Treasury Practice

Treasury tomorrow

Published: Jan 2016
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What will be the dominant issues on the treasury agenda in the year ahead? Will it be another big year for treasury transformation projects or will some treasurers have their hands too full managing market volatility and regulatory change? We ask a selection of industry experts to run through what they believe will be the big talking points of 2016 as we head into the new year.

The corporate treasury community are likely to see some big emerging opportunities in the year ahead, but treasurers will need to be on guard in case the economic weather begins to turn.

Treasury experts drawing up their predictions for 2016 largely agree on some broad themes – regulatory pressures will again loom large, mounting market volatility will test risk managers and new developments in infrastructure and treasury software will open the door to ever greater efficiencies.

These are not specifically new developments, but some commentators believe the driving forces behind them are now intensifying. Jacques Levet, Head of Transaction Banking for EMEA at BNP Paribas succinctly sums up the sentiment of his peers: “There is increasing pressure on the treasurers around the performance of their organisation; we are talking operational excellence, risk mitigation, and cost reduction.”

How well positioned are corporate treasurers to realise these goals? Precisely what impact will the increasingly gloomy global economic outlook have on developments? Answering these follow up questions in depth becomes, as we will see, a lot trickier.

A bumpy ride ahead

In the past year, foreign exchange (FX) markets have been affected by three issues above all else: the European Central Bank’s turn to accommodative monetary policies, China’s determination to allow market forces to play a greater role in setting the value of the renminbi, and expectations of an imminent interest rate rise in the US.

Experts believe these issues are likely to remain the principle FX drivers in 2016; but, we should not rule out more unexpected occurrences, the likes of which we have seen wreak havoc on markets in the past year. The shock of the Swiss franc being depegged and, to a lesser extent, the collapse of the Russian ruble, are but two examples of recent currency events that have jolted markets and put profitability pressures on some companies. For treasurers, the sensible thing to do is to work on the assumption that there will be more of the same this year, and adjust their risk mitigation strategies accordingly.

“What we have learned in the past year is that it is becoming ever more difficult to anticipate what will happen in the market,” says Philippe Gelis, CEO of Kantox, the London-based P2P foreign exchange providers for businesses. Decisions around what to hedge and how aggressively will ultimately come down to the particulars – profit margins and exposures – of each particular company. But in such volatile conditions some treasurers will undoubtedly see the need to become more active in their hedging. “What this means is that it is more important than ever to forecast your cash flows across all your foreign currencies and start hedging as soon as possible. The situation is becoming so complicated now that nobody can say what will happen next.”

What we have learned in the past year is that it is becoming ever more difficult to anticipate what will happen in the market.

Philippe Gelis, CEO, Kantox

Despite all the uncertainty, Gelis identifies two specific trends for corporate treasurers to watch closely. Regarding EUR/USD, which is set to be impacted by long-awaited monetary policy divergence, he says, “some people are already speaking about parity – I don’t know if that will happen, given that these are the two most traded currencies globally, so that pair is a big concern for our clients.”

His other main area of concern relates to the currencies of the five major emerging market countries that have colloquially become known as the BRICS. “Brazil will pose a big challenge as the economy now is in a really bad shape,” he says. “The Brazilian real is a currency traded increasingly by corporates and it has become very volatile. And we are seeing the same happening in South Africa and Russia.”

When Basel bites

Treasurers are already feeling the impact of Basel III on their banking relationships. Pressures stemming from the measures have created a squeeze on bank financing (which is particularly acute for SMEs) and to some banks reconsidering their cash management business in certain geographies. But it is the growing conflict over cash Basel has precipitated that is perhaps the biggest, most universally felt impact in the treasury community. In 2016, this is likely to continue to weigh heavily on the corporate sector’s relationships with banking partners.

