Members of The Neu Group’s Treasurers Group of Thirty unsurprisingly highlighted hedging and managing FX exposures as a key challenge. Record-high stock prices for many have made buybacks a priority and fueled M&A. Several members are either in the early stages of implementing treasury management systems or near completion, and a few members discussed recent transfers of pension obligations. Additional meeting highlights included:
1) Tax-Effective Treasury Structures Under Attack. Tax experts from Pricewaterhouse-Coopers and KMPG spent most of the session updating members on the OECD BPS initiative, concluding it will prompt bilateral tax treaty changes and give governments, especially in developing countries, ammunition to raise taxes on MNCs.
In addition, Europe’s State Aid investigations are ramping up, and momentum for US corporate tax reform is building.
2) Volatility in the Currency Markets. Chatham experts highlighted the unpredictability of currency markets and recommended applying a consistent, methodological approach to managing the risk. Participants noted that a portfolio approach to hedging has ancillary benefits, such as illuminating when hedges are excessive. MNCs must regularly remind investors about their hedging programs, prepping them for FX volatility spikes.
3) Effectively Managing Interest-Rate Risk. Rapidly dropping unemployment suggests an interest-rate hike may arrive sooner than anticipated, and the Fed remains unconcerned about failing to meet inflation targets, given recently announced wage increases by big retailers. Participants’ companies are either considering or just started increasing floating-rate exposure.
4) Open Forum. Amid headlines about network breaches at retailers, movie studios and government agencies, cyber risk has risen to the top of the worry list; and MNCs are still figuring out how to deal with it.
5) Activism Outlook for 2015. Activist investors have prompted changes at the companies of several T30 participants. Meanwhile, activists’ coffers are growing, and they never give up. Goldman Sachs’ bankers suggested several defensive measures.
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MNCs Face Tax Issues at Home and Abroad
Pam Olson of PricewaterhouseCoopers and Michael Plowgian at KPMG explained the origins of the OECD’s Base Erosion and Profit Shifting action plan and how it will impact MNCs, before touching on other tax-related issues.
KEY TAKEAWAYS
1) It’s not regulation, but it sure will prompt it. Governments are looking for ways to increase tax revenue and eliminate the zero tax rates achieved by MNCs. BEPS’ requirements for corporates to report key country-by-country financial metrics will likely prompt governments to increase audits. A multilateral instrument under development to increase efficiency and reduce the risk of double taxation will aim to facilitate amendments to existing bilateral tax treaties.
2) Comin’ round the bend. The OECD wants to see its BEPS guidelines implemented for accounting periods in 2016. The US managed to reduce the number of reporting items to seven, and that information must be reported to the MNC’s principal tax authority, which will distribute it to the tax authorities where the MNC does business. An MNC should align its transfer pricing documentation as closely as possible with its operations in a country, to effectively challenge audits or adjustments. Taxes abroad are going up.
3) State aid investigations ramp up. The E.C.’s state aid investigations explore whether national tax authorities are permitting certain MNCs to understate their taxable income by using favorable calculation methods—“hidden subsidies.” Apple, Amazon, Fiat Finance and Starbucks have all been hit. Where the IRS may collect back taxes going back three years, state aid investigations can push tax authorities to calculate back taxes going back a decade, applying interest over that period.
4) Finding the magic number. Competitive foreign corporate tax rates and US companies’ inversions have finally prompted legislators to consider domestic tax reform, likely lowering the domestic rate to 28 percent or 25 percent. Moving to a territorial system would eliminate the repatriation tax and create a minimum tax on foreign income. The administration’s budget proposes 14 percent, while Republicans want much lower rates.
OUTLOOK
MNCs had best match up their transfer-pricing documentation and operations as much as possible, and otherwise prepare for nosier regulators and higher taxes abroad. U.S. MNCs’ rush to lower-tax jurisdictions may finally prompt Congress to reform the corporate tax code.
Catching Up to Cyber Risk
The risk of cyber breaches is certain, but just how to deal with it is still being worked out by most T30 participants. Retailers carry an extra burden, because they’re responsible for their customers’ credit card numbers and other personal information. But companies selling to corporate customers aren’t off the hook.
The treasurer of a manufacturer of sophisticated products said the CIO, CFO, treasury and head of enterprise risk management (ERM) are still talking through the issues—“how can it disrupt what we’re doing and impact our main customers?” A couple of participants noted bringing in third-parties such as AT&T to gauge their weaknesses. Key was determining what sort of security framework to adopt.
