2010 in Review: Mounting Challenges for Treasurers

Publication: gtnews.com

This year has seen treasurers face challenges on several fronts. This review of 2010 examines industry trends and reveals the top 10 most read topics on gtnews this year. 

Looking back at 2010, it is fair to say that, thankfully, it has been less tumultuous than the couple of preceding years. This was the year that many economies around the world emerged from recession and, while not exactly sprinting into growth, the widely predicted doubledip recession has failed to materialise. So far, so good? 

Perhaps not - looking beneath the surface, there are clearly still many structural cracks in the global economy that could derail future stability. In Europe, the sovereign debt crisis threatens to catch up with many more countries in 2011, while the euro itself is under the most intense pressure of its short history. How long will German taxpayers be content to lead the bailout of other nations? 

In the US, the Dodd-Frank Act became law, creating huge changes for both banks and corporates in their accounting and reporting processes, while ‘QE2’ showed a marked difference in approach to deficit management compared with most European countries. Even China, seen by many in the west as the saviour of the global economy, has been struggling with a number of economic issues of its own. Under fire from the US and Asian neighbours for manipulating the value of the renminbi (RMB), the spectre of inflation also looms large in China. 

With considerations such as these, the role of the treasurer is not getting any easier. The rise in profile of the treasury department over the course of the credit crisis has been well documented, but in many cases this has not been matched by a similar rise in resources. So in a situation of having to do more with less, what have been the topics that gtnews subscribers have been reading the most this year?

Cash Management Concerns to the Fore 

Perhaps unsurprisingly, cash management issues dominate the ‘most read’ list for 2010. But within this broad umbrella description, a number of issues emerge, including cashflow forecasting, cash management systems and the centralisation of cash management processes. 

Forecasting 

Looking at cashflow forecasting, the gtnews Treasury Insider’s blog on the topic had the rather provocative title “Cash Forecasting: Is It Really Worth It?” In the post, the gtnews Treasury Insider explains that, while they don’t need convincing of the importance of cashflow forecasting, there are a couple of major challenges they face in their organisation: 

1. I need to encourage the subsidiaries to get into the habit of forecasting regularly, by which I mean once per week, with updates when necessary. 
2. I need to improve the accuracy of these forecasts. I am keenly aware that the nature of our business dictates the frequency required for forecasting. 

The Treasury Insider sees the issue for their company as being an internal personnel issue rather than a system issue. And the blog post gained a large response from the gtnews readers. Selected reader comments include: 

• “I can only support the absolute MUST of cashflow forecasting and also the need to have a at least three months outlook especially when you have to plan out your short-term financing needs, like we are having to do in my company.” 
• “We went from a loose two-week forecast model in 2008 to a very rigidly enforced 13 week model in early 2009 in response to the economic crisis. The outcome played a large part in ensuring that our company avoided any breach of financial limits or covenants - its simply that important.” 
• “Regarding your issue no 1, the best way to solve this is from the top down. Your CFO [chief financial officer] needs to be behind you. Anything less than that will get short-term attention.” 
• “Better cash forecasting will not occur until the link between profitability and liquidity is measured more precisely, and those involved are rewarded for meeting their goals.” 
• “... treasury needs to take the lead not only by owning the cashflow forecast process, but by clearly articulating the benefits across the organisation.” 
• “Technology also helps complete the information loop by quickly communicating back forecasting effectiveness at a level of detail that is actually useful to the remote user.” 

Clearly the optimum forecasting rate - daily, weekly or monthly - varies from company to company, and there were different views on this from the readers who commented. Common themes surrounded the importance of getting senior management onboard with the forecasting process, and also educating business units as to the importance of accurate and timely cashflow reports. To get a successful cashflow forecasting project off the ground, treasurers need to be adept at communicating the benefits to all invested parties. 

A centralised approach to cash management 

In their article that looks at centralising the cash management function, Diejana van der Wal and Heijmert Rijken from Rabobank acknowledge the role that cashflow forecasting can play as part of a centralisation programme. Integrated with cash pooling, it can be an important tool for improving cash management as it lets the treasurer have visibility of their company’s cash, no matter which country or currency the account is held in. 

