Treasury Today Country Profiles in association with Citi

Managing financial regulation

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Regulatory change continues to present considerable challenges for corporate treasurers around the world. From Basel III to KYC obligations, what are the most significant changes currently faced by treasurers – and how is the regulatory environment affecting the treasurer’s role and required skillset?

The changing face of regulation around the world has been a major concern for treasurers over the last few years – and this is likely to continue for the foreseeable future. “One could think that the slew of regulatory reform post-crisis is now coming to an end, given the sheer amount of laws that have been adopted and implemented in recent years,” comments Ruth Wandhöfer, Global Head of Regulatory and Market Strategy at Citi. “However, one would be wrong.”

Wandhöfer points out that while key pieces of regulation affecting banks – such as Basel III – have largely been implemented in recent years, other changes are expected for the future. “Elements of Basel III, such as the NSFR (net stable funding ratio) and TLAC (total loss-absorbing capacity), are still to come,” she notes. Meanwhile, other regulations coming into effect may have a more direct impact on corporate treasurers – such as the new money market fund regulations being introduced in the US and Europe.

Basel III

In some cases, regulation can have a significant impact on the products and services that banks can offer, or on their pricing structure. One such regulation is Basel III, which is currently in the process of being implemented. The regulation has significant consequences for banks around the world, as well as on their corporate customers.

“The most significant regulatory change impacting treasurers is Basel III, as this has impacted many long-standing liquidity management techniques, such as notional pooling, and substantially affected the way that bank deposits are compensated,” notes Jennifer Doherty, Global Head of Commercialisation, Liquidity and Investment Products, HSBC. “Under Basel III, certain deposits can be costly and inefficient for banks to hold on their balance sheets, which has reduced appetite for accepting such deposits.”

Doherty says that Basel III is leading some cash-rich treasuries to re-evaluate their investment approach, including the liquidity methods used as well as their broader bank relationship strategy. “Today’s environment means that it is increasingly difficult to generate returns on cash holdings and fully optimise their liquidity,” she explains. “A good example is notional pooling, which has been widely used by treasurers to improve visibility of cash and consolidate it. Basel III has considerably impacted the efficiency of notional pooling.”

Regulations old and new

Both recent and more established regulations can present challenges for treasurers. KPMG’s 2015 Global Corporate Treasury Survey found that Basel III and EMIR were seen as the regulations with the greatest impact on corporate treasury, both cited by 92% of respondents. Other significant regulations included Dodd-Frank and Sarbanes-Oxley, as well as the more recent Base Erosion and Profit Sharing (BEPS) measures.

KYC/AML

Another area which is the focus of considerable regulatory attention is that of know your customer (KYC) and anti-money laundering (AML) regulations. With regulatory authorities cracking down on terrorist funding and other illicit uses of funds, banks are having to comply with increasingly onerous KYC and AML obligations. This, in turn, is having a significant impact on their corporate customers, who are often required to provide the same types of information to a number of different banks.

“In more than just a few jurisdictions, part of the client due diligence that I have to do on a regular basis includes collecting a passport from someone who is authorised to sign on a demand deposit account,” comments Stephanie Wolf, Head of Global Financial Institutions, public sector banking and Canada sales at Bank of America Merrill Lynch.

Wolf points out that these challenges are not just a one-off issue, since requirements are not static and any change to them usually results in having to ask for new or more information from clients. The exact requirements vary from country to country: in some countries banks may need to carry out KYC checks on every single card holder within a commercial card programme. No such checks would be needed for the same programme in the UK or the US.

“I do think financial institutions are well positioned to guard against misuse of our financial system – but unfortunately this can mean a higher burden for clients,” Wolf says. “We certainly try to manage that.”

The impact of these obligations is considerable. Research published by Thomson Reuters in May found that 89% of corporate respondents had not had a good KYC experience. For 13%, this had resulted in a change in their financial institution relationships. When it came to specific challenges, a third of respondents reported that they had received inconsistent requests for information and documents, while 22% said that the delays and paperwork associated with the KYC process had cost them time and resources.

While banks are doing everything they can to make these processes as user friendly as possible, Wolf believes that more collaboration is needed in order to reduce the burden on corporates. “We are looking at how we can work together to standardise our requests and help clients understand what information is needed,” she says. “Conversations are taking place across the industry to discuss how information can be shared within regulatory guidelines and privacy considerations.” She argues that greater levels of information sharing would not only reduce the regulatory burden for companies, but may also enable banks to help tackle financial crime more effectively.

