ATLG members learned about the first steps to replace Libor, the new tax law’s GILTI and BEAT complications, and Bloomberg’s overlooked treasury tools.
Members of the Assistant Treasurers’ Leadership Group met in May at the Summit, N.J., headquarters of host Celgene, where executives from sponsor Bloomberg updated them on the first official moves toward a Libor replacement. Members discussed their companies’ timetables for repatriating cash in the wake of tax reform, and a KPMG expert apprised them of the need to model the new law’s often complicated provisions and how they will interact with each other—especially for overseas earnings—to arrive at the optimal tax outcome. Several ATLG members realized that they haven’t been fully taking advantage of their Bloomberg terminals’ forecasting and risk-management tools. The meeting’s top three themes were:
1) Move Over, Libor—SOFR is Here. The Federal Reserve Bank of New York began publishing the new Secured Overnight Financing Rate (SOFR) April 3, and in early May the CME launched SOFR futures. Now SOFR’s fate depends largely on the market’s willingness to accept it as the Libor substitute.
2) The New Tax Puzzle. The new tax law eliminates trapped cash but retains elements of worldwide taxation. AT30 members explored whether the US now makes sense as a treasury center location, given its new 21% corporate rate.
3) Bring It On, Bloomberg. Bloomberg provided a high-level overview of the latest tools, not only to display its terminal’s wide variety of data but to analyze the factors behind them, and the probability of certain outcomes.
Move Over, Libor—SOFR is Here
The Federal Reserve Bank of New York began publishing the new Secured Overnight Financing Rate (SOFR) in April, and in early May CME Group launched SOFR futures. Now SOFR’s fate depends largely on the market’s willingness to accept it as the Libor substitute. CME’s SOFR product may provide an early indication of that willingness and where SOFR is headed.
KEY TAKEAWAYS
1) Futures indicate SOFR’s future. Liquidity in the CME’s one-month and three-month SOFR futures has been light, but watch for growth. They are the first tools giving market participants exposure to the new benchmark rate, and trading in them will enable the development of curves to price other derivatives.
2) It’s up to borrowers. Yon Valtchev, Bloomberg’s fixed-income market specialist, said SOFR futures volume will develop eventually and SOFR OTC swaps should arrive by year-end, followed by cleared swaps next year—clearinghouses are already working to support them. The key, he said, will be corporates and other institutions taking on debt priced off the new rate, prompting derivative market growth.
3) A gift for big banks. Mr. Valtchev noted the Bank of England’s recently revamped Sterling Overnight Index Average (Sonia), which is also seeking to replace Libor. Sonia and SOFR are both overnight rates, and regulatory authorities are letting the market figure out how to translate them into the term products corporates rely on to understand their future payments. The big banks will most likely offer those solutions, as well as products to bridge the basis difference from having two new rates to price floating-rate debt. “These geographically based efforts will play out for the benefit of banks and not necessarily corporations,” Mr. Valtchev said, unless borrowers play an active role shaping the emerging markets.
4) Corporate impact is now. Half of ATLG survey respondents said their companies have Libor-based debt and derivatives extending past 2021. That’s the target date for SOFR adoption, and pricing Libor-based products may become difficult. Financial trade groups are working on standard fallback language to enable transferring from one rate to another, but corporates should already be reviewing such language in their existing transactions.
Reval’s Blues Swing Favor to Chatham
Several ATLG members complained about a decline in service from Reval since it was acquired by ION Investment Group toward the end of 2016. A few are considering up-and-comer Chatham Financial, especially for derivatives valuations. An early Reval customer lamented that because of the vendor’s poor service, his company put out an RFP to potentially find a new treasury management system (TMS). “I implemented our TMS and it took a year-plus,” he said. “So moving to another TMS is going to be extremely difficult,” given that the company now has five years’ worth of data that would have to be transferred to a new system.
Participants in the NeuGroup meeting agreed that it realistically takes about 18 months to implement a full TMS.
Another member noted a dramatic falloff in Reval service following the acquisition. The ownership of that vendor relationship is spread across accounting, treasury and procurement, and all three agreed that Reval was no longer a viable business partner. The executive recently attended a meeting hosted by Chatham and said, “they crushed it.” She added that she was impressed by Chatham’s coupling consulting on the new hedge accounting standard with technology that’s relatively easy to use.
OUTLOOK
Leaving Libor behind entails plenty of hurdles. The biggest one may be translating SOFR, Sonia and other risk-free rates that settle overnight into term products, especially on the cash side. Also complicating matters is the fact that these rates are developing regionally, potentially complicating cross-currency swaps. And so far continental Europe has made little progress toward its own Libor replacement.
The New Tax Puzzle
Pushed by the need for tax revenue, congressional Republicans’ new tax law retains elements of worldwide taxation, although it does eliminate the stranded cash bugaboo. Kathleen Dale, a principal in the international tax group at KPMG, gave an overview of the law’s complex components, especially related to overseas earnings, and emphasized the need to model how they may interact with one another. Members delved into the minutiae of the law’s impact on areas such as whether the new 21% corporate rate makes the US a more viable treasury center location.
KEY TAKEAWAYS
1) Not so fast on tax-free overseas earnings. Section 956 of the Internal Revenue Code treats loans by foreign affiliates to a US parent as taxable distributions unless strict conditions are met. It was almost repealed but mysteriously reappeared in the bill at the eleventh hour. Consequently, US companies with controlled foreign corporations (CFCs) could be subjected to a full 21% tax on loans from the CFCs. However, deemed repatriation has left many CFCs with lots of previously taxed income (PTI), and they can make loans to their US parents to the extent of their PTI without incurring incremental US tax liability. This is especially helpful “for jurisdictions that permit loans out of foreign earnings but not distributions, as the US parent can get access to that cash without having any incremental US tax,” Ms. Dale said.