In terms of pooling, one example of this helping to centralise liquidity management that is given is this article is the end-of-day sweep. This process makes it possible to transfer balances from local accounts to one central account or to centrally maintained accounts in the name of the local subsidiaries. It is also possible to automatically move the balances back to local subsidiaries, while profiting from the advantages of a central interest pool. 

Van der Wal and Rijken explain that this allows the treasurer to have better control over their cash, while they can also view it as a corporate asset within the organisation. 

System choices 

The most read piece of content on gtnews in 2010 was an article from Joergen Jensen at Nasarius, who provided a guide to cash management systems in Europe. In the article, Jensen examines a variety of areas related to cash management systems, such as the type of vendors (banks, enterprise resource planning (ERP) providers and specialist vendors), what you should look for in a system to suit your organisation, and how to approach the selection process. Jensen also takes a look at some of the specific offerings from the different types of vendors that are available, and offers some advice as to which types of systems may better suit which types of organisations. 

This year, gtnews also published a buyers guide to treasury management systems (TMS), providing a comprehensive report on the various issues that treasurers face when selecting and operating a TMS, featuring interviews and case studies from a variety of treasury professionals and a TMS matrix comparing the functionality of a large range of systems. You can download the TMS buyer's guide free of charge. 

SWIFT Success? 

Articles related to SWIFT take up two of the top four places in the most read chart on gtnews this year, demonstrating the demand for information that exists when it comes to the role that SWIFT can play in making corporate bank communication more efficient and secure. The content with most relevance to corporates in this list is Debunking the SWIFT Myth, written by Joy Macknight and published in July this year. In this feature, Macknight asked the question why, despite the benefits that SWIFTNet offered corporates by providing a single, standardised and secure channel, had not a greater number signed up to use the service? It certainly seems that preconceptions about the accessibility of the SWIFT network had played a role in the slow take-up, with many corporates questioning whether they have the volume of payment information necessary to justify the cost of gaining SWIFT connectivity. 

To combat this perception, SWIFT has launched a variety of different connection methods for corporates - from plugging in a USB stick to gain off-the-shelf connectivity through Alliance Lite, through to outsourcing connectivity to a SWIFT service bureau (SSB). The additional services that SWIFT is now looking to offer as part of an overall package is also helping to gain traction, through innovations such as: 

• Exceptions and investigations. 
• Trade finance. 
• Secure e-mail. 
• SWIFT Secure Signature Key (3SKey). 
• Electronic bank account management (eBAM). 
• Electronic invoicing (e-invoicing). 

As Marilyn Spearing, global head of trade finance and cash management corporates, Deutsche Bank, and chair of SWIFT’s Corporate Access Group, says in the feature: “Everybody is talking about electronic bank account management and e-invoicing - in other words really expanding what can be done through the same channel.” While SWIFT connectivity is still not going to be high on the agenda for some corporates, these value-added offerings look likely to give a welcome boost to SWIFT’s corporate numbers. 

To compare and contrast a selection of the SSBs available for corporates, download the buyer’s guide to SWIFT service bureaus that gtnews published this year. 

Evolution of corporate payments 

But there was a lot more going on in the world of corporate payments during 2010 than just debate over SWIFT. An article from Nigel McCook of Edgar Dunn & Company discusses the possibilities for future trends in payment systems. Analysing survey results, the article focusses on understanding the importance, both today and in the future, of individual payment products, as well as the key industry events that are expected to shape the payments markets over the coming five years. Some of the key findings discussed include: 

• Credit cards were the payment product given the highest rating in terms of current importance, followed by domestic debit cards. 
• Respondents from Asia gave comparatively higher ratings of importance to cash, mobile SMS, remote payments and remittance. 
• The top four payment products, in terms of their expected growth in importance over the next five years, are: 

1. Contactless cards. 
2. Mobile SMS/remote payments. 
3. Prepaid cards. 
4. Mobile NFC. 

These were among the payment topics under discussion at this year’s Sibos conference in Amsterdam. Following the past couple of years of battering this conference has taken - both from the Lehman Brothers’ collapse in 2008 and typhoon Koppu in 2009 - this year saw delegates and exhibitors alike emerge from their emergency shelters and hit the conference ready to do business and network. You can find full gtnews coverage of the conference here, including both the Corporate Blog and Banking Blog and a wealth of video interviews with perspectives from a number of industry experts. 

