The corporate treasurer has a far more difficult and extensive set of issues to deal with today than ever previously, not least in the area of foreign exchange. We talk to Lloyds’ Rob Garwood about how to navigate the latest economic, operational and regulatory developments.
Managing Director and Head of FX Solutions, Sales and Derivatives Structuring
Rob Garwood is Managing Director and Head of FX Solutions, Sales and Derivatives Structuring at Lloyds Bank Corporate Markets. He has worked extensively in foreign exchange markets on both the client buyside and the sellside and is responsible for the delivery of the bank’s range of currency products to both financial institutions and corporate segments globally.
What trends are you currently seeing in the FX market?
I think there are five key trends worth noting in the FX markets today that are having an impact on how our clients manage their currency exposures and on their operations generally.
The global economy is potentially at a turning point. We have seen the return of Global GDP to trend growth from the low point of 2009. Whilst that growth rate is welcome it is certainly not balanced – there is still uncertainty in the US, the UK and in peripheral Europe. You also have a degree of uncertainty over commodity prices and inflation. China and many other countries, including the UK, are facing inflationary pressures, and that in turn raises the question of when interest rates will start to rise in both the developed economies and in the key developing markets.
There is also significant political upheaval in certain parts of the world currently. Obviously there is the situation in the Middle East which has the potential to profoundly change the political and economic balance in the region; there are on-going regional elections in Europe which will affect how budgetary issues are being handled now and in the future in countries such as Ireland, Portugal and Greece.
From the foreign exchange market perspective volumes continue to increase and, importantly, we have also seen a jump in the volatility of volatility. In other words, markets are now switching from low volatility to high volatility and back again, rather than experiencing prolonged periods of one or the other and this clearly makes hedging decisions for corporations more complex and alpha generation for investors more difficult.
We are also witnessing key operational trends: it has never been more important to provide efficient and error free services over the whole trade cycle – pre-trade, at-trade and post-trade and at Lloyds Bank Corporate Markets we are sharply focused on providing an holistic approach across all these service areas.
Finally there are several significant changes occurring to key aspects of the regulatory landscape that will have important implications for all asset classes, including currencies. Whilst we need further clarity, from a product perspective it is likely that currency options will have to be cleared on an exchange; potentially some longer dated forwards will also have to be treated in this way; and in both the corporate and institutional client bases there may also be regulatory changes that affect a client’s ability to use certain types of financial products and solution.
The more general answer to this question is that the average corporate treasurer has a far more difficult and extensive set of issues to deal with today than they have had previously!
Specifically, and in addition to the key trends that I have already identified, and in particular the increase in the volatility of volatility, one important development is the continued globalisation of corporate activity. Whether large or small, more corporates are finding themselves moving into new markets, in pursuit of growth and diversification. This is bringing them into increasing contact with a broader range of currency exposures, whether that is through trade or direct foreign investment via M&A activity or direct financial asset investments. This trend will continue and in turn raises the question of how clients manage and hedge these exposures. We will continue to see a higher share of global GDP coming from emerging market economies with a consequent increase in FX flows, exposures and hence a greater impact on corporate balance sheets from these regions.
One other trend that will affect corporates’ FX-related risks is the evolution of hedge accounting regulations in both Europe and the US. The regulations have previously made certain types of hedging difficult if not impossible. Suggested changes to these rules may well allow corporates to increase the scope of their hedging activity. Certainly hedge accounting is a primary concern among the treasurers that we speak to and since IAS 39 and its revisions apply to core hedging activities, such as forecasting revenues and costs, debt exposure in foreign currencies and handling exposures from other cross-border activity such as M&A, they correctly see any changes to the accounting regime as having potentially large effects.
What are the key strengths at Lloyds Bank Corporate Markets?
Lloyds has an extremely strong client proposition in foreign exchange, in both the major corporate space and also with financial institutions. Our strength in Sterling, from both a flow and from a research perspective is a key advantage. Sterling is often a core currency for International corporate entities and, regardless of where clients are based, most have exposures in the currency. Our research in this area is leading edge and, coupled with our market share in the Sterling market, we are able to advise our clients strategically and execute their business in a sophisticated and efficient manner.
Additionally, we have a significant structuring group offering the client accounting, risk and derivative structuring solutions. By combining this team with our research product and first class relationship management teams across a broad spectrum of corporate sectors we are in a strong position to help clients through these more difficult times.