Wolf adds, “banks are working hard to collaborate, which is good news for the treasurers – it just can’t come quickly enough.”

To read more about dealing with KYC see this issue’s Treasury Practice article.

The age of regulation

While not an exhaustive list, recent and upcoming regulatory changes include the following:

Basel III

The introduction of Basel III has had wide ranging implications for the way in which liquidity is viewed by financial institutions – and consequently on the pricing and services offered to corporate customers. Implementation began in 2013 and is due to be completed by 1st January 2019.

BEPS

The final Base Erosion and Profit Sharing (BEPS) Action Points were published in 2015. The objectives of the rules include preventing companies from moving profits to different jurisdictions for tax purposes. The action points include several areas which may have implications for topics such as transfer pricing, country-by-country reporting, intercompany loans and in-house banking.

Dodd-Frank

Passed in 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was intended to address risks in the US financial system.

EMIR

The European Market Infrastructure Regulation (EMIR) came into effect in August 2012, although the final stages of implementation will not take place until December 2018. The focus of the regulation is over-the-counter derivatives.

IFRS 9

The new hedge accounting standard was published in 2014 and becomes mandatory for annual periods beginning on or after 1st January 2018.

Money market fund regulation

The US has recently introduced a number of changes, including the move from a constant net asset value (CNAV) to a variable net asset value (VNAV) model. Redemption fees and restrictions can also be imposed in certain circumstances. In Europe, proposed new rules are still in the pipeline.

PSD2

One of the most significant implications of the second payment services directive (PSD2) is the move towards open banking. This paves the way for the use of application programming interfaces (APIs) to give third party providers access to clients’ bank data in order to provide related services.

Sarbanes-Oxley

The Sarbanes-Oxley Act – also known as Sarbox or SOX – was introduced in 2002 to reduce the risk of accounting fraud following a series of accounting scandals.

SCT Inst

The proposed SEPA Instant Credit Transfer (SCT Inst) scheme is intended to enable instant euro payments across the SEPA area. The European Payments Council arranged a public consultation on the draft SCT Inst Rulebook earlier this year, with the proposed business and technical rules expected soon.

Section 385

In the US, regulations proposed in April by the US Treasury Department and the Internal Revenue Service (IRS) may result in internal debt instruments being reclassified as equity for tax purposes. This may have implications for companies with cash management structures such as cash pooling and intercompany loans.

Money market funds

Another area which is undergoing a considerable shift is that of money market funds (MMFs). Historically, most funds have run on a constant net asset value (CNAV) basis, whereby the price of a share is $1 (or £1/€1). Following the collapse of the Reserve Primary Fund in 2008, however, regulators have focused on bolstering the way in which money market funds operate.

In the US, new rules came into effect on 14th October which require prime funds and tax-exempt funds to operate on a variable NAV (VNAV) basis. The new rules also stipulate that funds can charge a 2% redemption fee or prevent redemptions altogether if liquid assets fall between a certain threshold. Over $1trn has already left the relevant funds since the beginning of the year in light of these changes.

“Most clients are just flipping from prime funds into treasury funds and waiting to see what happens,” says Mark Smith, Head of Global Liquidity, Global Transaction Services at Bank of America Merrill Lynch. “But those treasurers are flipping into an asset that is lower yielding, so the yield enhancement that treasurers can get from a money market fund versus a deposit is probably at a historic low.”

It’s not all bad news, however. Smith notes that the decline in prime fund investments has meant that prime funds are buying less of assets such as commercial paper, variable deposit notes and certificates of deposit (CDs). As a result, these assets are currently yielding at higher levels – presenting some interesting opportunities for treasurers.

Smith notes, “If you are a treasurer with a flexible, sophisticated investment policy, and if you have got the systems and the team needed to take advantage of this, there are some really good short-term opportunities.” As a result, he says that some companies are re-examining their investment policies to see whether it makes sense to review their policies in order to take advantage of the situation.

The situation is somewhat different in Europe, where negative interest rates mean that companies using prime funds are currently paying the funds to hold their money. Meanwhile, Europe’s money market funds are also tabled for regulatory change, although the money market fund regulation (MMFR) proposed by the European Commission in 2013 has yet to be realised.