Risk Management Issues Rise 

One of the more blatant legacies of the credit crisis has been the rise of risk management and mitigation that treasurers are responsible for. A glaring example of this is the fact that corporates now actively need to carry out counterparty risk analysis of their banking partners - something completely at odds with the ‘one global bank’ policy that many corporates were actively pursuing when credit was both plentiful and affordable. 

A key area of risk management this year has been foreign exchange (FX) - from currency volatility in Europe and South America to concerns over ‘currency wars’ in Asia, corporate treasurers have had to be increasingly mindful of their FX exposures. As such, it is no surprise to find the article from SunGard’s Ryan Heaslip in the top 10 content list. Entitled Cost-effective Foreign Exchange Risk Management, the article looks at steps corporates can take to ensure they have an efficient FX risk management strategy in place. Some questions Heaslip suggests treasurers start by asking include: 

• Are you currently able to gather a complete dataset of exposures?
• Is exposure information provided in a timely, detailed and accurate manner? 
• Is there an operational focus on reducing exposure? 
• Are risk factors used to rank exposures? 
• Is there a strategy that prioritises the types of risk to hedge (e.g. balance sheet, short-term forecast, long-term forecast)? 
• What type of derivative strategies will be used to hedge, after operational considerations? 

The topic of FX risk management was also high on the agenda at the inaugural Global Corporate Treasurers Forum Europe that gtnews hosted at the Grosvenor House Hotel in London in June. The event is an annual independent forum bringing together European corporate treasurers to meet face-to-face, listen to leading speakers and network with industry peers in a high level and exclusive environment. 

Discussion at one session of the forum turned specifically to the transaction risk element of FX risk - where the risk of value changes depending on where the transaction is. Some transaction exposure is not shown in the profit and loss (P&L) because it has not yet been recognised, or the contract is anticipated rather than committed to. A couple of the questions raised at the forum referred to a) whether transaction exposure should be hedged; and b) if it was hedged, whose responsibility within the organisational structure was this? 

One group treasurer explained that their company had decided not to hedge its transaction exposure as they would have had to involve all of its investors, which would have added complexity. It has an impact on reporting - the company would have had to have shown like-forlike figures, and they wanted to protect this information. The factors involved in weighing up whether or not to hedge this risk requires a full evaluation by corporates. 

If you are a treasurer or group treasurer, and would like to find out more about the Global Corporate Treasurers Forum Europe and register your interest in attending the 2011 forum at the Ritz Hotel in Paris, click here. 

Growth in Supply Chain Finance 

Another area of interest to corporates that received a ‘boost’ from the credit crisis is supply chain finance (SCF). The contraction of available credit in the market led to an increased need for bank financing. With a dearth of liquidity solutions available, SCF solutions gained a much greater global popularity. Picking up this trend, Alexander Mutter from Deutsche Bank examined what the future may hold for SCF offerings in his article that rounds out our top 10 for 2010. 

Mutter sees the growth of SCF leading to more diversified and bespoke solutions emerging, driven by banks. He uses the example of a supplier portfolio where there are large, mid-sized and smaller enterprises involved. “Today, a similar supply chain finance solution will be offered to all of them. In the future, the offering to the individual supplier will be customised according to their balance sheet objective, based on the need analysis of this portfolio and risk policies, as well as financial needs,” suggests Mutter. By taking this approach, the SCF offering will be more flexible and tailored to suit the individual customer profile. 

Responding to the growth in popularity of SCF as a topic among corporate treasurers, this year gtnews has worked with Enrico Camerinelli, a senior analyst at Aite Group and SCF expert, to publish a monthly blog on key SCF issues. Topics covered in 2010 include the return on investment in SCF, the importance of sustainable supply chains and the need for an industry standard taxonomy in SCF. You can find every blog post on the topic here. 

