Tech treasurers face the need to support higher levels of growth by turning treasury efficiency into value-added decision-making.
Tech20 members met in December for their 2015 BNP Paribas–sponsored annual meeting to discuss their current projects, the economic outlook and its impact on the dollar, rate policy and balance-sheet governance, along with treasury technology concerns, preferred treasury performance measures and analytics. The key theme cutting across all these discussions was the need for tech treasurers to support higher levels of growth. To do this, they need to:
1) Prove Treasury’s Worth to the Company. When considering how to upgrade treasury performance metrics, treasury needs to include value-added metrics. These are needed to incent better decisions and decision-support tools.
2) Review FX Programs to Ensure they Remain Effective. Diverging FX influences and a strong-dollar story continue to prompt FX programs reviews.
3) Cope with a Lackluster Economic Outlook and Market Volatility. With the US set to start PIRP, coping with the lack of macro support means maintaining debt capacity to finance growth, as financing at the margin shows signs of becoming dearer.
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Governance to Ensure the Best Course of Action
In anticipation of the Fed’s recent decision to raise short-term interest rates, members reviewed the state of their interest-rate risk management and the position of their debt structure (which for most tech firms continues to grow) and, indeed, their entire balance sheet vis-a-vis interest rates. The discussion revealed the prudence of incorporating such reviews into existing risk committee infrastructure or establishing additional balance-sheet risk governance to complement it.
A governance or risk committee can help assess the view the firm is willing to take on rates and the rate risk it will accept. One member with experience setting up a business asset-liability committee (ALCO) as an enterprise risk subcommittee said the key to making them work is to get representation of risk owners on the business side as well as treasury/finance. Another member combined an ALCO with a repatriation, capital markets and capital structure committee to form one “capital committee” to serve as a key integration point to bring together board, strategy and execution with a strong capital orientation.
What is Treasury Worth to a Tech Company? Upgrading Treasury Performance Metrics
Among Tech20 members, hard performance metrics tend to be cash flow and operating income and EBITDA reported to the street. Also, cash- and capital structure-oriented metrics tend to be those deemed most important for treasury. In the pre-meeting survey, members also indicated a preference for metrics biased toward value, either value creation (50%) or avoidance of value destruction (19%), versus cost/efficiency metrics (31%). This set up the theme for our member panel to help guide the discussion further, with representatives from each type of metric bias.
Key Takeaways
1) Question whether profit center has to be a dirty word for treasury. If being a profit center were dressed up with the value creation or avoidance-of-value-destruction label, would more treasurers embrace it? Maybe. While this premise was part of the setup for this session, one of the panelists on the value side actually switched his bias to cost efficiency over the course of the session. This underscored the pervasiveness of the treasury-as-a-cost-center mindset. Tax guys, on the other hand, are not afraid of being a profit center, which is an interesting point to consider as more tax directors are given the treasurer title.
2) Separate controllable from non-controllable. One member described an effort to separate controllable costs and risk-related losses (gains) from non-controllable ones in treasury’s performance scorecard. It is not fair to hold treasury accountable for things that are beyond its control—such as what happens with market rates—but totally acceptable to hold it to account for things it can control—such as the execution rate on a trade or forecast accuracy (where treasury advises).
3) Efficiency metrics should point to value created with the efficiency gains. Other members, even those biased toward efficiency metrics, noted that their CFOs tended to emphasize value as well: You need to create value with the efficiency. Treasury needs to be lean and fund dividends and buybacks, among other things, as efficiently as possible to impress leadership.
Outlook
While the bias favoring efficiency metrics continues to have a strong pull on members, there were anecdotal contributions suggesting efforts to set and beat capital budget or similar capital metrics that keep hope alive for the value side. For example, treasury is measured by how well it manages capital, based on capital return and cost metrics. Similar measures show up on the liquidity side, starting with reducing the amount of idle cash, but extending to more-advanced capital and liquidity planning, including answers to the question, how long will this cash last the firm? Increasingly, these measures point to the value treasury adds with the efficiency gains created. Eventually treasurers will have to make the case that measuring the value created is at least as important as measuring the efficiency gains that allow them the opportunity to create it.
Principles of World-Class TMS
An overview of findings from The NeuGroup’s Principles of World-Class Treasury Management Systems project identified the need to follow through on several of its recommendations.
- Resource requirements and the business case to get them tie treasury performance measurement to TMS projects. The main obstacle to achieving treasury’s desired treasury technology end-state is the lack of resources to select, implement and support a world-class solution.
- Piggy-back on larger transformation projects. Successful TMS projects are often done in conjunction with larger, more comprehensive treasury or finance transformation initiatives.
- Validate that what you are doing outside the TMS can’t be done within it. It is imperative that treasury look at where it is relying on spreadsheets and disparate applications/systems to see if these activities cannot be supported by a core TMS.
- Dedicated treasury IT support models are difficult to sustain. The trend is moving toward SaaS solutions to alleviate some of the support requirements.
- Adapting to the system instead of adapting the system. This eases implementation and future upgrades, saving time and money, and avoids the cost of customization. This puts the onus on the TMS ecosystem to embed best practices in TMS offerings.
Diverging FX Influence and the Strong-Dollar Story
This session built on the strong showing FX management received in member projects and priorities, which is consistent across all NeuGroups due to the strong-dollar cycle’s negative consequences for financial results. To see if this focus should continue, this session looked at what members should expect in currency markets going forward, given diverging monetary policies, especially in emerging markets. Daniel Katzive, Head of FX Strategy, North America, and Gabriel Gersztein, Head of FX and IR LatAm Strategy, both of BNP Paribas, led the session.
