idea that the credit crunch will be a distant memory by this time next year. With the number of extraordinary events in the financial industry that have taken place in the past few weeks, it is hard to disagree with this point of view.
Moving onto a more positive footing, 80% of delegates thought that the crisis is an opportunity to buy assets cheaply, demonstrating a very bullish attitude from the audience. Possibly this could have been added to by the bankers in the hall, similar to the gentleman from the AAA bank mentioned earlier, who are seeing institutions that 18 months ago would have been their rivals now crumbling in value. When looking at which region will grow faster in 2009 out of the US and the EU, the EU came out on top nearly two to one ahead (62% to 38%). Bearing in mind the venue for the conference being in warm and sunny Barcelona, this result may have partly reflect some continental pride from the European majority of delegates. In reality this is a tough question to call and the action taken by the US government in the short-term will go a long way to deciding the final result. This is one topic to revisit in one year, five years and even a decade from now.
With governments around the world having received a metaphorical bloody nose from delegates earlier in the day, the audience now had the chance to play politics by casting their votes on a couple of very important upcoming elections. When asked who the next president of the US will be, Barak Obama won by a landslide 74% to John McCain’s 26%. If this turns out to be the percentage split in November, there may not be enough chads in Florida (pregnant, hanging, or otherwise inclined) to deliver another Republican president. While this result reflects similar polls carried outside of the US throughout the campaign, global polls tend not to make too much difference to the American public who know that it is they alone who have the responsibility to make this important choice every four years. The McCain vote here may also have been hit by his perceived weakness on the subject of the economy, praising the strong fundamentals of the US economy and then trying to suspend campaigning in order to concentrate on finding a solution to the economic crisis. If Senator McCain does happen to find himself in Florida on the campaign trail, he may well need a new pair of flip-flops.
Another of the traditional powerhouse global economies with an election on the horizon is Germany. When asked who the next German Chancellor will be, delegates gave incumbent Angela Merkel an even larger majority than that of Obama, as she received 76%. Frank- Walter Steinmeier’s campaign team should possibly be concerned as he only finished third in the poll on 10%, behind ‘A.N. Other’s’ 14%. However, since this poll, Merkel has appeared to guarantee 100% of bank savings in Germany in a similar model to Ireland, before it then transpired that there will probably not be formal legislation in the country to formally increase protection. Even by the standards of the current market confusion, this seems to be an astonishing clarification that has already had a large effect on European markets. The credit crisis will make and break several high profile political careers, and it remains to be seen what effect this breakdown in communication will have on Chancellor Merkel’s long-term prospects.
And finally, after the serious nature of most of the topics on discussion, it should cheer everyone up that 15% of all delegates think that, in the new James Bond film, Quantum of Solace, Bond’s enemy will be none other than SEPA:
JB: “Do you expect me to talk, Hartsink?”* GH: “No Mr Bond, I expect you to standardise cross-border and domestic payment flows into a single scheme.” JB: “You’ll… you’ll never get away with!” GH : “But it has already begun Mr Bond, mwhahahaha!!”
It should make for riveting viewing at cinemas around the world later this month.
The Emerging Markets Perspective
One of the highlights of the conference was an interview by Axel Threlfall, from Reuters and former CNBC and Market Watch presenter, with Dr Mark Mobius, managing director of Templeton Asset Management. Mobius began by demonstrating how bull markets have traditionally always lasted far longer than bear markets - a positive message for these times and certainly something to bear in mind when it may be more tempting to reach for the financial panic button. It was from this perspective that, when asked if he would vote for the US bailout plan, Mobius said that he would vote against it. (This was after the House of Representatives had rejected the initial bailout plan, but before the Senate had approved the amended plan.) The main argument from Mobius was that the market has to pull the figures down itself, whereas any bailout is artificial. “Investors will get over it,” he reasoned. “[Opposing the bailout] is the only way that the system will learn from it.” Mobius added that Templeton expected the ‘deadwood’ to be routed out quickly if the bailout was rejected - in this scenario he expected there may be six to 10 months of downturn or flat markets, followed by growth and recovery.
Turning to Europe, Mobius predicted that it could be the French who will lead Europe out of the financial crisis. France's President Sarkozy is calling for change in accountancy rules regarding mark to market and, if he is successful with this legislative push, Mobius predicted that France could help European financial markets turnaround in one year. Eastern Europe will also help Europe as a whole, through its growth and productivity. Mobius used the example of Poland, which is now in a new phase of development and productivity as Polish migrant workers in the UK have begun returning home, something that is boosting their domestic economy. Mobius also suggested that there could be a better inter-relationship between Russia, eastern Europe and western Europe, mainly if the US is forced to focus on its internal financial fundamentals.
Has there been a knock-on effect from the US crisis into emerging markets? According to Mobius, there may have been but not in a negative way. He argued that China has been ready for this - for example it has been keeping exports ‘in-house’ while at the same time decreasing US imports. Income in the BRIC countries (Brazil Russia, India, China) is increasing at double the rate of the US/Europe. One of the main messages from Dr Mobius throughout his conversation with Threlfall was that now is the time to selectively invest in emerging markets, such as the BRICs. He also tipped Turkey and South Africa as good smaller markets to be involved with.
Emerging market funds were seen as risky places to invest, but people are having second thoughts now when looking at the turmoil in ‘emerged’ markets. Long-term returns can be good on emerging funds and Mobius argued that a diversified portfolio can reduce risk. The example he gave was to highlight how the BRICs countries are all very different. While individual countries can be volatile, a diversified emerging markets portfolio has a balance to it.