Looking Ahead 

2010 proved that, while the role of the treasurer has grown in stature, the demands this places on the treasurer are fierce and come in many forms. The economic world can still be paranoid and reactionary in the aftermath of the credit crisis and, as many corporates stockpile cash, perhaps some treasurers could be accused of fuelling the fire in this regard. It seems that this year has answered a number of questions - regarding global recession and the credit crisis - but thrown up several more challenges. 

Despite this, there are excellent examples of corporate treasury departments and individual treasurers demonstrating best practice across the myriad different disciplines mentioned above. We were lucky enough to witness this first-hand at gtnews in 2010 through the quality and quantity of entries we received for our first annual Global Corporate Treasury Awards, which was this year held in Amsterdam alongside the Sibos Corporate Forum. As you can see from the winning projects, teams and treasurers, innovation is alive and well in treasury departments around the world. 

Coming up on 4 January in our first upload of 2011, we’ll be publishing a series of articles offering perspectives and predictions for the year ahead and mulling over the challenges that are likely to come the way of the treasurer. Until then, best wishes for the holidays from everyone here at gtnews.

The Credit Crisis Legacy: Treasury Risk Mitigation and Management

Publication: Global Treasury Briefing, Volume 3 Issue 3

The variety of risks that the treasury function is responsible for increased markedly as a result of the credit crisis. Ben Poole examines the risk topics that were top of the agenda for treasurers attending Global Corporate Treasurers Forum Europe 2010. 

The role of a treasurer within an organisation can vary considerably from company to company due to a variety of factors - size and scope of the company, industry type, location of the business and subsidiaries, etc. Over time, the role of the treasurer has also expanded or contracted in line with economic forces - from a basic receivables and payables focus to a ‘mission-creep’ situation, where functions that traditionally resided in other business units, such as risk, IT and operations, began finding themselves on the treasury ‘to do’ list. 

Then came the credit crisis. When the money markets started to see funds ‘break the buck’ and acronyms such as CDO, CDS and ABS were attracting the attention of corporate boards, treasurers had to focus almost exclusively on shoring up or renegotiating lines of credit and reevaluating investment strategies across the board. The tumultuous market conditions put the treasury department firmly in the corporate spotlight - communication with the board was becoming commonplace and treasurers had an opportunity to demonstrate the added value that their function can bring to the organisation. But with this rise in profile came associated risks - senior management were now expecting much more from treasurers, but in many cases were not prepared to back this expectation with additional resources and staff, creating enterprise risk. And in daily treasury activities, risks were enhanced or even created from scratch - which corporates could have envisaged performing counterparty risk analysis on their banks in case they fell over? Added to the scenario were extreme movements in foreign exchange markets that created severe turbulence for multinationals of all shapes and sizes, while pension funds formed a risk headache in some countries rather than others. 

All in all, the portfolio of risk that corporate treasurers are facing now that the credit crisis is receding is vast and complicated. As such, it is no surprise that risk was the conversation topic of choice for many of the treasurers who gathered at the gtnews Global Corporate Treasurers Forum Europe 2010 (GCTFE 2010), at London’s Grosvenor House hotel. This feature gathers the main risk management takeaways from the event. 

Enterprise Risk Management - What is the Treasurer’s Role in Risk? 

The PricewaterhouseCoopers (PwC) UK Treasury Survey 2010 found that nearly 90% of respondents think the credit crisis has led to their department gaining increased attention from the board. In addition, nearly 80% said they think the treasury function is increasingly thought of as adding value, while even 60% said that business units are showing an increased interest in treasury. All of these are impressive numbers, but unfortunately just over 20% said that the level of budget invested in treasury had been increased to match this new position within the organisation - treasurers are effectively being asked to do more but without more resources. This lopsided position carries inherent risk. It is here that an enterprise risk management (ERM) strategy is required. 

