Whilst many consider Europe to be a single, integrated region, the events of the past year highlight that this is far from the truth. Political and economic uncertainty, notably in Western Europe, have caused treasurers many headaches; but the rise of emerging Europe, in particular Central and Eastern Europe, may soon present a number of new opportunities. Treasurers working in and with Europe have therefore had to navigate this turbulent and inconsistent landscape, while looking to seize every opportunity and drive best practice – not always an easy task.

Political tensions have been high in Russia and the Ukraine, with alleged military skirmishes taking place, putting the former Soviet bloc nations on high alert. In the UK, political tensions have also taken centre stage. Most notably a dissolution of the Union was avoided in September 2014 thanks to a resounding ‘no’ vote in the Scottish independence referendum – although the success of the Scottish National Party in the May 2015 UK election yet again raises the possibility of an independent Scotland in the future. Anti-European sentiment is also strong across the UK and with an upcoming referendum, talk of a possible ‘Brexit’ is back on the cards.

Despite this uncertain backdrop, for the first time since the financial crisis, all EU economies are set to expand in 2015, buoyed by a combination of a weaker euro, lower commodity prices and monetary easing, according to the World Bank. Growth of 1.8% is forecast across the EU countries in 2015, with 2.0% expected the following year – a marked change from the 0% in 2013. A large part of this growth is being driven by Germany, Hungary, Ireland, Poland and the UK, all of which posted particularly strong results in 2014. The struggling Southern European countries of Spain and Italy have also returned to growth.

Although these statistics give cause for positivity, the continued uncertainty across the region makes it challenging for treasurers to plan their currency, investment and counterparty risk strategies – Europe certainly cannot be treated as a homogenous region.

With this in mind, in this opening Section of this Handbook we will focus on some of the noteworthy country level trends that we are seeing across the region. We will then shine a light on emerging Europe and in particular Central and Eastern Europe (CEE) and Russia. Lastly, we will revisit a perennial topic, European regulation, and explore how the challenges corporates now face are different from those that have existed in previous years.

Instability on the continent

Grexit: on a knife edge?

All eyes have been on Greece in recent months. The debt crisis has left the country on the brink of default and shaken the Eurozone to its core. With debts of up to €242bn – owed to multiple creditors including; the IMF, ECB, Eurozone and other EU member states – Greece came close to defaulting on its repayment to the IMF. However, a deal was struck at the 11th hour to allow for a third bailout deal, but at a cost. The Greek government, at the time of writing is trying to push through new austerity measures including: streamlining VAT, broadening the tax base, commencing immediate action to make the pension system more sustainable, safeguarding the independence of the national statistics office, implementing automatic spending cuts, privatising the electricity sector, and letting the institutions (EU, ECB, IMF) return to Athens.

And whilst, at the time of writing, it is expected that the deal will pass through the Greek government, it doesn’t mean the end of trouble in Greece. The current austerity measures, and those which are proposed, have proved extremely unpopular with the Greek population.

Although the new deal may see Greece tied to the Eurozone for the short to medium term, it is by no means a long-term fix – as we have seen from the previous two bailouts of the country. A recent study conducted (before the new bailout deal) by Emerging Markets and G10 Independent Strategist Olivier Desbarres, highlights that finance experts are not confident about Greece’s future in the Eurozone, with only a third believing that Greece will be in the Eurozone in three years’ time. Aside from the bailout, Greece has other issues to address – such as its economy, which has shrunk by a quarter in five years, historically low unemployment (currently above 25%) as well as public unrest and the rise of far-right political organisations like Golden Dawn.

If Greece leaves the Eurozone, what will this mean? When the Greek crisis first emerged several years ago, it was feared that a default and Grexit would spill over to potentially create a financial shock of greater magnitude than the collapse of Lehman Brothers. Today however, fears are tempered slightly because Europe has installed safeguards to limit the contagion. Nevertheless, a Grexit would certainly add further pressure and put significant question marks against the long-term viability of the single currency.