Is Centralised Treasury Versus Decentralised Treasury the Wrong Debate?
It is understandable that the ongoing seismic events in the global financial markets dominated conversation at the conference in Barcelona, but there was still time for a detailed discussion about the preferred organisational structure of treasury. Sebastian di Paola, a partner at PwC, spoke to Kristian Pullola, vice president and head of treasury of Nokia and Aidan Clare, head of corporate finance and treasury for Tetra Laval and examined how each treasury has approached the centralised versus decentralised debate.
-------------------------------------- A Tale of Two Treasuries
Nokia Nokia is a globally managed, integrated company. It also manages the infrastructure business within a 50/50 joint venture with Siemens.
Business units are responsible for their profit and loss up to an operating profit level.
Business units are the risk owners for all business risks.
Treasury is the risk owner for all financial risk.
One integrated logistics and finance ERP system.
80 people in the Nokia treasury organisation - one-third in Helsinki, one-third in Geneva and one-third at centres around the world.
Treasury groups breakdown into:
FX risk management - identification and validation.
Insurance and risk finance - hazard risk management.
Customer finance - sales support and credit risk management.
Corporate finance.
Cash management solutions.
Risk management not in siloes - Nokia try to take an integrated risk management approach.
Tetra Laval The default mode for the Tetra Laval treasury is decentralised, unless there’s a strong rationale for centralisation. Treasury has sought to exert its mandate in this environment.
Key areas of treasury responsibility:
Financing.
FX and IR management.
Cash management.
Projects. Middle- and back office, and accounting.
Table 1: Tetra Laval Organisational Structure
After hearing the organisational structure for both the Nokia and Tetra Laval treasuries, delegates were invited to describe their company’s level of centralisation in treasury activities, and how this may evolve. The results were as follows:
Centralised and happy: 38%
Centralised, but trying to get closer to the business: 34%
Decentralised and trying to centralise more: 23%
Decentralised and happy: 5%
Clearly there is a very mixed picture out there, something recognised by the speakers. The main message from the session was that treasurers should try to look for ways to make a ‘distributed’ treasury, one that is not 100% centralised or decentralised but rather one that is best suited to the specifics of the treasury’s responsibilities and the individual business strategy. As Nokia’s Pullola explained, it doesn’t matter whether your company is organised in a centralised or decentralised manner, as long as it fits with the corporate structure. Certainly companies that grow through acquisition can find centralisation a challenge, but as Nokia is integrated it is easier to be centralised.
So what is the right level of centralisation? According to Tetra Laval’s Clare, it depends on scale (for example, Tetra is smaller than Nokia), on culture and strategy of the overall business, and on how the current crisis evolves. It is not something that you should be evangelical about - be pragmatic and don’t lose touch with the business.
Pullola from Nokia made the point that, whatever the balance of centralised and decentralised functions, it is vital that you recruit the right type of people. Treasurers need to think critically about the challenges of having a distributed team - how can they work together as part of one team. “Go out there and work with the business,” he summarised, “but watch out when they see how much value you could add!”
How Treasury Can Underpin the Business
Finally for this review of the EuroFinance conference in Barcelona, a discussion based on the results of the company’s Business Unit Survey put the boot on the other foot and showed what business units think of treasury. Martin Giles, managing director and EVP of The Economist Group North America, moderated the extended results conversation between Scott Hogate, assistant treasurer at Advanced Medical Optics, Annette Owen, global cash and banking manager for British American Tobacco, Paul Jonckheere, treasury project coordinator with Carrefour, François Masquelier, SVP head of treasury and corporate finance at RTL Group and, last but by no means least, Hans van den Bosch, head of treasury operations for Unilever.
A summary of the survey results showed that treasury is not thought of as being in an ivory tower and that it is actually getting better at communicating with business units. The respondents also agreed that treasury adds value but, before anyone’s ego gets too carried away, business units also suggested that treasury may not be doing enough to mitigate financial risk. Finally, the omnipresent credit crisis may elevate the role of treasury, again.
When delegates in the auditorium were asked if they formally benchmark business unit satisfaction with treasury services by conducting regular customer surveys, over three-quarters (76%) said they did not. This is something that could be of benefit for treasury to do, as a way of aligning treasury targets with the strategic goals of the business for the overall benefit of the company. Unilever’s van den Bosch provided an example of a centralisation programme between treasury and business in his company that had featured:
Streamlined banking relationships.
Streamlined IT infrastructure.
Treasury centres established.
Implemented under the catchy working title ‘One Unilever’, the new structure is working well, but also provided an example of the friction that can be created as a change is made to the organisation structure of treasury - in this case a change towards centralisation. Change will never please everyone, so to make the journey as positive as possible it is important to make clear to every unit involved:
The goals of any change.
How you will achieve these goals.
What the overall benefits to the company will be.
In organisational structure, as in the global credit crisis, transparency is key to a successful future.
*These characters are entirely fictional, and any similarities to individuals past or present are completely coincidental.
With many global markets in the grip of the liquidity crisis, what are the latest developments in liquidity risk management and mitigation?
In this year's third annual gtnews cash management survey, Cash Management Survey 2008 Reveals Liquidity is Corporate Priority in association with SEB, over 52% of corporate respondents said that financial risk management and mitigation was a high level of responsibility for them and their treasury department. This was second, only behind cash management, as the area of highest responsibility for treasurers. Clearly a major reason for this is the liquidity crisis in the global markets and the sharp focus that this has brought on liquidity risk.