Implications for treasurers

In this climate, treasurers have to be aware of many types of regulation, although different companies are inevitably affected in different ways depending on the nature of their businesses. David Stebbings, Director, Head of Treasury Advisory at PwC, points out that the extent to which a company is affected by regulation depends very much on which sector the company is in. “The closer you are to the financial services sector, the more you are affected by regulation,” he notes. The impact of regulatory change will also vary considerably depending on a company’s geographical footprint.

Some industries may be subject to their own diverse and challenging regulations. “I was working with a company that is opening a new facility in China,” says Stebbings. “They have a special team that goes around whenever the company opens a new operation. This team includes a treasury person who makes sure that the company is complying with all of the regulations relating to collecting cash, getting money out and understanding central bank reporting.”

Understanding the challenges

What particular challenges should treasurers be aware of? “Many of the regulatory developments will mean enhanced compliance cost and administrative burdens but could also reduce business flexibility as well as approaches to tax, location and overall business organisation,” explains Wandhöfer. “It will continue to be a challenge to keep all these different developments in sight as well as to assess their impacts, both individually and in conjunction.”

Meanwhile, Doherty notes that the need for safety in the context of their security, liquidity and yield is a key priority for treasurers today. “Treasurers have to manage a greater range of risks, while also demonstrating compliance with their investment mandate, so there is a greater risk management element to the role.”

Wandhöfer adds that because of the challenging economic and regulatory landscape for banks, “corporates will need to maintain a close watch on their banking partners in order to avoid any surprises that could challenge their operations.”

Such surprises could be significant. In recent months, a number of banks have pulled out of certain markets in a phenomenon known as de-risking. In the world of transaction banking, the decision taken by RBS to step back from offering cash management and trade finance services in most of its European markets has been particularly significant.

Technology challenges

Doherty points out that technology-related liquidity challenges have increased, and that certain markets and payment platforms are now migrating their infrastructure from batch-based processing to a real-time environment. “This means that treasurers increasingly need to manage cash and liquidity in or near real-time, rather than on an end-of-day basis,” she notes. “While the technology solutions to achieve this may be available, it means that treasury functions need to be much more technologically adept than they have been in the past.”

A master of all trades

In this increasingly challenging regulatory environment, treasurers have also had to acquire additional skills and gain a greater level of knowledge on regulatory topics than in the past.

“They are expected to be treasury experts, but they also increasingly have to be regulatory experts,” says Smith. “This means understanding what is going on in the regulatory landscape and how this will affect not only the company itself, but also the company’s banks. They are expected to be tax experts, as illustrated by the arrival of Section 385, which has a huge potential impact on how treasury functions are organised. And they have to be accounting experts.”

“Many of the regulatory developments will mean enhanced compliance cost and administrative burdens but could also reduce business flexibility as well as approaches to tax, location and overall business organisation. It will continue to be a challenge to keep all these different developments in sight as well as to assess their impacts, both individually and in conjunction.”

Ruth Wandhöfer, Global Head of Regulatory and Market Strategy, Citi

While being an expert in all of these areas is certainly challenging, Smith says that it also brings certain benefits when it comes to raising the profile of the treasurer within the organisation. “With so much critical knowledge being concentrated in the treasury function, treasurers are increasingly becoming seen as key advisors and are getting more board level exposure,” he says. “Treasurers are no longer seen as being just the guys who move the money around and get the bills paid – they are having far more strategic input into the strategy and the financial planning of the company.”

Meanwhile, the growing demands of the role are making it harder for companies to find the right person for the job. “Good treasurers are hard to come by and are in considerable demand,” says Smith. “I worked with a couple of clients in Ireland who were trying to get treasurers with any experience. They concluded that they would have to get somebody with much less experience and train them up.”

The challenges may be considerable – but for corporate treasurers the importance of keeping up with regulatory change should not be underestimated. “As a company we always follow the rules ourselves,” concludes George Dessing, SVP, Treasury and Risk at information services company Wolters Kluwer. “If the environment asks us to make changes, we follow immediately. At the end of the day, we want to be a good corporate citizen, so this is something that we follow quite closely from a business perspective as well as from a company perspective.”

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