Will the UK go alone?

Question marks also now hang over the UK’s future in the European Union. Anti-European sentiment has been building in the UK for a number of years and this came to the fore at the recent election in May 2015. The Conservatives promised that, if elected, the UK people would get their say over EU membership by 2017 – their majority victory has now made this a reality.

In recent months, both the EU and US have stated that they would like to UK to remain in the EU. According to Adam Chester, Head of UK Macroeconomics, Commercial Banking at Lloyds: “the main implication of a Brexit is that it would put the integrity of the EU into question if countries can leave just as easily as they join. Although this may not cause as greater economic shockwaves as a potential Grexit, it adds another crack in the European infrastructure.”

In Chester’s opinion there will be limited impact on trade flows between the EU and the UK because both need each other in this respect. There could however, potentially be currency volatility in both the run up to the referendum and after, which way depends on the outcome. Yet, there are so many moving parts and variables, that it is hard to predict what exactly will happen should a Brexit occur.

A Brexit was also considered in the study by Desbarres and the results indicated that, at least in the near-term, it is unlikely. Nine out of ten respondents forecast the UK would still be in the EU in 18 months’ time – around the proposed time of the referendum. It is interesting to note, however, that the ratio drops slightly to 82% when the time horizon stretches to three years, and 68% at the end of the current parliament in five years.

On the probability of the UK staying in the EU, Desbarres said: “Prime Minister Cameron has promised a referendum on the UK’s membership to the EU before the end of 2017. Cameron’s initial discussions with key trading partners to reform the EU and ultimately give the UK a greater degree of autonomy in decision-making suggest there is some scope for negotiation. The UK economy has performed well and the government committed to further cutting the fiscal deficit. This is likely to resonate with the likes of German Chancellor Merkel at a time when the Greek debt crisis is threatening the very fabric of the Eurozone. There is an argument to be made that Germany and France cannot afford to lose the UK.”

A show of strength

Elsewhere in Europe, outside the EU, there is also political disruption that has the potential to impact markets, not least the alleged Russian military intervention in Ukraine. The first incursion took place in 2014 when soldiers of ‘ambiguous affiliation’ began to take control of strategic positions in Crimea which was later annexed by Russia. Since then, Ukraine has been unstable with pro-Russia separatists rising up, violence flaring across the country and the constant threat of further Russian military action.

Andy Langenkamp, Senior Political Analyst at ECR Research, believes that Russia’s actions are in a large part driven by the rest of the world being distracted with other issues. It is his view that the US has a lot on its plate including turmoil in Europe, the Middle East and Asia. Furthermore Langenkamp believes that: “Europe is firmly focused on the economy to the detriment of addressing the Russian threat. The western European countries, in particular, do not regard Moscow as a direct threat and are often more interested in trade relations.”

Of course the Russia/Ukraine incident has not been without its economic consequences. The Russian rouble and the Ukrainian hryvnia have nosedived (impacted further by the price of oil). Investor faith in Russia has been impacted with Forbes reporting that, in June, the risk of insuring Russian government bonds against default rose to the highest level since the worst days of the 2009 financial crisis – suggesting the nation’s credit rating may soon be lowered to junk status.

Furthermore, as a result of Russia’s actions the country has been excluded from the G8. Sanctions have also been placed on the country, including assets being frozen – the first time that sanctions had been levelled by the US and EU against another G10 economy. It was also reported that Russia may be banned from the SWIFT network – although this has yet to materialise.

Emerging Europe

Hungary

Away from Russia and Ukraine there are some positive stories coming out of Central and Eastern Europe (CEE). One of these is Hungary, a country which many experts believe is a nation on the up, becoming more regulated and controlled, offering a relatively stable environment for investors.

Overall, the regulatory environment is steady, at least in comparison to its regional neighbours. “But the big issue going forward will be how much political and government intervention there is because there are numerous political appointments at regulatory bodies, including public bodies and the central bank under Fidesz,” says Dr Katya Kocourek, senior associate and lead analyst for Central and Eastern Europe, at Stroz Friedberg. “I think that there is some de-politicisation of the regulatory environment that needs to take place in order for investors to feel fully confident about Hungary again.