Many corporates have amassed large stockpiles of cash over recent years, at the same time as banks have become more selective around the types of deposits they accept. “In the past, if a client gave you a large deposit, you would be very happy,” says Ruth Wandhöfer, Global Head of Regulatory and Market Policy at Citi Treasury and Trade Services. The bank would then lend more and the balance sheet would grow. “But now we are in a situation where balance sheets are capped.”

Elaborating on the point, Wandhöfer explains that the introduction of the Basel Committee’s Liquidity Coverage Ratio (LCR) at the beginning of 2015 means that, to please the regulators, banks have to find more assets to balance the liabilities on their balance sheet without “overshooting the generic target.” Ultimately, this means the banks must optimise the liabilities they have by encouraging clients to pay in more of the operational deposits deemed ‘sticky’ by the regulators, as opposed to surpluses that are not required for daily activities.

The efforts banks are making to ward off the regulatory threat posed to them by the latter type of deposits are already becoming evident. In the past year, several Wall Street banks are said to have been focusing on cutting unwanted deposits partly through changes to fees. Conscientious treasurers will accordingly need to spend more time in touch with their banks in the year ahead if they are to be sure of finding a home for their company’s cash. “There is a need now for tighter communication and collaboration between corporates and banks,” Wandhöfer says. “Corporates will need to be more transparent going forward regarding their moves and how they expect to deploy liquidity, and we may even see something like a penalty charge being imposed should a client unexpectedly deposit a significantly large non-structural liquidity deposit.”

Rates and regulation

The banks’ main competitors for corporate liquidity, the money market fund (MMF) industry, is facing their own regulatory pressures, the final form of which remain, in Europe at least, uncertain. Indeed the industry spent much of 2015 waiting for action from the European regulatory authorities. Although a proposal was put forward by the European Commission (EC) at the beginning of the year, which was finally approved by the European Parliament (EP) in April 2015, the final stage of the legislative process – the Trilogue negotiation between the EC, EP and Council of Ministers – is still to commence.

Treasurers will therefore be keeping a close watch on developments in Brussels in the coming months, particularly to see whether the coming regulatory shake-up occasions the prohibition of Constant Net Asset Value (CNAV) MMFs, the accounting treatment around which many investors favour, and the emergence of new types of product such as the Low Volatility Net Asset Value (LVNAV) MMFs that were mooted in the EC’s final proposal.

The other tectonic force affecting the MMF industry at the moment is the rate environment. Accommodative monetary policies pursued by the European Central Bank (ECB) have pushed down yields on the short-term debt instruments that MMFs purchase, making it increasingly difficult for fund managers to generate positive returns for their investors. With no directional change in policy at the ECB appearing to be on the cards in the near future, credit ratings agency Fitch says, in its 2016 MMF Outlook, that it expects yields on euro-denominated MMFs to remain in negative territory in 2016 (in contrast to its outlook for sterling and dollar MMFs, which it says may see “their yields picking up timidly” in the coming months).

The risk of large redemptions by corporate treasurers unwilling to stomach ‘paying’ a fund to hold their assets would appear to be minimal though. Indicative perhaps of the dearth of good short-term investment alternatives out there at the moment, outflows to MMFs not only stopped in 3Q2015, they actually began to reverse despite the average euro MMF gross yield remaining at a negative 0.06%.

“I think that shows that corporate treasurers are, however reluctantly, now accepting negative yields on euro MMFs,” says Alastair Sewell, Senior Director at Fitch Ratings’ Fund and Asset Manager Rating Group. “We think that is a very material development.”

There are two implications stemming from this trend. Firstly, some investment policies may have to change (readers will find an in-depth analysis of this issue on page 33). “We would expect to see treasurers adjusting guidelines in a prudent way,” says Sewell, explaining that certain policy constraints could mean treasurers are missing out on a potentially useful segment of the market. “Historically, you see legacy practices baked into investment guidelines which can limit the choice or flexibility that corporate treasurers have. So as a first step we expect and we understand corporate treasurers are reviewing some of those legacy points in their guidelines.”