A New Approach to Risk
The approach to liquidity risk mitigation is the dominant theme in the article The Five Changing Faces of Risk Management, by Philippe Carrel of Thomson Reuters. Carrel explains how different areas of corporate risk, such as valuation risk, settlement risk and regulatory risk, are interlinked as they all have a direct impact on the company through the validation of its balance sheet. "Liquidity is the ultimate reward or punishment for the sound management of the other risks combined," states Carrel. Issues with liquidity can arise from poor risk management policies in areas such as funding, portfolio and collateral management, counterparty management, failed settlements and other operational issues. It is because of the structural web that interlinks these issues that liquidity risk cannot be seen as a stand-alone area. Rather, it should be perceived as the ultimate operational risk.
-------------------------------------- Sources of Liquidity Risk
Thomson Reuters' Carrel highlights three main causes of liquidity risk:
Market liquidity risk - the risks that assets held in portfolio or pledged as collateral may be mispriced or simply impossible to sell due to adverse market conditions. This is made worse in the world of structured finance where, with the lack of transparency of the underlying assets, money managers have stopped investing in these assets thereby drying up liquidity.
Funding liquidity risk - the funding and funding costs associated with the lending books. Reflecting the lack of transparency in the industry banks have limited lending lines in the interbank market leading to a drying up of funds affecting most credit markets.
Counterparty-driven liquidity risk - the liquidity risks related to a counterparty's unfulfilled obligations, missed or overdue settlements. Causes can stem from either financial problems with the counterparty, connectivity failures and especially from data mismanagement. The latter occurs across straight-through processing (STP) systems linking risk takers with their execution venues, brokers, custodians and administrators. These systems require complex and frequent database alignment. Failure to process transactions in a timely manner may result in payment failures which, in times of extreme market conditions, can disrupt the firm's liquidity management.
--------------------------------------
Funding Liquidity Risk
In Funding Liquidity Risk: Addressing the Challenges, Robert Smith, of Lepus, looks at the latest industry trends in this area. Smith describes how research into funding liquidity risk in the past six months has shown that the way it is perceived in the financial services industry is beginning to change. It is now a high profile area of risk management and, as such, it is receiving greater attention from banks and regulators than ever before. "One industry source that Lepus has spoken to recently stated that they felt regulators are inevitably beginning to focus on liquidity risk in a bid to prevent a repeat performance of the current liquidity crisis," states Smith.
With this greater focus, financial services organisations need to establish or enhance their metrics for measuring and managing funding liquidity risk. The approach to this can vary quite significantly depending on the characteristics of the organisation. However, Lepus's Smith defines three main methods:
Liquid assets approach - the organisation maintains liquid instruments on its balance sheet that can be drawn upon when needed.
Cash flow matching approach - the organisation attempts to match cash outflows against contractual cash inflows across a variety of near-term maturity buckets.
Mixed approach - a combination of the previous two.
In his article, Smith highlights the importance of the diversity of measures used, as they all offer slightly different insight and visibility. The approach of an industry source that he spoke to includes holding a stock of liquid assets as a percentage of liabilities, while having detailed rules in place to define a liquid asset. This source also monitors its projected cash flow against various stress scenarios. In terms of the organisation structure, funding liquidity risk metrics are usually part of board-approved documents that identify liquidity limits and approval levels. These will also highlight the individuals accountable for setting limits and exceptions.
Planning for when the funding liquidity risk metrics have their limits breached, Lepus's Smith highlights that it is vital to have a flexible response strategy that is able to cope with a variety of possible risk events - such as default probability, credit spreads or stock market volatility. A rigid step-by-step plan may not be able to cope with the variety of these risks, but having a series of different scenario responses prepared can allow management to decide on an appropriate response. This response can also then be tailored to the risk event on an ongoing basis.
Counterparty-driven Liquidity Risk
One of the other main sources of liquidity risk that Thomson Reuters' Carrel identifies in his article is counterparty-driven liquidity risk. This is related to a counterparty's unfulfilled obligations, missed or overdue settlements. A recent ruling in the US courts related to counterparty-driven liquidity risk is the focus of How Can US Oversecured Creditors Receive Interest at Default Rate?, an article written by John Francis Hilson and Professor Stephen L. Sepinuck from Paul Hastings. In a decision favourable to secured lenders, the US Court of Appeals for the Ninth Circuit ruled in General Electric Capital Corp. (GECC) versus Future Media Productions, Inc. (Future), that oversecured creditors are entitled to receive interest on their claims at the default rate set in their contract.
The roots of this ruling go back to March 2005, when Future went into default on a US$10.5m term loan and a US$5m revolver from GECC. The loans were secured by a first-priority security interest in substantially all of Future's assets. The default event caused the interest rate on these loans to increase by 2% per annum. Then, in February 2006, Future filed a Chapter 11 bankruptcy petition. Pursuant to a stipulation agreed to by the parties, GECC agreed to allow the debtor to use its cash collateral and the debtor acknowledged that it owed GECC about US$5.4m, which sum included interest at the default rate. The Creditors' Committee objected to that stipulation, but to facilitate a resolution of the matter, all of the parties agreed that the debtor's assets would be sold and about US$5.7m of the proceeds would used to pay off GECC in full, including interest at the default rate through 20 April 2006, subject to a later determination regarding what amount of interest was allowable.
