Much has been written about the ‘unintended consequences’ of regulation and our Editorial this month looks at the problem of over-regulation. Yet little has been said about the benefits. Can key regulatory reforms really bring anything positive to the treasury environment? On that topic, the response from treasury experts, it seems, is rather mixed.
EMIR, Dodd-Frank, SEPA, FATCA, the list goes on. Regulation has been a heavy burden for most treasurers over the last few years; and that’s not even considering the indirect impact of changes in the banking sector. In fact, regulatory compliance is “an increasing overhead, some of which is a tick in the box exercise and, thus, doesn’t add any value.” That was the candid opinion of one respondent to Treasury Today’s 2014 European Corporate Treasury Benchmarking Study – and many other treasurers hold similar views. “I prefer to remain polite and not comment on valueless, EMIR-like constraints,” said another.
Whilst the negative effects of regulation are not in question, it is perhaps pertinent to ask whether corporates are benefitting – either directly or indirectly – from these initiatives.
EMIR as a starter for ten
Designed to standardise over the counter (OTC) derivative markets across EU countries as well as improve transparency and mitigate systematic risk, the mandatory clearing requirements of European Market Infrastructure Regulation (EMIR) are, at the time of writing, still being finalised by the European Securities and Markets Authority (ESMA). The current draft requires corporates – that are already, or planning to become, central counterparty clearing house (CCP) members – to clear six months from the date when the legislation comes into force.
“Interest rates clearing legislation is expected to be completed first and come into effect in the third or fourth quarter of this year, with credit derivatives to follow,” says Olga Cileckova, Director at PwC. “If corporates are already clearing members or looking for direct access to CCPs, one assumes they are already voluntarily clearing most standardised contracts.”
The current clearing draft legislation also proposes a three year transition period for non-financial counterparties that are currently not clearing members but have OTC derivative activity above the clearing threshold. “While 2018 seems a long way off, there are reasons for corporates subject to clearing to be taking an interest now to assess the clearing options that will be available to them, the cost of clearing access and development of the legislation,” adds Cileckova. “Clearing services are expected to be impacted by the banking regulations, in particular Basel III.”
The corporate community has largely been shielded from the impact of OTC derivatives regulation in Europe thus far – delegated trade reporting is permitted and regulation of non-financial counterparties has been less onerous than for banks, observes Senior Analyst at Aite Group, Virginie O’Shea. Due to the extensive delays and revisions to EMIR, many corporates have held off on preparing for clearing requirements.
The biggest challenge for these firms is a lack of internal expertise on the practice of clearing, she adds. “Banks have been exposed to these requirements and challenges before, but corporates are not financial operations or compliance experts. The numerous problems that regulators have encountered in making sense of trade reporting data have not helped matters – there is general sentiment that reporting infractions will be almost impossible to detect for the next year or so.”
The inclusion of a phased approach to EMIR has been helpful, although the rules are still capturing a large number of corporate clients with varying degrees of sophistication says Chris Probert, Managing Principal, Capco. “Traditionally, these clients’ systems and processes have been less automated. Trades which may be seen as straight through processing for a multinational broker dealer could be manual for corporates, which presents them with operational and IT challenges to ensure they can meet their obligations.”
Aside from the technical challenges associated with clearing, there is the considerable administrative task involved in the process, he continues. “Corporates need to decide who will be their clearing broker and backup broker; what (if any) market infrastructure they will use; and how they would like their margin to be segregated, along with a wide range of other decisions. These decisions and the related paperwork take time.”
Probert suggests that the wide range of corporates impacted by clearing rules makes it impossible to label the whole group as either prepared or not. “Undoubtedly the larger, more sophisticated corporates (who may already be clearing) are in the main part ready. The issue is with the smaller corporates who have traditionally have been slow to react to regulatory changes and are likely to be up against the clock to get everything ready in time.”
Deloitte’s Treasury Advisory Service co-leader Karlien Porre, however, points out that while corporates have to comply with reporting and risk mitigation components of EMIR, most are exempt from its clearing requirements since they are classified as non-financial counterparties.
And on the subject of the upside of EMIR for corporates, she notes that “some companies would see compliance as a cost rather than a source of benefit. The real benefit is improved financial market stability.” On a counter note, Jan Vermeer, Partner and Founder of Treasury Services describes EMIR (and Basel III) as having contributed to higher banking costs for corporates who are determining their bank relationships based on a RAROC or risk adjusted return on capital model.
Basel III: the knock-on effect
One of the most significant but least-discussed regulatory changes that will impact corporate users of treasury management services is Basel III, explains Daniel Blumen, Partner at Treasury Alliance Group: “There is a direct connection between balance sheet changes the banks are making and the cost and availability of treasury services. Most corporates don’t know their banks’ position and so cannot act to take advantage of the changes or mitigate their impact,” he explains.
Furthermore, “while Basel III has prompted changes in banking services, particularly driven by the liquidity rules, the expectation of many corporates is that there will be more changes to come around treasury services, credit/liquidity facilities and ‘non-operational’ deposits,” says Robert Ceske, Principal and Head of KPMG’s US treasury practice.
One of the problems is that the banks are not yet talking to their clients, which keeps the issue off the radar of many corporates, Ceske suggests. “There will be significant shifts in business allocation and restructured credit facilities by corporates as the impact becomes clearer. The smarter ones are taking action now but this issue will be at the top of treasury discussions later this year.”
In some cases, Basel III has led to credit lines being tied up and banks asking clients to deposit for a period longer than three months, explains Cileckova, while in other areas – such as pricing of high frequency, low volume derivatives – the impact is less transparent. According to Enrico Camerinelli, also a Senior Analyst at Aite, the regulation has made users of corporate banking services more knowledgeable on how their bank partners are handling the compliance requirements. “Bank relationship management is becoming a must-have practice to assess whether banks have charged/are charging costs of compliance to corporate clients.”