Today, audit committees are frequently asking for ERM projects to be demonstrated. These are not like buzzword-projects of the past - such as economic value add (EVA). ERM is based on common sense and looks at all elements of risk. The first step in achieving this is to identify the critical risks for your organisation. A risk register can be hundreds of pages long, so the advice in the workshop was to investigate a framework tool, such as the Committee of Sponsoring Organizations (COSO) framework, which can aid the risk identification process. 

Treasurers entering this process need to have a firm understanding of the risk environment in their organisation - are they risk-taking, risk-neutral or risk-averse? Different business areas have different risk profiles and treasurers should only take risks that are acceptable to their shareholders - other risks should be managed away. Corporates must understand the internal environment that they operate in. Once this has been established and the risk framework is in place, the treasurer will be in a position for objective setting, event identification, risk assessment and risk response. All of these processes should be linked to the budget cycle. 

At the Global Corporate Treasurers Forum Europe 2010, John McAnulty, group treasurer at Richemont, explained that his company initially identified 10 risks, but then realised that this was too many and so reduced it to four or five critical risks that had the potential to knock the company off course. They then produced a very thin executive summary and action plan. McAnulty admitted that lots of groundwork has to be put in at the start of the ERM project, but that this gets easier. A consolidated risk report was also issued to key internal stakeholders, while standard risk action plan templates have been included by the company in strategic plans and budgets and a risk statement is included in the annual report and accounts., McAnulty explained how the company uses a common risk language to ensure this is clear and transparent to all parties. 

So if you don’t already have an ERM strategy, should you? Quite a few companies now identify and spell out key risks in their annual report. Any treasurer thinking about this will get huge support from non-executives at the moment, as risk management is a big topic of conversation for this group. Additionally, audit committees are increasingly looking at this. However, there are likely to be several challenges within the organisation to tackle on the way to establishing an ERM programme, and the following comments may crop up: 

• “This is just another management fad.” 
• “Risk is good.” 
• “We don’t have time for this.” 
• “This is no different from internal audit.” 

While this process may take the treasurer outside their comfort zone, the embedded understanding of risk that the treasurer has makes him or her the perfect owner of this project as part of a group management team. 

Managing FX Swings 

One of the areas of risk management that treasury is used to dealing with, but gained additional exposure as a result of the effect the credit crisis had on western markets, is the management of foreign exchange (FX) risk. Given the volatility in the currency markets, it is no surprise that the FX risk management workshop drew the attention of many delegates at Global Corporate Treasurers Forum Europe. Richard Roering, from the consultancy Zanders, illustrated that FX risk falls into the following categories: 

Transaction exposure: risk of value changes depending on where the transaction is. Some transaction exposure is not shown in the P&L because it has not yet been recognised, or the contract is anticipated rather than committed to. 

Economic exposure: future impact on cash flows as a result of long-term FX rate changes. 

Translation exposure: The FX exposure seemingly most likely to be forgotten by many treasury departments. It occurs when a subsidiary has a functional currency other than the reporting currency of the holding. This concept can be split into two further categories: profit translation exposures and asset translation exposures. 

FX management objectives are linked to company policy - therefore, common FX objectives include: 

1. Reduce the uncertainty of cash flow (protecting short-term cash flow implies a short hedging horizon). 
2. Protect business at budget rate or better in order to protect it within a defined time horizon. 
3. Reduce long-term P&L volatility. Hedging is typically 1-2 years forward on a rolling basis, with layered hedge ratios. 

Current thinking seems divided as to whether multinational corporations (MNCs) should hedge FX profit translation risk. Those in favour argue that translation gains or losses exist only ‘on paper’, while those against counter that translation gains/losses have an impact on the reported profit of the company. So what about in practice? Roehring had three points here: 

1. While they are in the minority, some MNCs can face a risk at the EBITDA level. 
2. Credit ratings are a key determinant in positive hedging decisions 
3. Larger MNCs are more likely to hedge FX profit translation risk. 

A group treasurer attending the workshop explained to the other delegates that their company had decided not to hedge its transaction exposure. The reason for this was that the company would have had to involve all of its investors, which would have added complexity. It has an impact on reporting - the company would have had to have shown like-for-like figures, and they wanted to protect this information. The factors involved in weighing up whether to hedge this risk or not requires a full evaluation by corporates. 