Key Takeaways
1) Dollar strength likely for another couple years. Conditions in capital markets are underpinned by the unprecedented monetary policy divergence that has changed the dynamics compared to historical strong-dollar cycles, most notably the speed of the USD appreciation. With G10 trading partners continuing to ease interest rates, US rate hikes will exacerbate the IR spreads in 2016. BNP Paribas predicts another two to three years of dollar strengthening.
2) China sneezes, LatAm catches a cold. Emerging markets have in recent years embraced south-to-south trading patterns, driven largely by China’s demand for commodities. A slowdown in China may export deflation to the G10. However, that is not the case for LatAm currencies, where terms of trade will deteriorate and the region’s risk premium will always be higher, regardless, resulting in a higher cost of capital, argues Mr. Gersztein.
3) Morning in Argentina? Argentina has presented businesses with profound challenges in recent years, especially very strict FX controls and related issues. And like other LatAm economies, the country’s reserves are not helped by commodity market slowdowns and structural fiscal problems. A possible silver lining is that election results in Argentina could point toward a more business-friendly environment there.
4) Brazil is unlikely to suffer serious capital flight. The BNP Paribas team noted that, political risk in Brazil notwithstanding (Dilma Rousseff and corruption scandals), they think the probability of default is low and CDS rates are overblown. Reserves, they add, are four times the amount of foreign participation in the local debt outstanding.
Outlook
LatAm is very vulnerable to a slowdown in global demand, generally, and in commodity demand, particularly. Coupled with a predicted continued rise in the USD, the region’s outlook appears risky, regardless of political scandals or election outcomes. At the same time, many corporates are looking at the cost of hedging in terms of forward points and deeming the currencies too expensive to hedge. Other cost metrics might bring much-needed perspective on this, such as those that take into account implied volatility, and thus might point to hedge actions outside the yes/no determinations of interest rate differentials.
Analytics for Optimizing Share Buyback Execution
Share repurchase is a significant activity at most member treasuries and a logical focus area for new analytic tools finding their way into the market. Accordingly, members evaluated a new tool designed to help optimize share buyback execution.
One thing this analytics tool does not do now is help companies justify the decision to buy back shares in the first place (although provider expects continued refinements). It only helps answer the question of how best to accomplish a buyback once you’ve committed to it. Providing support for the first decision, along with a slew of other decisions that treasurers are being asked to take, is likely coming, if not with this tool, then with others. Analytics and decision-support tools are going to be proliferating in the treasury space over the next several years. The trick is to get the pricing and the business case right, so that treasurers can be convinced to abandon their spreadsheets.
Economic Outlook with Market Volatility and US PIRP
BNP Paribas Senior Economist, North America, Bricklin Dwyer set up the discussion on interest-rate positioning with his hypothesis that there is little chance the Fed will get rates high enough to have much room to lower them effectively to help the economy out of the next downturn.
Key Takeaways
1) “Lower for longer” is the prevailing trend. Since the post–financial crisis recovery began, the global economy can be characterized as lower for longer: growth is lower than is usual in a recovery phase, but it has hung on longer; inflation is lower because the gap between output and potential output is more persistent than normal, resulting in lower rates for a longer period than expected during a recovery.
2) Monetary policy is pushing everyone into equities. Lower for longer also applies to risk premia, which are pushing all investors, including banks, toward equities to get return on investment. Even with the global sell-off of assets by foreign central banks, Treasury spreads have not widened significantly, making equities more attractive.
3) Consumers feel relatively good if they have jobs. Fewer people are getting fired (even in mergers) because firms have cut so much already. Hence, consumer demand will keep the economy from tanking too desperately in the near term. What’s more, the level of labor participation that is seen as break-even for the US economy keeps getting revised down. This is a floor under wages, despite weak productivity growth and low inflation, which means that commercial entities are seeing their margins squeezed.
4) The specter of QE4. As “terrifying” as it may seem, QE4 is a likely outcome in five years, Mr. Bricklin noted, and as such easing is borrowing from the future; we have to expect that the future will look much better than normal or those lending to this economy will not get their money back. Essentially, monetary policy is a cyclical tool that is being used to deal with a structural problem.
Outlook
As Mr. Bricklin noted, three of the last four cutting cycles have seen rates cut more than 500 bps. “We will never get to 5% with a 2% inflation target in the next five years,” he pointed out. Then why bother at all to raise rates? Not raising rates would essentially mean conceding that monetary policy is no longer a relevant tool to smooth out economic cycles, according to Mr. Bricklin. Having said this, and despite his comment about the likelihood of QE4 and borrowing even more against the future, Mr. Bricklin expressed optimism. To find the growth, we cannot give in to the pessimism, which will only make it harder to discover.
Conclusion
As BNP Paribas’ economist noted, tech’s role in driving productivity in the economy is needed now more than ever to boost growth enough to pay for all the recent borrowing against the future with QE. Thus, Tech20 treasurers must put their shoulders to the wheel and ensure their firms are taking the capital they are earning (and borrowing) and putting it toward goods and services that drive productivity higher. Putting good governance around capital decisions will help, but so will deploying more decision-support tools to mitigate risk and justify growth-chasing decisions, generating greater confidence that such growth is possible in the process.