Talk among tech treasurers meeting near the Golden Gate Bridge spans transformation to follow the sun, teams to support RPA and when treasury needs to push back on tax.
The annual meeting of the Tech20 Treasurers’ Peer Group 2017 in November near San Francisco Bay sponsored by BNP Paribas offered members thought-provoking discussions on topics including treasury transformation, constructing an FX risk policy, treasury’s sometimes complicated relationship with the tax team, acquisition finance, hurdle rates and credit ratings. Here are the key highlights from the three-day event:
1) Elevating FX Risk Management to “Industry Standard.” Coming up with a policy around currency risk and hedging requires a bit of art along with the science, and the group helped one member answer key questions to find the right mix. Is your FX risk policy aligned with the company’s needs and goals?
2) Treasury Transformation—One Journey So Far. A tech giant reveals to the group how it’s overhauling treasury operations, structures and systems to “scale bigger and faster with a strong control environment.” How far along on the road to successful transformation is your department?
3) Aim for Better Tax and Treasury Synergy. The relationship between tax and treasury should be grounded in facts and figures, and treasury should not fall victim to thinking that tax people wield some sort of magic wand. Does the tax-treasury dynamic at your organization need a dose of reality?
Elevating FX Risk Management to “Industry Standard”
In a “solve my problem” session, a Tech20 member from China at a company without a full risk policy asked the group for help with formalizing a policy and strategy for FX risk management. He noted that benchmarking revealed a wide range in tech firms’ approaches, from those with high-level sophistication in FX risk management to the few without an FX hedging program at all.
KEY TAKEAWAYS
1) What’s the objective? Peers advised this member to consider carefully the FX risk management objective when setting policy. For revenue or earnings hedging, for example, he should consider to what extent analysts are focused on FX impact, and whether a pro forma ex-currency reporting strategy could allow a lighter hedging touch. Over the long run, the currency impact on revenue or EPS can tend to even out, and hedging is more a matter of the company’s appetite to ride out a cycle or not. New hedge accounting rules will also make it difficult to keep gains and losses below the line and will instead hit the hedged item line.
2) Agree on objectives, their hierarchy and constraints. It matters how objectives are defined and measured as well as distinguishing between primary and subordinate objectives. One company in the NeuGroup network has as its top objective minimized volatility of quarterly reported earnings, as measured by the FX-driven standard deviation of (1) quarterly earnings and (2) quarterly YoY earnings growth. Other key objectives, but subordinated to the top one, are to protect annual budget volatility and to gain from upside while protecting the downside using options when appropriate. The framework also needs to operate with certain constraints on cost and hedge ratio and tenor.
3) How much discretion in the policy? Companies vary from allowing very little discretion in hedge ratios and trade timing to setting generous ranges around target ratios and trade dates to take advantage of market conditions. For example, some members have tried to become less predictable with their balance sheet hedge execution to prevent dealers from front-running them. Also, riskless arbitrage opportunities may emerge—for example between CNH and CNY—which treasury may not want to eliminate by choosing a policy of zero hedge discretion.
4) Is VaR the right analytic metric? Value-at-risk analysis has its uses but its complexity and caveats may introduce more questions than necessary at senior management and board levels. Members urged avoiding VaR as a reporting metric since many are de-emphasizing it and moving risk analysis to scenario or stress testing, which is more easily understood and embraced in the C-suite.
Capital Allocation Using More “Quanty” Hurdle Rates
At some companies, the capital allocation model may reside only in the head of the CFO. But we found in the pre-meeting survey that the old reliable capital asset pricing model (CAPM) method, using members’ own company beta, is the most common method to calculate the weighted average cost of capital (WACC). About one in five use their WACC for all hurdle rates, but over half use WACC combined with other evaluation methods. A member from one of the lower-margin tech companies in the group shared how his company is implementing a capital allocation model based on WACC + a certain profit level, plus four added risk premiums, three of which are market-driven: country risk; counterparty credit risk; industry/sector risk; and a non-market-driven legal risk (for example, if the company is involved in the design of a product and not just contract-manufacturing it for another party). Members were impressed with the level of detail of this approach. And the company’s customers in Tech20 began to wonder how they stack up under the counterparty credit risk criteria!
OUTLOOK
As this treasurer takes his FX risk management policy forward, his peers recommended that he avoid locking down all the details in the first go-round, since the policy requirements will be further clarified as the FX program develops. In other words, allow the policy to evolve.
Treasury Transformation—One Journey So Far
At what point do you decide that the treasury organization is no longer fit for the future growth and development of the company? And how do you go about transforming treasury to align its mission and service delivery with the company’s growth strategy and business model? The assistant treasurer at a major tech company shared the dramatic treasury organization overhaul currently underway that aims to scale support for the business as its grows to super mega-cap size.
KEY TAKEAWAYS
1) Transform treasury to follow the sun. The objective of the transformation is to enable treasury to scale its support of the rapid global growth of an increasingly diverse product offering. As important as the ability to scale, however, are reduced working capital requirements and optimized banking and in-house bank structures. These are enabled by digitized, automated processes on more updated and fit-for-purpose systems in a strong control environment. In a departure from a tech treasury mindset that has tended to be entirely HQ-centric, the new structure will include “follow-the-sun” coverage with treasury centers in London and Singapore.