Pension Risk Looming Large in Certain Countries 

Many western countries are facing severe risk issues in the corporate pensions market. In the UK, this is particularly the case with defined benefit (DB) pension schemes, which have total assets of £775bn but total liabilities of £975bn.1 Pension schemes are closing and members of these schemes are ageing, meaning that the funding imbalance here will remain for a long time to come. At Global Corporate Treasurers Forum Europe, Chris Sheppard from professional services group Mercer addressed some of the issues that corporates need to be aware of in their pension risk management strategies. 

Because companies and trustees have different interests at stake in a DB pension, it is important that a model for the risk management process of the pension scheme is agreed upon by both parties. Sheppard produced a basic five-point plan to create such a model: 

1. Define the mission. Is this to provide short-term balance sheet control for the sponsor, or long-term self-sufficiency for the scheme? 
2. Quantify the risk budget. What is the sponsor’s tolerance of cost variability, and what is the trustees’ tolerance of funding level deterioration? 
3. Decide how the budget is spent. Will you target rewarded risks and value creation, or unrewarded risks and value protection? 
4. Allocate responsibilities. What are the roles of the company and the trustees in the governing and executive functions of the scheme? 
5. Establish a process. What events will be triggers in your scheme management, and what will be the responses to these triggers? How can you ensure ongoing monitoring? 

There are a number of market trends that could have an effect on the five points above. Increasingly, swaps are being used to hedge interest rates and inflation at predetermined trigger levels. Longevity solutions are on the rise as mortality reserving increases. Enhanced transfer value exercises will continue and increase as accounting reserves increase (so that P&L impact reduces). There is an increased use of equity derivative solutions to reduce downside risk. Schemes are being closed to future accrual and the search for lower risk alternatives is continuing apace. 

Against the backdrop of these market trends, what action can treasurers take to ensure the best for their organisation? Sheppard made the following suggestions: 

• Understand the risk being taken in your DB schemes. 
• Assess the impact of those risks on the company. 
• Define your company’s tolerance to risk. 
• Set risk reduction triggers appropriate to this tolerance. 
• Ensure that robust risk governance is in place. 
• Establish a process to monitor and take action. 
• Monitor market trends and opportunities. 

Conclusion 

The risk management portfolio that treasurers are responsible for today is considerably greater than it was a couple of years ago. It is too early to tell if this additional burden will subside as the credit crisis fades, but perhaps from the treasurer’s perspective it would be better if it didn’t. The current elevated role of the treasurer provides an opportunity for those in the role to add value to the business and demonstrate the skills that will take their personal careers one step closer to senior management. By taking control of the various risk management functions mentioned in this article, treasurers can demonstrate their overall corporate finance skill-set, and prove to senior management that the treasury function offers much more than merely a cash management functionality.

Global FX Markets Thriving in 2007

Publication: gtnews.com

Competition among providers, technological advances and sophisticated investment and risk management strategies mean that corporates are viewing the FX market as a major investment opportunity. 

The global foreign exchange (FX) market is the world's largest marketplace. In 1977, the average daily trading volume was US$5bn, but in the past three years this has seen growth of over 38% and daily volumes reached US$2.9 trillion this year. This is around 50 times more than the daily trading volume on the New York Stock Exchange. There are a number of reasons for the strong growth - the FX market trades 24 hours a day, is globally diverse and technological advances that automate the trading process create efficiencies. 

The FX market is also being boosted structurally, as Rick Schumacher, at Wall Street Systems, describes in his article, Foreign Exchange: Keeping Pace in an Explosive Market. Just as Russia did in July 2006, when countries make their currencies convertible on the capital account, the trading volume of that currency increases. "Worldwide structural changes are allowing significant increases in assets allocated to international markets," notes Schumacher. This highlights the strategic shift to increasing international allocations that is currently happening in the FX market, which is driving the market's continued growth. 