Later, the Creditors' Committee wanted GECC to return US$165,000, which was the amount it was claimed to have collected over the pre default interest rate. The Bankruptcy Court ruled that GECC was not entitled to interest at the default rate, based on a previous decision from the Ninth Circuit but, when GECC appealed, the Ninth Circuit reversed the decision of the Bankruptcy Court.
This ruling by the court benefits secured lenders in this area of counterparty-driven liquidity risk. As Paul Hastings' Hilson and Sepinuck explain, the ruling "unquestionably allows oversecured creditors to recover interest on their claims at the default rate, at least in some instances." However, they are left with a couple of important questions from the ruling:
Which oversecured creditors are entitled to interest at the default rate? Could a creditor whose loan agreement provides for double or treble the interest after default find they have their claim disallowed, either under state law or some bankruptcy principle of equity?
If some oversecured creditors are denied interest at the default rate, does that apply only to both pre-petition and post-petition periods, or only to the accrual of interest post-petition?
No doubt there will be future legal actions in the area of counterparty-driven liquidity risk as oversecured creditors find out how much, if any, interest at the default rate they are entitled to. It's certainly something worth checking with your lawyer! New developments in the legal and regulatory world, such as this ruling by the Ninth Circuit, occur on a regular basis at national level and also internationally through the regulators. It is therefore important for organisations to keep up to date with these developments in order to ensure that their liquidity risk strategy is compliant and follows best practice.
Mitigating Liquidity Risk
When it comes to a framework for mitigating liquidity risk, Thomson Reuters' Carrel suggests that organisations should not only prepare liquidity buffers as a counterbalance to the risks, but that they should also carry out a fundamental review of risk factors and their alignment with the risk policy of the firm. "This is not straightforward as the risk factors a firm is exposed to may not be immediately visible, especially where securitisation and derivatives are involved," advises Carrel.
Every organisation should tailor its own counterbalancing framework in the context of its own exposure, exposure of its clients, and the nature of the business and then align it with the approved risk policy. In order to make this framework operate successfully across the entire organisational structure, there also needs to be transparency. "As the sound management of such sensitivities and the capacity of the risk managers to pre-empt on those risks will be eventually rewarded or punished with liquidity implications, we can conclude that the most important aspect of the new risk management is transparency," explains Carrel. This transparency should cover pricing models, clarity of processes, counterparty relationships, connectivity and IT setup, regulatory compliance and the adequacy of the overall framework with the shareholders' collective appetite for risk.
Hopefully, in light of the current sharp focus on liquidity and liquidity risk, the new risk mitigation and management techniques discussed across industry sectors today will be implemented in a thorough and transparent fashion across the entire enterprise, consigning departmental or siloed risk management to the past.
Short-term investments made by treasurers have come under a great deal of scrutiny over the past year, as many previously sound instruments have under-performed or collapsed. Which investment instruments should treasurers be considering, and what value should be placed on security, liquidity and yield in an overall investment strategy?
The sub-prime mortgage crisis in the US and the ensuing liquidity crisis have had a profound effect on short-term investment options for treasurers around the world. CFOs, CEOs and boards are scrutinising treasury departments closely to see which investment instruments have been selected. Treasurers in turn have been in closer contact with their asset managers and banking partners to understand what is happening in the financial markets and how this is affecting their own liquidity. In this period of uncertainty, what strategies should treasurers be employing in order to achieve security of investment, maintain liquidity and create yield?
A good start would actually be to keep in regular contact with your fund manager. The liquidity crisis may have meant that you put names and voices to the people helping to manage your cash investments for the first time, by building on these relationships, treasurers can learn much more about the instruments that their cash is invested in.
The Investment Strategy Risk Conundrum for Treasurers
Due to the market problems of the past year, it is understandable that security and liquidity are the main qualities that treasurers look for in a short-term investment instrument. But what about yield? Different fund types and investment instruments were falling over themselves to offer investors the best yield ratios up until a year ago, but is this still important? Well, it should be, but it is important that treasurers understand how the yield projections they are being shown have been put together and, as always, if something looks too good to be true then it probably is. This is a theme picked up by Mark Rimmer, from BlackRock, in the Guide to Money Market Funds - Part 1: The Current Landscape, which discusses key issues to keep in mind when choosing a cash manager. "The underlying investment dynamics of a top-yielding fund might be based on some unattractive investments from a long-term perspective and this is the type of investment information that you should ask your fund manager for," says Rimmer. Once again, it is clear that developing a good relationship with your fund manager is vital, as this can help avoid any nasty surprises further down the line.
The balance between security, liquidity and yield that treasurers face when making short-term investments is something that François Masquelier, honourary chairman of the European Association of Corporate Treasurers (EACT) tackles in his article, Post Sub-prime: The Impact on Treasurers Managing Liquidity. All investments should ideally bring a return in terms of yield, but in the current climate this can be easier said than done, as treasurers need to also ensure that their investment strategy diversifies risk, remains liquid and also favours the corporate's main bank relationships. Remaining liquid can represent a cost in terms of failure to earn interest, and Masquelier identifies the fact that corporate strategies and objectives are not always aligned in this regard, something that can have a serious effect on a company's bottom line. "It's a subject that CFO's may have neglected too often in Europe. Last summer's events reminded everybody that this market could present considerable risks because of a lack of visibility on certain funds that qualified as dynamic, or even because fund managers were frantically searching for a higher return," says Masquelier. Higher returns, by their very nature, have a higher underlying risk profile, so it is vital to remember this when looking at short-term instruments to invest in.