“Hungary is undergoing quite a rigorous consolidation process of its banking sector. That’s connected to the fact that it’s re-structuring a lot of its debt, including external debt and a lot of its corporate debt,” says Kocourek. This is similar to the consolidation recently seen in the Polish banking sector but in contrast to Poland, Hungary stands out because its banking sector is around 50% foreign owned. The rest is made up of banks which the government has a stake in.

For businesses entering Hungary, the country may present something of an unknown, especially because it is a nation which hasn’t attracted as much investor interest. It is therefore important that investors actually become acquainted with the quirks of the country and its tax and regulatory environment. “One of the best ways to do that is to conduct vigorous due diligence, that’s a key part of the process because going into these markets can throw up unusual things and as I highlighted, the ‘thing’ with Hungary is the extent of the interventionist policies that the government has been pursuing,” says Kocourek.

Poland and the rise of SSC

For many, Poland is considered CEE’s star pupil. In 2014, its economy grew 3.4% year-on-year becoming one of the EU’s key growth markets. Moreover, the country presents a positive outlook, driven by its improving labour market, boosted consumer confidence and domestic demand. The economy has also proven resilient to turbulent economic headwinds from the rest of Europe with its currency, the Polish zloty, remaining relatively stable, supported by its current account surplus in the first half of 2015 and one of the highest real interest rates in emerging markets.

Given these developments, the country is becoming an attractive destination for foreign investors. As Monika Dabrowska, Head of TS Sales ING Poland explains: “Poland has been a key place for investors to do business in CEE in recent years. This has been encouraged by the Polish government, which has offered various forms of state aid to foreign investors.” In addition, the banking sector is also the largest in CEE, built from both local and international banks and serving both individual and corporate clients well.

Poland has also become a highly attractive location for shared service centres (SSCs), an industry that currently employs 150,000 people – forecasted to increase to 200,000 in 2020. Dabrowska highlights numerous reasons for this including:

• Labour market – there are 1.5 million students in Poland. Each year 400,000 higher education graduates enter the labour market. They are well-educated and speak foreign languages – Poland is also sixth in the world with respect to English language command, according to the Education First: English Proficiency Index 2014. Their labour force is also comparatively cheap compared to other countries in Europe.
• Office (real estate) market – Poland boasts a well-developed office infrastructure and the growing SSC sector is an important driver of further office market growth. There is 7,500,000 m2 total modern office stock in Poland. The market has recently recorded a 9% year-on-year increase in office stock. Apart from Warsaw, 65% of take-up was generated by companies from the SSC or business process outsourcing (BPO) sector in 2014.
• Location – Poland is located in the centre of Europe, with good infrastructure across the country and intra-European connections.
• Convenient time zone both for the Americas and the Far East.
• Poland is culturally close to the West, but at the same time there are no barriers with the Far East communities

In addition, Poland has been a member of the EU since 2004, and a Payment Services Directive (PSD) compliant country since 2011. Although Poland is not a member of the Eurozone yet, the tools for corporate treasury management are available (eg SEPA payments since 2007). “The banking infrastructure in Poland is one of the most advanced in the world, with host-to-host connections available, real-time and mobile payments,” adds Dabrowska.

Estonia: the e-economy

Meanwhile, Estonia is positioning itself to become an attractive location for corporates and their treasury departments, thanks in part to its digital economy.

When Estonia gained independence from the Soviet Union in 1991 less than half of the country’s population had a telephone line. Fast forward to 2015 and the small Baltic nation has developed impressive technological capabilities and embraced the digital way of being. Today, 80% of the population aged 16-74 years uses the internet, while 83% of households have internet capabilities and 98% of banking transactions in Estonia are conducted through the internet.