2) A modeling exercise. The law’s new GILTI and BEAT provisions guarantee the US will collect taxes on at least some non-US earnings. The trick for corporate tax and treasury departments will be juggling their responses to these and other components of the law, each potentially impacting others, to arrive at the most tax-efficient solution. “This is a modeling exercise,” Ms. Dale said.
3) Satisfying investors. ATLG pre-meeting survey respondents by far see share repurchases as the primary expected use of proceeds from repatriation flows, followed by debt paydown, capital expenditures, M&A and dividends. Employee compensation and benefits barely registered. Among those paying down debt, 60% will target bank debt and 40% commercial paper balances. A plurality of members, 46%, had already publicly communicated their plans to deploy repatriated cash, while 9% said they would when they finalize their strategy, and 9% said the amount was too immaterial to bother.
4) Talk to tax. Asked for the top questions treasury should discuss with tax colleagues and within the department, Ms. Dale recommended:
- To what extent is the company legally restrained or facing withholding taxes or other financial penalties in terms of bringing back cash, which costs can be controlled, and are there offsetting foreign tax credits?
- In which currencies is previously taxed income denominated, and how much will it cost at any given time to bring it back in dollars?
- Is this the correct time to repatriate cash given specific FX rates, or is it better to monitor the currency markets opportunistically?
The More Things Change, the More They Stay the Same
ATLG meeting moderator Ed Scott, former treasurer at Caterpillar, recounted his 35-year career at the company and offered advice to up-and-comers. Executives today often change companies frequently, whether as a result of M&A or to accelerate their careers. But Mr. Scott said, “Even though my career was spent at one company, many of the same principles likely still apply.”
For example, it always pays to broaden your experience, call upon it as you move ahead and build a base. “If you’re moving laterally, don’t cry about it if it helps you build a base of experience,” he said. While CFO at Cat Financial, he was asked to become chief audit officer. “I had no background in accounting, but it was the best thing that could have happened,” he said. “I met with each board member and knew them on a first-name basis.” Mr. Scott displayed a triangle to explain there was “nothing random” about his career. It illustrated five levels, starting at the bottom of the triangle with analyst and moving up to supervisor, manager, department head and corporate officer.
Each level—approaching the top of the pyramid—had fewer potential positions, but no levels could be skipped. “Every level provided an opportunity to learn new functional and leadership skills that were key to achieving my career goal,” Mr. Scott said.
OUTLOOK
Given that shifting political winds may change portions of the law, Ms. Dale recommended that companies avoid contorting their financial structures for tax reasons and instead focus on finding the optimal structure for funding operations. “If the formation or restructuring of a treasury center makes sense from both an operational and tax perspective, then it is advisable to pursue,” she said.
Bring It On, Bloomberg
Bloomberg terminals may be pervasive, but many ATLG members haven’t been using them to their full potential. Executives from Bloomberg provided a high-level overview of the latest tools, not only to display the terminal’s wide variety of data but to analyze the factors behind them and determine probabilities.
KEY TAKEAWAYS
1) It’s not just the data. New currency valuation tools cover 40 major currency pairs and can reveal counterintuitive intelligence—for example, China’s renminbi is now overvalued from a historical perspective, contrary to politicians’ claims. In terms of where FX rates will be in six months, treasury executives can query their companies’ bank group, the traditional method of generating a median forecast, then gauge its likelihood by doing scenario analysis with Bloomberg’s FX probability calculator, which uses options-market volatility. A similar approach can be taken to interest rate and commodity markets.
2) Fleshing out supply-chain risks. Another tool enables a company to view the links in its supply chain and where the risks lie in each, whether it’s currency, politics, or other, and compare them to competitors’ supply-chain risks. One ATLG member said it was the first time he had seen such a supply-chain screen, calling it “great,” while another said it got him “thinking about how that could help the businesses understand the risks they’re sitting on.”
3) Real effective exchange rate rules. The weighted average of a country’s currency in relation to an index or basket of other major currencies, adjusted for the effects of inflation, is a more informed way to think about a currency’s value. Policymakers think about their currencies’ values this way, rather than bilaterally.
4) The euro’s many faces. The euro pair is actually multiple numbers, said Stephen Jonathan, FX market specialist at Bloomberg, noting that it’s particularly important for corporate treasury to recognize that behind the front-page number there are multiple prices and levels of competitiveness that impact strategic decisions such as where to build a factory.
Pension Risk Advice From the Trenches
An ATLG member described in detail her company’s path through Chapter 11 bankruptcy and how restructuring its pension plan, including laying off part of that risk to the Pension Benefit Guaranty Corp. (PBGC), helped right the company’s financial ship. Nevertheless, pension liabilities remain on the company’s books, creating several potential risks. New mortality tables, for example, increased the expected death age of females by two years and males by three years. “The minute the IRS came with the new mortality tables, everybody saw a decline in their funds’ status,” she said, adding that her company took the accompanying financial hit at the end of 2016. Other risks include increasing PBGC premiums, asset allocation resulting in overly optimistic expected returns compared to market performance, and overreliance on market conditions to improve funded status. Consequently, the company has instituted a glide path, so that the fund’s allocation mix changes as it approaches its target date. The benefits include:
- Maintaining discipline through good and bad times.
- Reducing temptation to maintain risky exposures after strong returns.
- Helping maintain exposure to risky assets when the market is stressed.
- Informing all key stakeholders about the strategic plan.
OUTLOOK
In terms of currencies, political risk is becoming ever more prevalent. Equating an election result with a percentage move in a currency can be fraught with misestimation. However, Bloomberg is seeing more and more providers developing multifactor models to quantify that risk, and it is working with a few to provide the service.