Where to Get Your FX Fix 

Traditionally, the major high street banks are where corporates go to buy or sell foreign exchange. However, competition has emerged in the FX market that has squeezed the dominance of banks. Taking the UK FX market as his example, James Arnold, at Investec, highlights one challenge to the banks in his article, Non-banks in the UK's FX Market. When FX was dominated purely by banks, it could be argued that areas such as pricing and service were not as competitive as they could have been. This encouraged non-banks to enter the market. Aided by the fact that the FX market in the UK did not require Financial Services Authority (FSA) regulation or banking status, non-banks offered corporates a simple premise - they allowed corporates to book their FX rate and make a payment at the same time, offering attentive customer service and competitive rates. As Arnold notes, "This one-stop shop philosophy attracted many clients. All of a sudden, UK companies could book an FX rate and send their payments with just one phone call." But banks have not been usurped. The diversity of investment instruments available in FX markets extends beyond the reach of non-banks. For example, FX options, which offer corporates a degree of flexibility and security with their investment, can only be traded by FSA-regulated institutions. The entrance of the non-banks to the market has had the effect of forcing banks to improve their competitiveness, not just in the markets where they compete head to head, but across the board. 

In addition to non-banks, the rise of algorithmic trading has shaken the tight grasp that banks had on the FX market. Banks are no longer able to control FX prices and spreads as they used to, because algorithmic trading has levelled the playing field between the buy and sell side. "Trading orders can now be automatically executed; market timing and price can be better controlled; and large volume trades can be automatically divided up into several smaller trades to reduce their market impact," explains Wall Street Systems' Schumacher. 

Who's Investing? 

The broad spectrum of investment instruments, such as forwards, structured derivatives, swaps and options, in the currency derivative market attract a wide range of investors. For example, the flexibility of structured derivatives allows investors to benefit from currency development at the pace they require to hit their goals and can accommodate a variety of risk profiles. 

Hedgers are drawn to the FX market due to the flexible, tailored solutions that are available to them here, according to Anders Vik and Valérie Schneitter, of Credit Suisse, in their article, Foreign Exchange: An Overlooked Asset Class?. They explain, "In addition to portfolio or cash flow protection against FX risks, the hedger may have the opportunity to benefit from potentially favourable spot movements and enhanced hedging compared to forward transactions, or to reduce the upfront hedge cost compared with a hedge with options." 

In addition, investors and yield enhancers are drawn to FX due to products that offer capital protection even in unfavourable conditions. Some investments can generate returns in rising, falling, or stagnant market conditions. New investment opportunities are being seen in emerging markets, with particularly good growth in Asia and Latin America. "Moreover, structured derivatives offer investors access to currencies that are not freely convertible, such as the Chinese renminbi," explain Credit Suisse's Vik and Schneitter. For example, currency baskets that offer simultaneous exposure to a large number of different currencies are increasingly favoured. 

Technology Increases Sophistication 

As with all areas of finance, technology has an important role to play in FX, making processes more sophisticated and generating extra returns as a result. Electronic FX trading (e-FX) currently accounts for more than 40% of total FX volume, and this is expected to grow to 44% by the end of the year. Electronic trading has made it easier for more investors to enter the market, trade-processing costs have dramatically fallen, and smaller banks are better able to compete with their larger competitors. Schumacher, at Wall Street Systems, explains, "FX straight-through processing reduces capital and hardware costs and, in addition, trading fees for buy-side clients have been reduced substantially and on some platforms have even been eliminated." 

And yet the growth of the FX market, partly boosted by technological innovation, could be putting a strain on the very technology that helped it expand. This is the view of Adam Hawley, at Caplin Systems, in his article, Defining a Web 2.0 Strategy for Online FX Trading Portals. Hawley argues: "The technology deployed in response to the first wave of online trading is not advanced enough to cope with the demand of today's market-savvy participants." As expectations and demands on the FX market evolve and grow, so must the technology that underpins so much of the market activity. This is being seen in the development of Web 2.0 and Rich Internet Applications (RIAs), which are a way of using the Internet as a platform for FX. When it comes to developing a strategy for implementing the new generation technology into their FX operations, there are four areas that Hawley identifies for special attention: drive down latency on core platforms; deliver core functionality to clients over the web; combine FX trading services with other assets; use RIA technologies to deliver the functionality of a desktop trading application through an Internet browser. 