Back in 2005, the Estonian IT sector contributed to 9.2% of the country’s GDP but, today it is now the country’s fastest growing sector generating nearly 15% of GDP. Furthermore, the wide uptake of IT solutions provided indicate the eagerness of Estonians to use innovative solutions in all fields of life – education, employment and health care, for instance. Aptly, Estonia boasts high cybersecurity levels, rated fifth in the world by the Global Cybersecurity Index.

The development of an IT-driven economy is led by the Estonian government’s strategic choices. For example, the government has increased the availability of integrated e-solutions with its national ID card. The chipped photo ID stores digitised data about the user which can be used for all manner of purposes including logging into an internet bank, accessing public and financial tax services and for signing agreements electronically. In Estonia, a digital signature is just as valid as one in ink and using e-signatures saves the Estonian economy approximately 2% of GDP each year.

Of course, Estonia’s enhanced digital services and networking is important for the country’s corporate sector. Technology and a number of other factors are helping the country gain increasing global recognition as a viable corporate landscape and the country is looking to become a favourable destination for corporate treasury centres and shared service centres. Some of these additional factors include:

• Euro adoption since January 2011, helping simplify cash management processes.
• An educated, skilled and multilingual workforce.
• A simple, stable tax system with no tax on retained profits, no withholding tax on interest or dividends and numerous double taxation treaties, facilitating efficient flows and long-term planning.
• Low country risk with one of the lowest levels of sovereign debt to GDP in Europe and a government committed to balanced budgets and AA- credit rating.

Made in Turkey

Away from CEE and sitting at the very south-eastern edge of the continent is Turkey, a country many experts believe to have significant growth potential given its demographics; the median age is below 30 and there is a high per-capita GDP.

One of the main drivers of growth in Turkey is the manufacturing industry which accounts for 24.2% of total GDP. It is an industry that has been growing now for over a decade and the country is set up to be the region’s leading manufacturing hub and one with the potential to rival the Asian giants of China and India as the world’s largest.

According to the 2013 Deloitte Global Manufacturing Competitiveness Index (GMCI), Turkey will move up from 20th place in 2013 to 16th place in terms of current and future manufacturing competitiveness by 2018. This means that Turkey will be the second (after Germany) most competitive manufacturing hub in the region covering EMEA (Europe, the Middle East and Africa) as well as Central Asia and the Caucasus. In fact, some big name companies, including Nestlé, have recently expanding their manufacturing operations in Turkey.

Deloitte claims that Turkey has some world class features that attract investors, including its strategic location at the crossroads of Europe, Asia and the Middle East, and the size of its domestic market. It has also overcome a series of economic and political challenges in recent years – although the country could be impacted by the unrest in the Middle East from Islamic State.

Away from manufacturing, Turkey is also leading change through e-invoicing. In 2014, new regulation came in that looks to promote e-invoicing by corporates and the public sector, for example e-invoicing is now compulsory for certain companies operating in the hydrocarbon sector or with products subject to special taxes (tobacco, alcohol and light beverages).

This mandate is set to be extended because, in June this year, the Turkish Revenue Authority (TRA) have said that any Turkish company with TRY 10m gross sales turnover at 2014 year end will need to use e-invoicing by 1st January 2016 at the latest. TRA has earmarked approximately 27,000 companies to meet this criterion.

Regulation

Although, as we have already demonstrated, Europe cannot be treated as a single region, something that does unite the continent and its treasurers is regulation.

Compliance is a word many treasurers have learned to dread in recent years, with the activity taking up an ever bigger share of the department’s valuable time and resources. According to Treasury Today’s 2014 European Corporate Treasury Benchmarking Study, nearly half of the treasurers surveyed said the amount of time dedicated to compliance and regulations now ranges between 10-30%, a three-fold increase since the financial crisis, some treasurers commented.

However, after two successive years of managing very practical compliance projects such as the Single Euro Payments Area (SEPA) and derivative position reporting under the European Market Infrastructure Regulation (EMIR), the challenges are now different.

