Persistently low interest rates have fuelled a record-high disconnect between debt and equity, an increase in capital markets activities and growing investor appetite for return on capital. A slump in crude oil prices in early 2015 and volatility in foreign exchange (FX) markets, such as the US dollar’s ongoing strength against the euro, have illustrated the magnitude of today’s headwinds and the need to avoid complacency.
Managing Director Head of Solutions and Advisory Services, Asia Pacific Treasury Services
Vice President Advisor, Solutions and Advisory Services, Asia Pacific Treasury Services
Since instability in developed markets often disproportionately impacts developing markets, corporate treasurers in Asia Pacific will need to make tactical decisions that demonstrate their ability to play a strategic role in their organisations.
Asia Pacific volatility expands
Macro economic environment
Central bank policies on interest rates in the US, UK, Europe and Japan that have long been quite similar are now diverging. Europe and Japan are expanding quantitative easing at the same time the US and the UK are pulling back.
Global currencies are showing tremendous volatility, fuelled by central bank decisions — in January, Switzerland’s central bank abandoned its cap on the Swiss franc’s exchange rate against the euro, throwing global FX markets into turmoil1.
Oil prices also surprised the market by dropping below USD 50 for the first time since the financial crisis, and this drop will continue to have a major impact for most companies in 2015. Oil deflation could potentially have a greater impact on economies than fiscal or monetary policy.
Corporates have maintained conservative balance sheets even amid the financial crisis recovery, with cash rising from 8.3% of assets in 2008 to 12.7% in 2013 and net debt dropping from 20.8% of enterprise value to 10.9% over the same period.
High internal hurdle rates, averaging 18% among a sampling of S&P 500 firms, are one driver of the cash accumulation. The rates reflect a higher risk-averse disposition towards long-term investments in an uncertain environment.
As a result, activist investors, particularly hedge fund managers, have put further pressure on corporates to acquire or spin off companies rather than stockpile cash and maintain a balance sheet with low-yielding assets.
Regulatory changes, such as those that resulted from Basel III, are often viewed as primarily affecting banks. In fact, they have a major impact on corporates, as the increased costs of regulation lead to higher-priced bank services and a lower supply of credit.
To fuel growth in their own markets, regulators in Asia are taking significant steps toward deregulation and/or liberalisation. Regulators in China further liberalised the market in November 2014, making cross-border sweeps easier and documentation simpler. India allowed Indian subsidiaries to access funding from their international affiliates.
Regulators are also making changes to attract Regional Treasury Centres (RTCs) in certain Asian markets. Hong Kong amended its laws and announced plans to introduce attractive tax incentives, China de-regulated its policies in free trade zones, and policymakers in Malaysia and Thailand relaxed regulations to provide incentives to attract treasury centres in their markets.
Technology is changing significantly as countries and corporates strive to become more efficient. Across Asia Pacific, the trend is toward standardisation, including the use of SWIFT, electronification through sophisticated clearing centres and leveraging mobile penetration to solve last-mile access issues.
Developing countries throughout the region are upgrading their systems from a basic clearing and settlement infrastructure to more efficient digital treasury technology, such as the China National Advanced Payment System (CNAPS) II and an innovative real-time payments platform in Singapore, known as FAST.
Corporates are also enhancing their infrastructure, with many moving to bank-agnostic technology such as the industry standard ISO 20022 format and the SWIFT network. With a focus on treasury management systems, corporates are taking advantage of banks’ investments in innovative solutions in mobile and smart banking.
Navigating 2015: a treasurer’s focus
In this dynamic environment, the fundamental short-term and long-term roles of the treasurer in optimising capital and mitigating risk, while increasing operational efficiency and ensuring sufficient control, remain the same. Treasurers look to achieve these objectives by managing cash and funding working capital and capital expenditures, and at the same time, aligning capital structures by achieving the right balance between debt and equity in capital markets.
What has changed, however, are the key actions and decisions treasurers will need to take because of external factors described above. Based on that, we believe most treasurers will prioritise five key activities in 2015.
1. Create an effective hybrid centralisation model
To establish the appropriate treasury structure, it is important to fully understand the business drivers, from sourcing and production to how the firm manages fund flows back to the region or repatriate funds to the parent company. It is essential for treasurers to strike the optimal balance between centralisation and decentralisation by understanding what should be centralised to maximise the benefits of an RTC or in-house bank and what needs to remain local.
Particularly in Asia, where infrastructure and regulatory frameworks diverge between markets more than in other regions, achieving an optimal balance between global consistency and local flexibility is of utmost importance.
2. Diversify sources of funding
Amidst regulatory changes that may lead to price increases or decreases in credit supply, as well as interest rate hikes, treasurers need to identify sources of funding for both normal business activities and new opportunities. This role, and their deep understanding of the needs for supply chain and working capital funding, are critical because their assessment affects the corporate strategy and determines which projects can be funded.
It is also important for treasurers to target a capital structure that provides financial flexibility to fund growth and prioritise sustainable long-term opportunities. Strategies for successfully managing funding include diversification of sources of funds, optimising excess cash through fee offsetting, spreading maturity dates, and ‘just-in-time’ funding.
3. Optimise operational efficiency
Technological advances such as enhanced Enterprise Resource Planning (ERP) and standardisation enable treasurers to work more efficiently, ensure more effective processing and perform previously-error-prone manual tasks accurately in minutes rather than days. Benchmarking against leading players allows treasurers to critically evaluate the current situation and to better plan their operational efficiency journey.
With the help of technology and information systems, treasurers can apply their skills more effectively by channeling their time and resources into value-add activities and utilising intelligent tools for analytics in order to support and achieve their objectives in the operational efficiency journey.
4. Develop an enterprise-wide risk agenda
Given the increasing scope and complexity of regulatory and policy changes both regionally and globally, treasurers can only manage across risk categories well if they fully understand the entire business and what is driving risk. Traditionally, treasurers have focused on FX and liquidity risk. There is now a need to think about combined exposures.
It is also important for treasurers to forecast and manage risk more dynamically and proactively, exploiting their deep understanding of the business to formulate strategies to tackle root causes of risk, rather than hedging against temporary conditions. These include taking a holistic view when looking at changes in the world and counterparties, and devising a sustainable risk management strategy.
5. Prepare for shareholder activism
With the rise of shareholder activism and the pressure of bringing increased value to the table, companies are constantly looking at ways to better manage their cash and take advantage of low borrowing rates for mergers, acquisitions, capital expenditures and spin-offs.
Although treasurers do not actively make decisions on acquiring or divesting, they need to be in a position to act swiftly to integrate or adjust core treasury operations based on changes that may arise. Planning ahead ensures an effective funding approach for such activities to readily integrate core treasury operations seamlessly under tight timeframes.
Thriving in 2015
In light of high uncertainty and increasing volatility, corporate treasurers in Asia Pacific have greater opportunities than before to play a key role in achieving corporate objectives and demonstrating their strategic value to the firm. By focusing on these five priorities, treasurers can enhance the competitiveness of their company and ensure they are well prepared to take advantage of any opportunities that come their way.