2) Develop centers—not silos—of excellence. Treasury leadership is being divided among four functional ATs to develop centers of excellence for treasury operations, trading and investments, risk and strategy, and corporate finance. “Yet, we don’t want treasury to be carved up into silos, so people will regularly migrate across,” said the AT presenting.
3) Rethink the org structure to support key work streams. The company is envisioning a workflow-centric organization instead of the traditional functional “Christmas tree” hierarchical org chart. While not fully nailed down yet, rethinking the org chart in this fashion may also support the goal of balancing operational and strategic aspects of different roles on the team.
4) Standardize and automate with industry-standard systems and processes. The transformation project also is focused on developing more automation using standard processes and implementing the latest version of SAP HANA for the cloud as its TMS. A team of engineers had been brought into treasury to assist with creating add-on automation of processing, leveraging SAP and the firm’s own technology.
5) What can you move to an SSC? Finally, treasury operations of a more transactional nature will be evaluated for integration with shared services centers. This will also help automation that is being implemented sooner at SSCs than in other parts of finance and treasury.
Banks Happy to Fund Acquisitions
In a session spotlighting recent examples of acquisition finance, it came to light that members have been able to negotiate very advantageous terms lately. In one instance, a member got its then-M&A advisor to fund a bridge facility without draw or duration fees. In another case where Tech20 sponsor BNP Paribas was one of the banks, a company succeeded in holding deal underwriters to their agreed fees despite changes to the financing mix as the deal evolved. It is important to anticipate different acquisition finance scenarios, terms, conditions and subsequent bank syndication roles and fees early in the process since it is difficult to change these once financing commitment papers are signed. Here, it was made possible only because the client proactively shared the roles and economics among its banks despite pressure from its lead M&A bank to create competition and best execution.
RPA Reality
Several members noted they are staffing up teams within treasury to support robotic process automation (RPA) and other digital treasury transformations, which prompted those that are not to realize they now have to get busy doing the same.
OUTLOOK
The exploration and implementation phase of this company’s transformation plan is over, and the realization and deployment phase will run throughout 2018. The solution is being built and tested in phases as treasury documents future-state processes and controls, trains users and validates operations, with a goal of running entirely on the new solution by January 2019.
Aim for Better Tax and Treasury Synergy
What conflicts arise where tax and treasury intersect? How should a proactive treasurer approach (and control) this relationship? And when tax and treasury leadership are combined (as they often are), how does the single leader deal with competing priorities of the two functions? Led by two members in charge of the combined tax and treasury teams at their respective firms, a lively debate ensued.
KEY TAKEAWAYS
1) “Because tax said so” is not a magic wand that ends discussion. Tax and treasury leaders need to communicate and collaborate to optimize the effective tax rate without creating unnecessary movements of cash, overly complex legal entity and bank account structures and other costly inefficiencies. The relationship between tax and treasury should be grounded in science, and treasury should not be taken in by the notion that tax people wield some sort of magic. Several members noted taking steps to seat tax and treasury together to foster better understanding and communication of each side’s objectives and actions. “My treasury operations team just accepted that tax said that certain entities and their bank accounts could not be closed for ‘tax reasons,’” one member said. “And then I realized they had not even asked tax in any detail about the matter.” This seemed to be a common theme. “My treasury operations team gave me this ‘account cannot be closed for tax reasons’ line, and I’m the tax director,” said one member who is also treasurer. She looked into it and concluded they could “close everything related with that entity down.”
2) Push back with true cost of account structure. If treasury pushes back with the costs of keeping open non-vital accounts, tax may reevaluate the structure and determine that it has an equal probability of producing a potential tax saving without them. Treasury should discuss the entity/account rationalization with real figures to force a business decision based on cost, the value of cash utility and other economics.
The Tech Ratings Game
The annual ratings breakfast featuring tech analysts from all three major rating agencies validated the growing acceptance of leverage to temporarily transform businesses in tech through acquisitions or other means. The four-notch spread across the rating agencies for one member company suggests that disruptive forces are still not being taken as real by credit analysts. Every company wants to be a tech company now and every tech company is making a play in non-tech sectors. Rating analysts need to keep it real and adjust. The now-famous rap on the semiconductor sector by one of the analysts, for example, keeps growing to reflect all the factors changing the business. All the analysts cited the sector’s traditional volatility as a reason not to improve their semiconductor ratings. But demand for chips and processors is soaring, fueled by ever-more powerful smartphones and wearables, automotive mobile connectivity, the internet of things, and exponential growth in data centers to support the cloud. Plus, tax reform will free up more of growing global operating cash flows to support interest payments and sustainable leverage.
OUTLOOK
It’s time to take tax off its pedestal. Aim to equalize tax with other costs, meaning tax should just be one of many costs of doing business. What might help is to “give tax people an execution objective on treasury KPIs, such as number of bank accounts closed, to enhance their understanding of treasury and vice versa,” recommended one member. “This helps create a sense that there is only one finance team.”
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