We were particularly pleased to see that our holistic approach to servicing our corporate clients has received such favourable client feedback. For example, the most recent Greenwich survey in the UK corporate space voted Lloyds number one for overall quality of service.
At the most basic level we have the research, distribution, trading and execution capabilities necessary to service the corporate sector from the small commercial corporate through to the largest, most sophisticated multinational companies.
Most significantly though, this is a period of time in which banks’ intellectual capital has never been more important and we have the skills and platform to gain trusted advisor status with our clients.
To understand and serve clients better we are sector based both at the relationship management level and at the sales level allowing us to be entirely aligned to our client needs. To support those clients our structuring teams help clients understand the impact of financial markets on their businesses both from an interest rate and foreign exchange perspective. The team offer financial solutions to meet those needs and risk sensitivities whether their requirements be in hedging and risk mitigation solutions or through advice on accounting issues, Basel III or even Solvency II planning.
When you then consider our extensive sales force, structuring and research teams, add the lending resources the bank can mobilise for our corporate clients, and couple that with best in class Relationship Management then I believe we have a have a very powerful client proposition.
Can you describe the process you use to determine the optimum risk management solution for a client?
Our first job is to look at the clients’ needs, their risk tolerances and their exposures. We are not in the business of pushing products, especially in this environment, where the simpler, more holistic solutions are often the most effective. In complex environments corporates generally want to operate as simply as possible so it is a part of our role to give them some bandwidth to look at all of the options they have at their disposal and the hedges they wish to put in place. So, whilst the modeling that the Risk Solutions group undertakes is extremely sophisticated, we are determined to make the solutions as simple and intuitive as we can for the client.
We clearly need to know the risk sensitivities that each of our clients have. For those with relatively high risk tolerances, we may advise them to look at their hedging programmes over shorter time periods containing firmer market views; whilst for those with relatively low risk tolerances they may well have to look at structures that work over different periods of time with limited currency level dependencies. Again, retaining client flexibility wherever possible is always a primary objective of ours. We analyse the currencies the corporate is most heavily exposed to, consider the time periods involved and then we focus on the primary hedging solutions that fit within the selected client parameters.
Just moving away from foreign exchange for a moment, and looking at corporates on the liability side, we are seeing corporates globally with very high cash levels, partly because they are generating good profits but partly because of the uncertainty of the market. They are tending to maintain substantial cash balances in a very low interest rate environment. Again therefore, clients need guidance and advice in these difficult times on the balance between yield and security – on deciding what the optimal cash levels should be.
In both foreign exchange risk and liability management, our aim ultimately is to provide simple solutions to gain trusted adviser status with our core client franchise.
What plans do you have for expansion in FX over the next 24 months?
As I’ve outlined, we provide a first class service today to our existing clients. The aim is to build on this client proposition and to both increase our penetration of our core client base and to expand that service to a broader geographic footprint. That means moving first into continental Europe followed closely by the US and later Asia. This is about providing a set of global solutions for our core clients. From a global perspective our near term target is to move into the top 20 by volume of foreign exchange.
Is this realistic? Absolutely. We have a significant market capitalisation and we service our current clients well today. That level of service quality is a key differentiator and as I have already said, we have an excellent track record, backed up by the endorsement of our clients as evidenced in the Greenwich survey.
So this is an already successful platform which we want to deliver to an expanded group of clients.
What innovations are you seeing in the FX area and how are you responding?
The key point here is that the next burst of innovation in foreign exchange will not necessarily be product related, it will just as likely be in terms of the simplicity, efficiency and quality of service. One of our key initiatives is Arena, our new e-solutions platform, which we are planning to launch in the third quarter of 2011.
Through this we will deliver pricing capabilities, content-rich research and strategy thought pieces. We will deliver our own structuring advisory services – all through one platform – and over time we will be delivering those same services across other asset classes as well, primarily in the debt space.
It is important to stress that we have tried very hard not to make this a product push. Instead, we have spoken to our client base and asked them for their view on how tomorrow’s e-solution platform should look. We have then liaised with them continuously through the product development cycle by way of a client advisory board; and that board has provided constant feedback to us to ensure we deliver a client-required product that supports their longer-term goals.
Again, this will enable us to win and maintain trusted advisor status by supporting the client through the whole business cycle. So, whether it is through simple execution facilities, whether it is risk mitigation advice or whether it is alpha generation ideas, I believe that Arena will provide a valuable platform that enhances the client experience with us.