Treasury organization, liquidity challenges, technology choices and regulatory obstacles top of mind for EUROTPG members.
The members of the EUROTPG convened in late May for their 2016 H1 meeting in Lisbon. Members welcomed more new peers into the group than at any previous EUROTPG meeting, and representation changed for long-standing member organizations, adding fresh perspectives to ongoing challenges, such as:
1) Liquidity Management: Low/Negative IRs, Basel III and Coming Tax Changes. Members — already increasingly challenged by regulatory constraints like Basel capital and liquidity ratios — will now also be burdened with the potentially crippling impact of Section 385 in combination with BEPS on pooling, intercompany loans and related operations.
2) MiFID 2. Think you’re not covered by the latest Markets in Financial Instruments Directive (MiFID II)? Think again.
3) Leveraging Technology: TMS and Systems Infrastructure. SaaS providers are growing their market share among TMS providers, making for more seamless upgrades for those who adopt the best practice processes those systems are designed to support.
Liquidity Management Challenges: Low/Negative IRs, Basel III and Coming Tax Changes
Regulatory changes involving money market funds, BEPS and Basel III are key forces that need to be dealt with, along with persistent low-to-negative interest rates in the Eurozone. In that environment, what can (and must) treasury do to ensure access to liquidity, effectively invest excess funds and be in compliance to avoid scrutiny from regulators?
Key Takeaways
1) Floor it to avoid negative IR headaches, at least internally. In general, members are addressing negative rates (or potential for negative rates) on bank loans, debt securities, swaps and/or intercompany loans by accepting or inserting floor level rates in contracted terms and conditions. It is by far the most preferred way of dealing with negative rates on intercompany loans.
2) Cash-flow forecasting is often not worth the time. Cash-flow forecasting may or may not be worth the time it demands from different areas of the organization. It probably does make sense for debt-laden companies to forecast cash flow, but for cash-rich companies, it may end up being required only for certain circumstances — like needing to pay for an acquisition. If it is required, however, a clear communication of the needs and rationale helps.
3) What does the investment policy say about counterparty risk? In the discussion about acceptable investment alternatives and yield-seeking, it may be tempting to lower the bar on counterparty risk. It also comes into play when deposit banks suffer downgrades, which may prompt a debate internally about updating the investment policy to lower ratings criteria to allow wider diversification of deposits.
4) Divergence on IHB implementations due to regulations? Implementing an in-house bank to centralize funding, investments, risk management, payments, etc., has long been considered a best-in-class approach. However, the impact of several new regulations in combination (Basel III, BEPS, Section 385) may prompt many to review the economics and processes of in-house banks to ensure the rationale holds up economically, while also complying with the new regulations.
5) Fund where you need it? Centralized funding is one of the activities that may be curtailed by BEPS and Section 385 regulations, depending on your interpretation. So while one member’s plan is to fund via the finance company centrally for the organization globally, another is considering funding operations closer to where the funds are actually needed.
6) What’s the appropriate funds transfer price? With centralized funding and traditional intercompany loans, BEPS will at the very least prompt a serious discussion on how interest rates (funds transfer pricing) are applied as they will come under increasing scrutiny. Two schools of thought are typically in evidence here: The first says that one corporate rate should apply globally; the second says that each entity’s rate should reflect its circumstance and credit-worthiness. The latter is where Section 385 is going, which means additional analysis and individual rate-setting by sub, thoroughly documented, instead of a uniform rate.
Outlook
Treasury centralization has been the ultimate end state for decades and, increasingly enabled by good technology, it continues to be considered best practice. Centralizing funding, investments, payments, collections, risk management and hedging for the entire corporation into an in-house bank is a higher state of centralization to which many aspire or have already achieved. But this ideal structure is now under threat from “Section 385,” recently proposed legislation in the US (the domicile of many members’ parent companies) designed to limit tax-motivated corporate flight via inversions. It specifically targets intercompany transactions and loans, which under certain circumstances will be reclassified as equity (hitting the tax deductibility of debt). It is not yet clear exactly how this will affect liquidity management structures such as pooling and intercompany loan setups, but treasurers should investigate this with their internal and external advisors, and compare notes with their peers who may be using different advisors.
Negative Interest Rates: Be Proactive
When it comes to deposits in negative interest‐rate jurisdictions, 46% of members are paying banks negative interest expense to take deposits; 31% of members draw upon bank funds to bring their net position with banks to a negative balance (or less net positive) to avoid paying interest on deposits.
A combination of sweeping and swapping to USD (if economically sound; don’t take FX swap costs for negative IR cost), and a “greater discussion on balances” internally may help determine that subs can operate on much lower balances to avoid paying interest, which will be a boon when interest rates go up again.
There is also scope for pushing back on key banks to accept deposits without charging as part of an ongoing relationship. Banks need to accept some costs of doing business with you, after all. The key is to communicate the company’s critical banking needs and accept that “give and take” is part of the process. If you have worked hard to reduce balances (see above), you could negotiate a cheaper or free overdraft facility with your core banks. Also stand firm when there are non-negotiable items like not being allowed to have negative balances over quarter-end, for example.