Even basic bank deposits are exposed to significant risk, as Alain Kerneis, from Goldman Sachs Asset Management, discusses in his article, Managing Corporate Cash Reserves During Turbulent Times. Corporates with large allocations in bank deposits are exposed to significant counterparty risk since the market in the UK and US significantly re-priced the risk of default from financial institutions. "Although a survey published in 2006 showed that European non-financial corporations held on average 60% of their reserves in bank deposits, we believe that the recent market events will prompt many corporations to limit their allocation towards bank deposits," says Kerneis. He also expects treasurers to spread their bank deposits across a larger number of counterparties or diversify across other low risk asset classes such as short-dated government bonds.
A corporate's risk management policies are tightly linked into its short-term investment strategy, more so today than ever before. David Rothon, from Northern Trust, looks at the risk aspect of MMFs in his article, Cash Management Perspectives on Short-term Investments. He makes the point that enhanced and short bond funds can be just as appropriate for investors as MMFs, providing that their appetite for risk and the objectives of their funds' strategy are in line with one another. "As this process of risk reappraisal evolves, investment strategies in the short duration space will become more clearly defined, enabling investors to better manage their risk budget," says Rothon. A broader, better-defined product array will give investors the confidence and conviction to tactically manage their cash going forward.
Regulations Helping Growth of MMFs in Europe
In Europe, the MMF market has lagged behind the US in terms of assets under management, but recently it has been catching up quickly. A major reason for this has been a shift in the regulatory landscape. Changes to the Basel II capital adequacy framework and the introduction of the European Union's Markets in Financial Instruments Directive (MiFID) has made investing in MMFs an attractive prospect for banks. Under the original Basel Accord, financial institutions were required to make large provisions against these investments. MMFs were also treated the same as higher risk equity funds, making them relatively expensive for banks to hold. However, this has now changed, as Kevin Thompson, from Fidelity International, discusses in his article, Money Market Funds Weather the Credit Storm. With the new framework, the risk weighting of MMFs has been reduced to 20% from the earlier 100%. Banks are also required to hold far less capital in highly rated MMFs, which makes these instruments an attractive option for short-term cash placements by banks.
"Additionally, under MiFID, banks will be allowed to invest client money into AAA-rated funds, earning a higher return than just relying on bank deposits," explains Thompson. "With these structural and regulatory changes coming into place, we expect the market in Europe to grow significantly over the coming years." As cash from banks floods into the MMFs, this adds to the security of the market from the perspective of the corporate treasurer.
Need For a Better Definition of MMFs
The downturn or even collapse of some short-term investment markets has lead to many calls within the industry for a better definition of what an MMF actually is. As EACT's Masquelier says, it is important not to confuse treasury-style MMFs with similar looking products that actually have a greater risk profile. "It is unfair and even dangerous to claim that the risk would be the same when the duration of underlying investments is longer (greater than three months) and that the return on investments is clearly greater than the reference indexes (e.g. EONIA, EURIBOR, LIBOR)," explains Masquelier.
"With an AAA-rated stable net asset value (NAV) MMF, corporate treasurers can be confident in the knowledge that they have access to their money on a T+0 basis and they are able to maintain this flexibility,"says BlackRock's Rimmer. This type of MMF, often referred to as a 'treasury-style' MMF, has been a success story of the past 12 months, as treasurers have been attracted by the relative security and liquidity they offer as opposed to enhanced cash funds or bank deposits, for example.
The credit crisis has created an inflection point in the MMF industry regarding how investors view MMFs, perhaps permanently. Karen Dunn Kelley, from Invesco, describes in her article, Money Market Funds Evolving from Market Turmoil, that since last summer, her company's cash management team has conducted hundreds of meetings with investors who have been surprised by the impact of the credit market crisis and now have a heightened awareness of the risks in their MMF investments.
Trade organisations agree with the IMMFA in calling for clarity of definition for MMFs in order to avoid previous errors of judgement regarding the underlying asset risk of different short-term investment instruments. François Masquelier says that the EACT, like many national treasurer associations, thinks that distinguishing a treasury-style MMF from other cash funds such as enhanced, cash-plus or dynamic MMFs is crucial. "Turning to 'pure' monetary funds with an AAA rating (IMMFA funds) has shown during the crisis that it was possible to guarantee liquidity while offering a solid return greater than the EONIA index (for euro funds)," he explains.
This clearer definition is beginning to take shape, as Kathleen Hughes, from J.P. Morgan Asset Management, highlights in her article, Short-term Investors Get Smart. She refers to how the treasury-style MMFs have also been defined as qualified money market funds (QMMFs) by IMMFA. QMMFs are the most conservative of the broader MMFs category, which is widely used in Europe to describe everything from stable NAV funds to enhanced yield funds, short-term bond funds and even total return style funds. "The differentiating factor between all of these types of fund has always been liquidity," says Hughes. "QMMFs are buy-and-hold strategies that invest solely in securities maturing in the near-term. Therefore they do not normally rely on the presence of market participants to buy securities from them in order to meet the liquidity demands of their shareholders."