Secondly, corporate treasurers are already becoming more active in their forecasting and segmenting their cash. As a consequence of this, Fitch expects to see the European market for short-term investment products for treasurers grow significantly. “We are certainly aware of various fund providers having approached us with ideas for new funds targeting yield hungry corporate treasurers, who wish to generate a little bit of incremental return but at the expense of selectively taking more risk.”

New year, new treasury

Should the predictions of our industry experts come to pass, there will be no shortage of challenges for treasurers to get their teeth stuck into over the course of the next 12 months. The more forward-looking, precocious members of the profession will, however, no doubt already be thinking about how these same challenges can be reconceived and turned into opportunities.

This is the mind-set that separates those that simply survive and those that truly thrive. Take the recent bout of FX volatility. Reactive treasurers might stop at making some minor alterations to their hedging strategies, perhaps taking out less forward contracts and switching to options for certain currencies. Meanwhile, treasurers with a more proactive mentality might decide to return to the fundamentals of cash forecasting, and explore ways to improve the visibility of cash positions across various geographical structural dimensions. A similar approach could be applied to short-term investments. If regulation and the yield environment is making it a struggle to use bank deposits and MMFs, perhaps it is time to explore what other instruments – tri-party repos or segregated mandates, for instance – might be used instead.

Once such exercises have been concluded, the treasurer may well find that in addition to solving the immediate problem, the changes made lead to a more effectual, resilient treasury over the long term. New tools might be needed to help treasurers to do that though. While it would be wrong, indeed dangerous, to suggest that technology alone is the answer to all the challenges the treasurer faces, new innovations are now in development that have the potential power to radically transform treasury. We cannot say, with any certainty, whether this will happen over the next year, but it is clear that the industry buzz around certain experimental technologies is right now on the rise.

Historically, you see legacy practices baked into investment guidelines which can limit the choice or flexibility that corporate treasurers have. So as a first step we expect and we understand corporate treasurers are reviewing some of those legacy points in their guidelines.

Alastair Sewell, Senior Director, Fitch Ratings

“In order to tackle these challenges, treasurers need help,” says BNP Paribas’ Levet. “They also need to find new ways of working – and the new technologies we see emerging will help them do just that.” Levet cites three categories of new technologies that he thinks banks and vendors need to look at to create what he calls “game changing solutions” for treasurers: big data, blockchain and artificial intelligence. He says: “I am convinced that, in all three of those families, breakthrough solutions are imminent. But at the same time, when discussing these new technologies we should not only highlight their truly disruptive potential, but also consider how they can, today, help banks significantly improve their existing processes and hence deliver dramatically enhanced services to their clients.”

On blockchain especially we have seen evidence this year that these are not just hollow words. Under the R3-led initiative, the Distributed Ledger Group (DLG), banks are pooling money and resources to explore how distributed ledger technologies like blockchain might be applied to a variety of purposes including the overhaul of the existing payments infrastructure, the settlement of securities and even some less obvious use-cases such as in the execution of certain compliance processes such as Anti-Money Laundering (AML) and Know Your Customer (KYC).

Right now R3 says its priorities are determining what component of distributed ledger solutions should be open source, the launching of a ‘lab environment’ in which to test solutions, and the building of an architectural framework as development of the codebase begins. One thing is for certain: whatever solutions emerges from this project in 2016 and the coming years, a world of new exciting opportunities is now opening up for treasurers. And that should mean that irrespective of the stiff challenges they are facing, the coming year need not be anticipated with a sense of dread.

“They should be looking forward to it,” adds Levet. “The role of the treasurer has considerably evolved and it is now that of a strategic partner in the organisation. Treasurers will as well have the opportunity to co-develop solutions with banks and vendors around innovative technologies to improve the way they operate. The opportunities brought forward by this collaborative approach and those new technologies far outweigh their respective risks.”

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