Basel III and the abandonment of mid-market funding

Over the past 12 months, Basel III has begun to really bite. The comprehensive reform measures have been designed to improve regulation, supervision and risk management within the global banking sector – but Basel III is having unintended consequences, namely pushing up the cost of banking services for corporates. The EuroFinance Basel III Index, published in May 2015, shows that over a third of the 227 treasury executives surveyed feel that the pricing and availability of their banking services have been negatively impacted by the regulation. Meanwhile, a further 48% expect that the pricing situation will deteriorate further in the future.

Perhaps the biggest change will come in the cash management services banks provide though. With idle cash accumulating fast on corporate balance sheets and banks actively discouraging the depositing of anything other operational balances this undoubtedly poses a greater challenge for the corporate investor moving forward.

Although the data points to a wide variety of companies being impacted by the Basel III regulation, there is one section of corporates in particular who have been impacted more than most; the mid-market corporate community – those sitting approximately in the €500m to €1.5bn revenue bracket.

These companies rely heavily on traditional funding sources such as bank loans (a Deutsche Bank research highlights that bank loans constitute 23% of small and 20% of medium sized firms’ balance sheets compared with only 11% for large firms). Yet today, obtaining financing through these traditional channels has become increasingly challenging.

Private placements in Europe

Limited access to funding and increased costs is pushing corporates of all shapes and sizes to look elsewhere to fulfil their needs. For the mid-market, which has been particularly impacted, it may be that going forward the community no longer needs to rely fully on the banks anyway. Indeed, the range of finance solutions open to ‘quality’ mid-market firms has expanded in recent years.

Traditional bank lending has been joined by an increasingly well-trodden path to the debt capital markets, in particular private placements. This model is well established in the US (with roots back to the 1930s) but there is a nascent equivalent market in the UK, Germany (the Schuldschein serves the country’s ‘Mittelstand’ sector of mid-market businesses) and France (Euro PP). Although EuroPP is just two years old, it has already raised more than €7bn, albeit mostly for French companies funded by French insurers.

One benefit of having a ‘local’ market is that investors will more likely know the companies they are dealing with. If there was any doubt that, globally, these offerings are of interest, S&P Capital IQ figures state that European companies raised around €60bn on the US and European private placement markets between 2012 and 2013. There is little sign that this is slowing down.

Investors are also clearly coming round to the idea that the mid-market asset class is a serious means of diversifying their own holdings. As yields in some traditionally secure asset classes hover barely above ground, pension funds and insurance firms – the institutional mainstays of the PP space – need to find an acceptable return on their ‘buy to hold’ investments. The quality mid-market sector has shown itself to be a useful addition to their lagging portfolios. In May 2014, Deloitte’s Alternative Lender Deal Tracker reported 33 leading alternative lenders as having taken part in 105 European mid-market deals over the previous six economic quarters. Private debt funding, it seems, has an equal appeal for both the institutional investor and the mid-market corporate. With the flexibility now to offer delayed draw-down, firms do not even have to time their approach to the market quite so perfectly.

Basel III and cash pooling

Basel III may also soon have an impact on corporate cash pooling structures. As Zanders’ Wolters explains: “we observe that, despite the regulatory uncertainty surrounding Basel III, banks in the Netherlands are still offering multi-entity, multi-currency notional cash pooling and even are willing to guarantee the solution for limited number of years. However, we also observe that banks are increasingly pushing corporates to single entity notional pooling as a more sustainable and cost efficient long-term solution.”

Switching from multi-entity to single entity notional pooling implies the need for physical cash sweeping between entities and hence triggers intercompany administration. Banks which are able to offer a good intercompany administration tool in their electronic banking platform are in a better position to migrate clients from multi-entity to single-entity notional pooling. “On the other hand, corporates are advised to consider upgrading their ERP and TMS capabilities in order to be ready to implement automated intercompany administration when needed,” he adds.