This undivided attention on very short-maturity instruments is a big distinction between QMMFs and other MMFs with higher risk profiles. Some longer-term enhanced, dynamic or total return funds implement active strategies that can buy securities maturing as far out as 30 years, which means they have been at the behest of market liquidity when it comes to meeting shareholder redemptions. J.P. Morgan's Hughes notes: "Such strategies worked perfectly well until market liquidity vanished in the summer of 2007, forcing the fund's to sell securities at discounted prices." These losses were then passed onto investors, which is the last thing treasurers want.
Which Funds to Choose?
Treasurers have started to differentiate between the MMFs that are available to invest in, and the asset managers that are offering the product, with risk factors now being a key factor in fund selection. The size of the fund, its portfolio holdings and the strength of the provider are increasingly under scrutiny. This is something that J.P. Morgan's Hughes points out in her article. "The size of the fund, in particular, directly addresses large investors' fears of being a big fish in a small pond. If you make up too much of the fund, how confident are you that adequate liquidity will be provided?" she says.
The financial strength of the provider is now also a consideration when looking at which short-term instruments to invest in. While mutual fund investments are 'ring-fenced' in terms of the fund provider's balance sheet, the funds themselves are not guaranteed by the asset management company, or the parent bank entity, if one exists. Despite this, many investors believe that if the stable NAV of an AAA-rated fund is in jeopardy, the provider will act to prevent any losses being passed onto shareholders. If this assumption is correct, the provider can only do this if their balance sheet allows it - which is why there is a focus on the financial strength of the provider. This is even the case when investors look at treasury-style MMFs. As J.P. Morgan's Hughes states: "These changes have been profound and are likely to be permanent."
Taking Advantage of Technology
While treasurers can benefit greatly from an active working relationship with their fund managers, technology can also help when it comes to investment decisions. This is a topic that Basak Toprak, from Citi, highlights in What Now? What Next? - Part 3: Harnessing Technology to Simplify Investment Decisions. Investment portal technology is one such advance, which allows corporates to access information about all of their investments online through one channel. "The convenience of seeing all of their investments on one screen with the ability to compare them in terms of their assets under management, ratings, yield and average maturity is a significant advantage," says Toprak. MMF portals are provided by both banks and independent operators and, at a time when transparency of products and investment is critical, portals can provide visibility, mobilisation and optimisation of corporate cash.
In his article, Investing Through the Liquidity Crisis, Kirk D. Black, from the Bank of New York Mellon, shows a practical example of how an MMF portal can benefit the investor. The US Federal Reserve recently reduced its funds target rate significantly in an attempt to ease the liquidity crisis. This has helped MMFs to outperform most short-term issuers of commercial paper and other corporate discount notes and government securities. As a result of this, many investors are moving their portfolios from individual security issuers into heavier concentrations of MMFs. "An investment portal allows the investor to efficiently purchase a market of MMFs, taking advantage of their current out-performance. Should the Fed pause easing for an extended period or reverse course into a tightening posture, portal users can redeem their MMF positions and re-enter securities markets on the portal, purchasing instruments such as commercial paper and other discount notes," explains Black. Keeping ahead of the market curve is important, especially in the current turbulent climate, and managing your short-term investments through one of the many available portals can be a helpful.
Significantly, Citi's Toprak points out that "while adoption of portal technology grows in the transaction space, they do not replace existing relationships with fund managers or the need to have someone at the end of the phone to answer questions on the investment offering or provide feedback on market developments."
Conclusion
As the market turbulence of the past 12 months has dealt blows to competing short-term investment instruments, the security and liquidity that treasury-style MMFs afford has seen their popularity rapidly increase, particularly in Europe. Going forward, it is important that investors do not revert to a laissez-faire approach to short-term investments - security and liquidity are the vital components at the moment, but to neglect yield could cost corporates in the longer-term. It is important for treasurers to arm themselves with as much knowledge of the market as possible, which can be achieved by having a good relationship with fund managers, as well as utilising any technology that can simplify and enhance investment decisions, such as MMF portals. The funds industry itself needs to ensure that it is catering for investors by providing accurate and up-to-date information on the investment instruments it offers, and that these are clearly defined with transparent risk profiles. The growth of treasury-style MMFs has shown that, even in tough economic times, there are good short-term investment opportunities out there and, if the industry learns from previous mistakes, these can grow. For example, at a recent conference looking at MMFs, Donald Aiken, the chairman of the IMMFA, said that he would not rule out the return of enhanced cash funds given time, albeit in a slightly different format. By keeping up with industry developments such as these, treasurers can be in a position to take advantage of future market alterations and add value to their company by doing so.
Latin America is a diverse region for treasury operations, with many different economic models, regulatory regimes and technology infrastructures spread over the continent. This commentary examines some recent developments in treasury issues here.
Treasury operations and processes in Latin America can differ wildly from country to country depending on a whole host of factors, such as economic integrity, local regulatory factors and technology infrastructure, to name a few. This week on gtnews we have published six new articles that examine a variety of Latin American treasury issues, covering regional and country-specific developments.
Latin America is one of the more complex places in the world in which to manage cash, liquidity and risk. However, strides are being made across the region to improve payment infrastructures. This topic is covered by Nancy Russell, from NLRussell Associates, in her article, Payment Systems in Latin America: Advances and Opportunities. She describes how advances in national payment systems have progressed since 2000, pointing out that central banks in more than half the countries in the region have now implemented real-time gross settlement (RTGS) systems. "These countries include: Argentina (1997), Bolivia (2003), Brazil (2002), Chile (2004), Colombia (1995), Costa Rica (1999), Ecuador (2004), Guatemala (2006), Mexico (1995 and 2004) and Peru (2000). Several other central banks in Central and South America are also planning to implement RTGS systems in the next few years," explains Russell.