Banks are still working on Basel III implementation and there has been little price impact on corporates due to competitive financial markets – that is the view of Dino Nicolaides, Deloitte Treasury Advisory Services co-leader. “There has been limited impact on lending, although we have seen more UK and European corporates accessing capital markets directly for funding as opposed to the loan market, which is a shift towards the US model. Some argue that the financial crisis and Basel III have accelerated this process.”
Another possible implication for corporates is that banks may decide either that they no longer want their business because they are either over-exposed to the company or that the mix of business done with the company has to change. “In the past, the bank would only have to consider counterparty risk,” explains Jerry Norton, Vice President Financial Services at CGI. “Now it has to look at the liquidity coverage ratio and the leverage ratio and understand the impact of corporate activity across its book. In some cases this might mean the bank will favour business from a specific industry sector or drop certain types of business.”
It’s not all bad news though. Neil Vernon, CTO Gresham Computing believes the opportunity to reduce their capital adequacy requirements has encouraged banks to take a closer look at how they can better serve their customers’ needs and that they are delivering better service and more innovative products as a result.
The lowdown on money market funds
In addition to pending clarity of EMIR and increased discussion of Basel III, corporates had been waiting for further clarity on the changes to European money market funds (MMFs) regulation – which was announced in March. See our article focusing more in-depth on the implications of new European MMF regulation on page 24 of this issue.
Ring-fencing in the UK
Of specific regulatory consideration for UK corporates is the Bank of England Prudential Regulation Authority’s (PRA) implementation of ring-fencing of core UK financial services and activities for banking groups with core deposits in excess of £25bn. The government has stated its intention for ring-fencing to take effect from the 1st January 2019. The PRA has acknowledged that this is of interest to customers of the affected banks and intends to undertake further consultations during 2015 and publish final rules and supervisory statements in 2016 to provide firms with sufficient time for implementation.
“There are concerns among corporates that they might have to change sort codes and other account details if their business was moved into the part of their bank that is not ring-fenced,” explains Norton. Elsewhere, some smaller companies will find themselves dealing with the ring-fenced bank (RFB), yet the derivatives offered by the RFB will be limited and will not necessarily cover all their hedging needs.
SEPA trundles on
Finally, SEPA continues to be a headache for many corporates. Not least because all the hard work does not seem to be paying off yet, especially for the smaller players. “Some of the larger, pan-European companies have also yet to reap the returns on their considerable investments, although improvements in terms of process standardisation and lower banking costs are starting to filter through,” confirms Norton. He says these improvements are being felt most keenly by corporations with significant business-to-consumer operations, including utilities, mobile operators and insurance companies.
But opinions about SEPA improvements – and limitations – going forward are somewhat split. Magnus Carlsson, Manager of Treasury & Payments at the Association for Financial Professionals, focuses on one of the practical limitations of SEPA, namely the size restriction for a payment to only 140 characters. “This means that instead of sending payments for multiple invoices in one transaction, corporates have to use one transaction per invoice. So even if the cost per invoice was considerably lower, the overall cost for sending payments could very well be greater than with the legacy system.”
However, KPMG’s Finance & Treasury Management Partner in Germany, Carsten Jaekel, takes a more positive view and suggests that many corporate customers now have a better understanding of the benefit of single formats. For him, the Common Global Implementation initiative will build on the foundation laid by SEPA and eventually lead to significant savings from fully-fledged payment and collection factories. According to Cileckova, SEPA has made the euro payment system more efficient overall – leading to savings in transaction costs – and that many companies are now focusing on the second round of SEPA optimisation when the new Payments Services Directive becomes a pressing implementation issue.
Benefits of SEPA for corporates include: a wider portfolio of banks to process their payments business, increased pricing competition, cost benefits from optimised and standardised enterprise resource planning (ERP) bank interfaces using the ISO 20022 standard for payments and account information services. SEPA is also improving straight through reconciliation capabilities by enriched data carried in the messages and has introduced the direct debit payments instrument in order to collect funds centrally across all countries and customer accounts.
“However, as a result of the financial crisis, many corporates have become very risk conscious and reluctant to consolidate their payments business with a single bank and location within Europe, so this obvious benefit has rarely been implemented,” suggests Capco Partner Bernd Richter. Camerinelli also acknowledges that although use of the ISO 20022 standard allows for the alignment of payments transactions in all SEPA countries, it is yet to be fully exploited.
“There are concerns among corporates that they might have to change sort codes and other account details if their business was moved into the part of their bank that is not ring-fenced.”
Jerry Norton, Vice President Financial Services, CGI
Elsewhere in SEPA-land, in December 2014, the Euro Retail Payments Board (ERPB) decided to step up work on instant payments, person-to-person mobile payments and contactless payments as well as issuing a set of recommendations to address outstanding issues in the SEPA credit transfer and direct debit schemes, such as the move to IBAN only and the harmonisation of payment standards between banks and customers.
The ERPB is concerned that the emergence of new solutions might end up creating a fragmented market in Europe for instant payments. “Solutions for instant payments should avoid the ‘silo’ mentality of closed systems that don’t communicate with each other and take advantage of the harmonisation and integration already achieved with the SEPA project,” says Yves Mersch, member of the ECB’s executive board and chair of the ERPB.
Always look on the bright side
In the midst of the headache that regulation can be, and with so many conflicting opinions to take on board, it is often difficult to see the silver lining. But as Mersch alludes to, taking advantage of regulatory benefits, or at least opportunities, is something all corporates must strive to do. And although the regulatory burden is not likely to lighten in the near future, in some areas at least, corporates can look forward to their hard work delivering worthwhile rewards.