Get Ready for MiFID 2
The Dodd-Frank Act (derivatives regulation in the US) and EMIR compliance, especially regarding transaction reporting, has filtered through for the most part, and now it’s time to bone up and respond to MiFID 2, which takes effect in January 2018. Chris Leonard-Appleton, a London-based Director of Regulation at Thomson Reuters, led the session.
Key Takeaways
1) Hedging is exempted from requirement that all trading parties be authorized as financial firms. One of the major issues with the original legislative text was that members of an MTF had to be authorized as financial firms, which would have affected all corporates trading on FXall or similar platforms. Thomson Reuters therefore requested the European authorities provide a clarification to allow corporates executing their hedges on MTFs to be excluded from this requirement; Article 2.1.d.ii in MiFID has been subsequently re-drafted as part of the “quick fix” to allow corporates to undertake hedging activity on MTFs (how to prove that the trading is for hedging purposes is not fully clarified but may end up involving similar declarations to those in Dodd-Frank and EMIR to exempt hedging from the scope of those legislations).
2) Transaction reporting is where it’s at — mostly — for the buy-side. Treasury functions should be thinking about how to meet applicable reporting obligations; data requirements (e.g., providing sensitive data to trading venues and counterparties; what can be transacted where (trading venues like MTF, off-MTF, SEF, off-SEF); and how changes to trading venue workflows will affect treasury’s trading activities. The complicating factor in the reporting requirement is that the number of reporting fields for MiFID 2 far exceeds that of EMIR and Dodd-Frank, and mandated provision of sensitive data may cause privacy concerns for many individuals.
Outlook
Call your lawyers — you’re not done with regulations. Many treasurers may be forgiven for thinking that, after Dodd-Frank and EMIR, “we’re done” with regulatory compliance. Think again. It’s time to again crank up the discussion with the legal department to confirm how compliance stands vis-a-vis current regulations, and what needs to be done and by when for what’s coming. It is a mistake to prematurely conclude not to be covered by MiFID 2. It applies to all European trading entities and to non-European entities if they trade with European counterparts.
Finding Your Treasury Identity
The definition of treasury differs by organization. Each company is unique and has its own path to where it currently is. Treasury’s place in a corporation is unique: It attends business needs, manages risks and grows and changes with the company. At the same time, treasury can be seen as a reflection of the culture, history, structure, evolution, age, maturity, size, geography and complexity of the organism it inhabits. While many challenges are shared with other companies, each solution needs to be tailored to its specific personality and circumstances.
Regardless of how your organization — and your treasury unit — see the role, you must be able to articulate treasury’s game plan and value. The relationship between treasury and the board of directors (BOD) goes via the CFO. His or her attitude to treasury is important to the “personality of treasury” in each organization and how it will be viewed at the BOD level. Treasury must be able to articulate the value it brings to the enterprise, such as the risk mitigation it provides, for example.
Leveraging Technology: TMS and Systems Infrastructure Update
Many members are in some stage of upgrading, scoping, selecting or implementing a TMS. This is often done in conjunction with other changes to standardize and automate for efficiency, more autonomy from banks and better controls. A member company’s merger brought into focus the need to analyze the systems infrastructure of both companies and make choices between the solutions that are already there and/or select additional or replacement technologies for the combined company.
Key Takeaways
1) Bring some objectivity into the end-state assessment. In the merger of two companies, the risk is high for too much subjectivity in systems choices based on previous setups and one side dominating the other. In anticipation of a merger, two tech giants brought in an independent advisor to look at the infrastructure of both companies as well as future business needs to determine the best TMS end-state of the combined entity. One company’s Quantum setup has a lot of customization to it, which has complicated matters, so Reval’s SaaS platform, which the other company is already looking at, makes it an appealing choice.
2) Do not design processes around how things are done in the US (or in any one jurisdiction). Many members are from companies with a US parent and highly centralized processes. The problem is when one view of how processes should be managed gets to dominate a global organization. It’s better to figure out best practices on a global level and adjust processes for local inefficiencies.
3) Balance functionality and stability. In the merger, the winning TMS will ultimately be one that is a “tool that does everything and more,” in the words of a member. Treasury is well served, for example, by having its own ledger in the TMS. That allows for some flexibility to more easily take advantage of new functionalities that become available over time, while maintaining some stability at its base.
Outlook
New technology is an enabler of better processes and should be evaluated in light of how processes can be modernized, improved and streamlined while achieving treasury’s mission with better efficiency and controls.
Managing Ratings
Are you focused on ratings for ratings’ sake? According to discussion among members, that’s the wrong way to look at it.
At one organization, maintaining its superior rating is important, but it doesn’t limit activity; rather, it simply adds accountability. There, the mandate to maintain the rating brings a discipline to M&A activity and other investments that more flexibility perhaps would not: Deals need to add value and the onus is on business development teams to demonstrate that.
When focusing on ratings, ask yourself if the ratings agencies understand your business. One EUROTPG member noted that last year’s acquisition of several assets in the US “tied up the debt numbers for a while,” which brought a spotlight on ratings and consequently ratings agency management. Knowing whether ratings agencies truly understand the business and finding a way to bridge that knowledge gap can help ensure their analysis reflects the true nature of your business and not just, well, their model.