MMF reform

Another area that the European policymakers have been focusing on is the continent’s trillion-euro money market fund (MMF) industry. Traditionally, the industry in Europe has been dominated by constant net asset value (CNAV) funds although these have been highlighted as systemically risky and vulnerable to investor runs. As a result of this, the European Commission (EC) has announced that it will phase out CNAV funds in five years. During this transition period there will be a new product brought into the market: Low Volatility Net Asset Value Funds (LVNAV).

The belief is that LVNAV funds would seem to do something to address the concerns around CNAV by forcing funds to better reflect market changes (to a small extent at least). Crucially, however, LVNAV would also largely preserve the favourable tax and accounting treatment perceived by many to be an intrinsic value of MMF investments. LVNAV funds will not become a permanent fixture of the European MMF landscape as some might like, but treasurers should at least now have sufficient time to prepare themselves for the switch.

For more on MMF reform and what this means for treasurers across the region, see Section 3.

SEPA: are we there yet?

Elsewhere, the SEPA migration deadline for Eurozone countries may have passed, but the regulatory initiative is not yet over. Non-Eurozone counties have until 31st October 2016 to be compliant and there is still some work to do regarding the migration of the remaining niche services by February 2016 – although this is more a continuation of the earlier work. These include legacy formats such as NORMA 58 and also the removal of local variations that have materialised in ISO 20022 XML.

According to Rob Allighan, Product Manager, Euro Payables & Receivables Product Director Global Transaction Services, EMEA at Bank of America Merrill Lynch progress is now being made. “There is now real evidence of collaboration across Europe to try and resolve these matters,” he says. Examples of this include:

• The EBA SEPA work group (SMART) have published documents on local practices across the SEPA countries to help users see where, for example, a local account may be needed for tax.
• Both the EBA and EPC are trying to address the challenges regarding R messages and their handling.
• The issue of IBAN discrimination has been recognised.
• The lobbying powers of the Common Global Implementation group with both its corporate and bank members to help deliver a standardised approach to XML messages will help, but still corporates see variations in Germany or Italy for example and the industry drive for standardisation is weakened by these variations.

For corporates the focus now is to realise the benefits of SEPA. In Allighan’s opinion the rapidly evolving business, payments and receivables environment means that a wait-and-see approach is not an option. “We are encouraging our clients’ treasury teams to take advantage of the opportunities afforded by SEPA, to improve process efficiencies.” This includes the ability to introduce and use consistent processes for accounts payable and receivables; and efficiency improvements for the working capital management cycle. For example packaging receivables centralisation with virtual accounts to help significantly boost the portion of payments on which companies can achieve straight-through reconciliation. The pan-European nature of SEPA direct debits makes this much more achievable”, he adds.

Read more about SEPA’s progress in Section 2.

Regulation as a catalyst for change

With payment efficiency and centralisation firmly on the agenda with SEPA 2.0, corporates are exploring new and innovative ways to achieve this. As Wolters explains: “The longer-term trend of centralising payments is coming together with a new generation of cloud based corporate payment solutions.”

These are often referred to as ‘payment hubs’, and integrate enhanced payment workflows, bank-independent connectivity via SWIFT, standardised (XML) payment files and seamless interfacing with (legacy) ERP systems. “These solutions are typically delivered as the increasingly accepted model of Software as a Service (SaaS) and may be supplemented by various value added services, offering a true ‘one stop shop’ for corporate payments,” says Wolters.

“We see corporate payment hubs as an interesting option for corporates which are, because of the recent changes in the transaction banking landscape, required some to reconnect multiple ERPs to multiple banks. On the other hand, Zanders sees these types of solutions as a serious threat to the traditional SWIFT Service Bureaux or the standalone SWIFT Alliance Lite 2.0 offering which seem more focused on the technical connectivity only.”

Whichever way this payments hubs trend develops, it is promising to see treasurers taking the opportunity to use regulation as a catalyst for change. Over the coming months to years, it is this desire to innovate and create efficiencies that will distinguish best-in-class treasury functions.