Argentina, Brazil and Chile have also established private sector high-value clearing-houses: Interbanking in Argentina (1998), Camara de Pagamentos Interbancaria de Pagamentos (CIP-Sitraf) in Brazil (2002) and Camara de Compensacion Interbancaria (Combanc) in Chile (2005). These are supervised and regulated by their respective central banks and use a similar model to the Clearinghouse Interbank Payments System (CHIPS) in the US. As they use prefunding, bilateral and multilateral netting, banks are better able to manage their liquidity costs. End of day settlement of net positions is affected through participants' accounts at the central banks using their respective RTGS systems.
Many countries in Latin America have established automated clearing-house (ACH) systems, most of which are privately owned and operated but authorised and regulated by the central banks. The exceptions to this are Colombia, Costa Rica, Ecuador and Venezuela, where the central banks serve as operator of the ACH systems. In Colombia, besides the government-run ACH, there is a second privately operated system that is owned by the banks - ACH Colombia.
Countries that have implemented ACH systems for interbank electronic credit transfers and/or direct debits include: Argentina (2002), Bolivia (2006), Chile (1999), Colombia (1999), Costa Rica (2001), Ecuador (2002), Honduras (2007), Mexico (1996), Panama (1998), Peru (2001) and Venezuela (2007). "Guatemala's new ACH system is in the testing phase and expected to become operational during the second half of 2008," adds Russell.
While many Latin American countries have advanced their payments infrastructure, Russell also points out that additional opportunities still exist. Local governments and companies operating in the region, including multinational companies with subsidiary operations in the region, need to assess and review their in-country cash management operations on a regular basis to make sure that they are taking advantage of the most efficient payment and collection methods available. For multinational companies, for example, it is important to evaluate local country and regional cash management banking partners on a regular basis. "Despite the challenges and with all the positive changes in the region, there are almost always opportunities to increase the use of electronic payment methods and to reduce costs," notes Russell.
Collecting the Cash
As a corporate operating in Latin America, how can you actually get your hands on the cash a customer owes you? This subject is tackled by Fernando Lardiés, from Banco Santander, in his article, The Puzzle of Collections in Latin America. Lardiés argues that a practical collections approach to the region means that you need to look at other collections instruments beyond just electronic payment instruments. "The widespread use of cheques makes the automation of collection processes more complicated, when compared, for instance, with Europe (with honorable exceptions like France). In some countries digital cheque truncation is possible (Brazil, Mexico, Argentina), but in others (Chile, Venezuela, Colombia) this is not yet the case."
Many countries in Latin America have restrictions in their legal and regulatory environments, particularly in regard to credit/debit taxes and restrictions on the movement of funds. This makes it difficult to replicate the cash management practices that are seen in other regions, mainly cash pooling combined with collection processes conducted in parallel by different banks. Latin America also still has a high reliance on retail branch networks. Most people prefer to pay their debts in person at a bank branch, although they could just as easily use an electronic transfer or, in some countries, even have their accounts directly debited.
Banco Santander's Lardiés points out that banks with a local presence in a number of countries can offer corporates common communication interfaces and protocols, in case a corporate seeks centralised or standardised collection handling. "The underlying local collection instruments might have whatever specific features are needed in each country, but a common communication protocol can be designed jointly by the corporate and the bank based on open standards," suggests Lardiés. He uses the example of EDIFACT DIRDEB and CREMUL, which provide the flexibility to handle different local collection instruments under a standard umbrella solution.
Corporate Cards Evolving in Mexico
Corporate card schemes and programmes are evolving all over the world from different levels of sophistication and this is particularly the case in Latin America. As a payment instrument, the corporate card has had difficulties breaking into a market that is so dominated by cash and cheques. However, as David Chevrel from Aconite reports in his article, The Corporate Payment Cards Market in Mexico, this is changing in Mexico.
There are four bank issuers in Mexico, three of which offer corporate credit cards, one that offers debit cards and one financial services company, which markets several corporate products, including gasoline, purchases and meeting cards. In order to qualify for these services, companies must have an impeccable record and hold accounts with these institutions in order to benefit from these services.
The problem that corporate card programmes were faced with was that, until a couple of years ago, credit and debit cards were not accepted by many vendors, such as petrol stations. This influenced companies against giving cards to their executives and meant that they had to provide them with paper bonds or other means of payment. Today, however, cards are accepted in most of the stations, which has been an important catalyst in the spread of corporate payment cards. The cost of petrol is tax deductible and corporate cards have simplified the process of calculating these deductions, saving management time in administrative and financial departments. "The opportunity to reduce costs related to calculating tax deductions should help drive corporate card growth in Mexico," explains Aconite's Chevrel, pointing out that access to a tool that simplifies this process is important to corporates of all sizes.
Chevrel also uses the results of the Aberdeen Group's study to show how further growth in the use of corporate cards will come from outside of the travel and entertainment area. The study showed that, in Latin America, 83% of companies plan to use cards for advertising and marketing services and 53% are looking to expand commercial card use to non-travel categories as a means of driving growth.
Do Argentina's Numbers Add Up?
