Emerging markets have long been a critical part of the business mix and growth strategy of multinationals. But how best can treasury navigate emerging market risk and regulation?
Managing fast-growing trade in emerging markets is a top priority in corporate treasury at British ingredients maker Tate & Lyle. “We are currently spending a great deal of time making our emerging markets treasury proposition as good as our developed markets treasury proposition,” says Oliver Whiddett, Head of Group Treasury at Tate & Lyle, where new consumers in emerging markets are driving growth for the company’s high margin, speciality ingredients.
According to the Boston Consulting Group, some 300 million additional households will enter the consuming class in emerging markets this decade; populations in developing countries are growing four times faster than those in developed countries.
Managing trade and investment in emerging markets ushers in a new level of complexity for treasury, in charge of financing, hedging and safely steering the company’s financial interests in these more challenging jurisdictions. How do fast-growing companies ensure a strong emerging market treasury?
Get the FX right
Even if a corporation has a small exposure to emerging market currencies, exchange rate volatility can cause chaos, pushing up costs or evaporating margins.
Corporates tend to have fixed hedging programmes in developed market currencies. But when it comes to managing FX risk in emerging markets, where hedging is expensive because of transaction costs and interest rate differentials, a bespoke and dynamic approach can work best.
Companies with growing China trade will have to navigate a complex and volatile currency risk that usurps most other markets. Deciding whether to manage their renminbi hedging policy on a centralised basis from head office, or if delegating decisions to subsidiaries is a better fit, is an important consideration.
Hub and spoke
How to structure treasury in emerging markets is the next question. In one model, multinationals are choosing to move their emerging market treasury to financial hubs in regions like Singapore, the UAE or Miami. It’s a model that establishes “policy level” governance and regulatory coverage and provides access to sophisticated financial services.
In other cases, companies may operate a devolved approach, delegating control to local entities in more challenging countries, owing to in-country regulations, complexity of markets or limitations in the financial environment.
By ensuring broad expertise, product offerings and geographies in core banking relationships, treasury can often tap the subsidiaries of their core banks in far flung jurisdictions. Yet local bank relationships also bring local market and industry expertise.
Whiddett particularly advises treasury teams to develop local banking relationships that are strong enough to weather the bad times, not just the good. “If the ratings drop and the cash flows fall away there are never so many banks knocking on the door.”
Working with banks in emerging markets adds a new level of counterparty risk. Sovereign downgrades are a common hazard that can increase borrowing costs, shrink liquidity and put pressure on local banking systems.
Local banks’ ability to integrate technology is another consideration. Local banks may not have electronic banking platforms, relying instead on manual, administratively-heavy processes.
Rules and regulation
Navigating regulation in emerging markets is a priority. The problem manifests particularly in cash management, where trapped cash due to sudden or unexpected currency or capital movement restrictions, impacts access to working capital across emerging markets and through supply chains.
It leaves some treasury teams deciding to keep as little cash as possible in the local market. Some corporates request that the receivables be paid in another currency altogether, collecting revenues offshore with payments made in US dollars to circumvent the currency restrictions.
A clear view of what cash the business needs, often difficult because the business is expanding, is crucial.
Other regulation may be more mundane, but just as frustrating. Cross-border payments typically require additional documentation and the use of cheques, common in some markets, also poses challenges around the timely realisation of funds.
Tate & Lyle’s Whiddett concludes: “Ideally, we are one step ahead of the markets the company is focused on. We’ve already looked to our banking group or started conversations with new banks, and we are already across local regulations, capital restrictions and our hedging options.” Anticipation, it seems, is the magic ingredient.