RIA technologies allow external web facing services to be integrated into the platform, such as research and news feeds. This allows traders to make instant decisions as news is happening. In fact, technology is advancing to take this trading decision out of the hands of the human trader, and putting it into the hands of software trading programs instead. News providers such as Dow Jones and Reuters have introduced more structured news feed capabilities to help this happen - by adding XML tags, news feeds can become 'computer readable' by algorithms. "By turning streaming text into 'textual data', such news is much more amenable to automated interpretation by a trading strategy. With the right tags, a strategy can analyse and react to news much more quickly than a human trader could," explains Chris Martins, at Progress Software, in his article, Algorithmic Trading in the FX World. 

Technology in algorithmic trading is also moving on, from the original 'black box' algorithms, which suffered from being commoditised and didn't allow alpha returns to be realised. The next evolutionary stage in this type of trading has been dubbed 'white box', and these algorithms provide trade strategists with a greater level of control and the ability to act upon unique trading ideas and incorporate these into the code of an algorithm to hopefully generate alpha returns. As Progress Software's Martins notes, "The ability to customise algorithms according to a firm's unique requirements and quickly develop algorithms for first mover advantage brings increased opportunity for competitive gain." 

Investor Strategy 

One way for investors to get a return from the FX markets is to exploit the inefficiency linked to global interest rate differences. While a 12- month money market investment in Switzerland earns interest of 3%, a similar investment in Brazil could earn 10.75%. So-called 'carry strategies' try to profit from these differences, by investing in high yield currencies, and borrowing from low yield ones. This simple premise actually requires a fair deal of skill in predicting market volatility and the ability to take on the risk that this entails. "Timing and risk management are key to the success of such strategies. Even if the risks linked to simple carry trades cannot be eradicated, they can be greatly minimised," say Credit Suisse's Vik and Schneitter. 

In their article, Global FX Markets Today, Kristian Siggard-Jensen and Johan Ditz Lemche, at Saxo Bank, sound a note of caution for carry traders, suggesting that they have become too focussed on differentials and are ignoring global macroeconomic signals. Without the highly volatile market that existed two or three years ago, carry traders are now willing to take more risk as the chance of losing a lot of money is comparatively low. However, Siggard-Jensen and Lemche predict that the interest rate hikes seen in Europe and the US are coming to an end - and it was these rate rises that helped boost returns in the carry trade. They predict a macroeconomic realignment occurring in the near future, which will start either in the US, Japan or New Zealand. "If we were carry traders, we'd look for another month at the most, then take the profits and find something else to put our money into," say Siggard-Jensen and Lemche. This example shows that the global FX market is much more complicated than purely buying one currency, selling another and making a profit. The skill is in managing your risk exposure according to what you can afford and what you hope to get in return, taking into account a number of global market nuances. 

As with other financial markets, the more risk you can afford to take on in FX, the greater the potential returns are. Another form of risk is seen in algorithmic trading - the risk associated with delegating your FX trading to an automated system. However, the same technology that creates this risk can also be used to mitigate it. Technology exists that can monitor portfolios and constantly check value-at-risk to make sure that any breaches of risk thresholds are immediately identified. "Corrective actions can be instantly taken, such as trading to take a position back to a more risk-neutral status," explains Progress Software's Martins. 

Conclusion 

Today's FX market offers investors a wide variety of investment opportunities to suit all tastes and requirements. The rapid growth of this asset class in terms of instruments, currency markets and technology mean that corporates should investigate how adding or enhancing an FX thread to their investment portfolio could boost their returns. As with all asset classes, there are risks in investing in FX, but with a clearly thought out strategy and the right risk management protocols in place, these should cause corporates no undue concern. And with a large variety of banks, non-banks and traders competing to offer corporate FX services, the efficiencies available make the FX market just as viable as any other.