There is no use in sugar-coating it: the risk to the curtailment of global expansion is at its highest point since the last wave began a decade and half ago. It means financial risk management should be front and centre and that means treasurers are on permanent call. It was a gloomy but perhaps not unexpected message for the members of the IACT assembling in Dublin for its annual conference last week.
There is no doubt that the economy is very late cycle – never before has a period of growth lasted more than decade, since records began. With the whole world sitting on a trade time-bomb, the “elevated risk of recession” is real, said Michael Bell, Executive Director, Global Market Strategist, J.P. Morgan Asset Management.
As economic fundamentals weaken, typically it means access to loans becomes harder for all. The main central banks are leaning against this weakening effect by keeping rates low, but for how long can this continue, asked Bell. A recent PMI survey (which includes the voice of both large and SME corporates) shows that, in the US, CEO confidence is dipping and that job cuts are increasingly likely as a third economic bounce (we’ve already seen two in this cycle) seems most unlikely.
In the last 12 months, US consumer confidence has slowed too. In interest rate terms, a binary outcome is expected by many economists. Growth could stall as ‘watch and wait’ prevails amongst the spending public. Or, if confidence and growth continues downwards, central bank stimulus (QE) could be reintroduced. The outlook, said Bell, “is all about re-acceleration or recession”, adding that “the next three months or so are critical”. With corporate debt at its highest level since the 1930s, the threat of a downturn means treasurers need to be fully alert.
Politics and economics
There has always been background political noise in the world of trade, but if US/China tariffs intensify further, it is likely to tip the economy into recession. President Trump is seeking re-election, and every incumbent seeking a second term has done so by avoiding recession, but then as Bell commented, there is a lot of national support for the Trump administration’s latest tariff measures.
Elsewhere, the more immediate UK election (where the outcome of Brexit is still unclear) is characterised by manifesto promises of huge spending sprees. These could help boost the economy but only if they are well-targeted and executed quickly. That is a matter for the electorate to decide.
In mainland Europe, Stefan Kuhnert, from the European Commission’s Office of the Directorate General for Economic & Financial Affairs, pointed to a “subdued” outlook for the wider EU area, with trade tensions having hit the region’s manufacturing, especially Germany’s. The uncertainty, he said is “not going away” and German companies are being forced to make changes to their supply chains, impacting imports and investment, an effect which is now “spilling over into its neighbours”, “flattening” growth prospects.
With the EU’s fiscal stance being “broadly neutral”, Kuhnert believes that its approach is not expected to contribute to growth. With Brexit, trade tensions and a manufacturing downturn, the balance of risk, he believes, “remains on the downside”.
The topic of interest rate benchmark rates being swapped just added to the necessary task-list for treasurers. The transition from EURIBOR or EONIA to ESTR (there will be a cross-over period but by January 2022 ESTR will be the only rate) requires the formation of a legal action plan, an operational and valuation impact analysis, and an understanding of the accounting and hedge accounting impact, said Andrew Spooner a Partner at Deloitte.
The switch will be relevant to a raft of contracts. Although IFRS has allowed the old rules to continue for a while (an amendment for which should be endorsed in December), the continued use of EONIA may confuse account office assumptions made in the medium to long term. In particular, treasurers may have to talk their accountant colleagues through the hedge accounting impact when EONIA ceases and contracts are changed. However, the risk, noted Spooner, is that the change to the new rate may force a break in hedge accounting, with all losses suddenly hitting the P&L.
Although the aim is to preserve the status quo for a while, post-change (an exposure draft should be issued in Spring 2020), Spooner urged treasurers to amend their contracts now, applying the IASB rules issued earlier this year. Doing so will bring additional reporting into play but this, he assured, is “not onerous”. Failing to amend now, however, will risk auditors rightly demanding how treasurers could know how any hedge accounting will be applicable going forward.
Come 2020, if treasury is changing contracts, then Spooner suggested waiting until H2, so any new amendments and exemptions can be incorporated, otherwise basis risk is on the menu; moving debt and derivatives in H1 could cause imperfect hedge accounting.
No annual conference is complete without a series of straw polls and IACT duly obliged. From this, the ‘number one external concern’ was unearthed, with a majority of delegates (36%) citing Brexit/trade wars. Their ‘preferred breakfast topic for 2020’ (IACT runs a series of breakfast meetings throughout the year) was tax and accounting impact (38%). The ‘biggest treasury challenge now and into 2020’ was technology (35%), a response potentially dovetailing neatly into ‘the most time-consuming task’ which was cash forecasting (30%).
Another poll later in the day found that 83% of treasurers now see sustainable finance as being ‘more important’ to their organisations in the next two years. The event called upon two treasurers actively operating in this space (one from a utility and one from a vehicle rental business), producing case studies which Treasury Today will be covering in forthcoming editions of Insights.
In the meantime, the key to success, said one of the speakers, lies in the understanding that, as a nascent activity in treasury and finance, “it’s all about trying to sell the transition”, and not bludgeoning people into accepting it.
For deeper insight into the process, read Treasury Today’s Talking Treasury Forum.