While the corporate card market in Mexico appears to be looking up, another article issues a warning for the economic health of another Latin American country. In his article, Back to the Future for Argentina's Economy, Martin Krause from ESEADE Graduate School, argues that the current commodities export boom is overshadowing deep-rooted problems in the economy of Argentina. The country is now enjoying the benefits of high prices for the commodities it exports - it shows twin surpluses and US$50bn in reserves at the Central Bank. "This has led many to believe the country is immune to an international crisis… though probably not one of its own making," says Krause.
The bad economic indicators that Krause points to start with inflation. It is only three years since Argentina went through the largest debt restructuring in its history, yet price inflation seems to be running out of control and debt concerns have returned. Price and debt are also related through the new bonds the country issued after the default. They are adjusted to a price index, but one that ultimately relies on the consumer price index (CPI). "The government has found no better way to deal with increasing inflation than cheating on the index. No wonder the country risk has been going up since February 2007, the time when it started to become evident that the government was tampering with the statistical process and removing independent officials at the statistical agency," comments Krause.
So what are the numbers behind this bad economic position? During the last year of de la Rúa's government in 2001, foreign debt was 54% of GDP (US$144.2bn). Today it is over 56% of GDP (US$144.7bn). Why is this the case if the economy has been growing at an average rate of 8% during the last few years? "The answer lies in the deep devaluation that reduced GDP in dollars, a figure that it is now only recovering in dollar terms. If we also include the amount of debt due to holdouts, the number goes to US$170bn, 67% of GDP," states Krause.
ESEADE's Krause goes on to suggest that Argentina is paying the price for its close ties with the Chavez government in Venezuela and its failure to access the international capital markets, which could particularly help in solving the holdouts issue. He uses Argentina's neighbour, Brazil, as an example of what could be achieved by following a different economic model: "Brazil has achieved investment grade, receives more than US$30bn of foreign direct investment (FDI) every year and has just placed a 10-year bond for US$500m at a rate of 5.3%."
Soy Source of Optimism
As ESEADE's Krause has mentioned, if it were not for the rising prices of Argentina's commodity exports, the country's economy would be looking ill. Ana Belluscio takes an in-depth look at one of the unlikely economic heroes in her article, Secure Profits For Argentina's Soy Investment Funds. By using its roots as an agricultural country, Argentina has found a new way to use an old practice for profit. The catalyst behind this has been the growth of soybean sowing pools. These are headed by experts (who usually have fields themselves) who organise procedures, seek tenants to rent fields and prepare planting, spraying, harvesting and sales plans. Once the business plan is defined, they seek external investors (private capital, whether from individuals or corporations) that agree to invest in return for a percentage share in the profits. These small number of large soybean sowing pools now own over 80% of the soy market's share. "Since they handle large planting areas and production volumes, these pools can negotiate better prices with suppliers of raw materials and services, thereby increasing the profit margin for investors," points out Belluscio.
The sowing pools usually offer investors closed operating systems, meaning that they can only withdraw their invested capital (plus earnings) once the crop is sold. The open system, where investors can withdraw their capital at any given time of the process, is not common in Argentina. This method obviously helps to add certainty to the financial process for investors in this commodity and can prevent a 'run' on soybeans.
"The cultivation of soybeans produces statistically a net profit of approximately US$2.15 per US$1 invested (2006 statistics) whereas, comparatively, the net profit of corn culture is US$0.45 per US$1 invested," explains Belluscio, which shows why soybeans are such a popular commodity to invest in. And the soybean is set to become even more popular - as alternative fuel sources become highly soughtafter, the development of soy biodiesel from soybean oil is sure to lead to an escalating soy demand for the future. As soy demand increases around the world, from the European Union to China, and international prices for soybeans continue to rise, there will be greater gains for soybean sowing pool investors.
Trade Finance in Latin America
In his article, Factoring and Trade Finance Services Continue to Increase in Latin America, Jack Villacis, from Surecomp, casts an eye over trade finance services in the region. Villacis talks about how he has seen an evolution in trade financing requirements in Latin America where local companies are no longer producing exclusively for their own markets but are now fighting for global presence and market share. Surecomp's Villacis describes how, in terms of trade finance banking products and practices, Latin American corporates still depend heavily on letters of credit (LCs). "This is a result of the need to mitigate risk, as well as the need for immediate access to funds, explains Villacis. For many years, exporters as well as importers relied heavily on trade-related loans to finance their working capital needs and it still is a common practice in Latin America for most LCs and collections to be converted into trade-related loans.
Other improvements in the Latin American trade finance market include greater automation, compliance, anti-money laundering (AML) initiatives and Internet banking. Many regional banks have started the process of either improving or implementing automated trade finance departments and factoring. Currently, banks are investing heavily in technology thanks to the fall of import and export barriers and the need to enhance systems comparatively with their North American and European counterparts. Villacis says that countries including Argentina, Panama and Costa Rica are beginning to catch up with the rest of the world in terms of Internet-based trade finance technology. In contrast, he states that Bolivia, Uruguay, Paraguay and El Salvador remain slow in offering these products, with banks and corporates appearing to be reluctant to undertake the required changes.
Conclusion
One point that is clear from all six of the Latin America articles published on gtnews this week is that, if you don't recognise the differences that exist between individual countries in terms of economy, cash management processes, regulatory regimes and legal requirements, you will struggle to do business here. Entering the Latin America 'market' is not the same as entering western Europe or north America, for example, where there has been greater harmonisation of systems and practice. Individual countries here are at radically different stages of development and maturity so it is sensible to have a country-by-country strategy built into your more general regional business plans.