Cyber-risk insurance was viewed as a component of the solution, but concerns remained about the damages it may not cover; if, for example, a company’s defined contribution or health insurance provider is breached and employee records are stolen.
Plus, the underwriting process is anticipated to become much more difficult. The participants generally agreed that bringing bankers and insurance brokers to the next meeting to discuss cyber risk should be a goal (see related story).
Volatility in the Currency Markets
Chatham Financial’s Amol Dhargalkar and Steve Castleton conducted a lively discussion with T30 attendees about the currency issues corporates face and hedge-accounting developments.
KEY TAKEAWAYS
1) Utilize friendly reminders. Currency rates are all over the place, and no one can predict the next FX event. One Chatham client issued a press release soon after the Swiss announcement, reminding investors about its longstanding hedge on the Swiss franc and reaffirming it was ongoing. Another client told investors about the natural hedge provide by its Swiss business. Keep investors informed.
2) Portfolio approach to hedging has ancillary benefits. Participants voiced their tendency to design their currency hedging programs on a currency-by-currency basis while also running simulations and accounting for portfolio correlations and volatility as a whole; one also includes commodities in the mix. Those shying away from the portfolio approach voiced concerns about correlations holding together. Another said the portfolio approach enables building a global framework for the company’s global exposures.
3) Best offense is a consistent defense. Chatham recommends implementing a long-term hedging program to remove discretion around when to trade, how much, the amount to hedge, and the timing. Dollar-cost-averaging in such a program may in some years result in losses that require explaining to the board and investors, but it provides certainty about what currency risk will look like going forward.
4) Talk to FASB, and get ready for long haul. Companies can employ hedge accounting for financial hedges but not for the cost of components. The Financial Accounting Standards Board (FASB) is revisiting those rules. Chatham recommends companies talk to the board about their real-life experiences. In addition, FASB is heading resolutely toward the “long-haul” method to apply hedge accounting and away from the matched-terms concept.
OUTLOOK
Currency volatility is here for the foreseeable future, so companies must prepare to address Wall Street’s concerns. The portfolio approach to hedging can help assess risk exposures but is not a panacea. Changes anticipated from FASB will likely enable hedging components of risk, and companies must prepare for applying the long-haul method to achieve hedge accounting.
Activism Outlook for 2015
Industry professionals envision an increase in shareholder activism in light of falling prices and growing activist investor successes. Their battles could get even uglier in 2015 as hedge funds continue their trend toward piling into the same stocks.
KEY TAKEAWAYS
- n The fast and furious. Activist campaigns continue to increase across all market capitalization levels and the playbooks of the activists are becoming more aggressive and contentious. Steady M&A volume, record levels of cash on corporate balance sheets, fewer structural defenses such as poison pills, and companies’ stocks trading below the sum of their parts, are all driving factors. Even the largest companies are now vulnerable.
- n Know your friends. The mix of shareholders continues to shift as some funds begin to partner with activists. Index funds have become an ever-larger presence in the corporate shareholder base and they have displayed a growing willingness to support activist nominees as.
- n Every situation is a “victory.” Activist shareholders often take credit where credit is not due, so managing the media both preventively and after they’ve struck is critical.
- n When tenor becomes a problem. There is increasing scrutiny of directors as part of the activist’s campaign and these directors are being targeted for having lack of industry expertise, lack of shareholder ownership, sitting on too many other boards, conflict of interest and long tenure.
OUTLOOK
Shareholder activism has grown significantly in the past two years; recent campaigns have taken on a more aggressive tone, while activists publicly launch campaigns with little or no notice to the company. They have gained increasing support from institutional investors and are asking for much more than just increased share buyback and higher dividends.
Effectively Managing Interest-Rate Risk
Chatham’s Clark Maxwell and Amol Dhargalkar discussed relevant factors influencing the Fed’s rate-hike decision. The session also tackled various conundrums related to hedge accounting, and FASB’s effort to revisit the guidance.
1) Should I float? T30 participants were actively contemplating more floating-rate exposure, adding to existing floating-rate that now often takes the form of commercial paper. The treasurer of a major manufacturer said the company’s current exposure was 100 percent fixed, and it will use CP when working capital needs arise. Another said his company’s floating-rate theoretical target is twice the current 20 percent, and when rates rise it will layer in more floating exposure.
2) Yes on unemployment, fail on inflation. At the start of the year the non-accelerating rate of unemployment (NARU) was 5.8 percent, and the Fed had recently been pegging it at 5.5 percent, matching the headline unemployment rate and implying rates should be increased. Will it drop to 5.2 percent in the next three months, and could the headline unemployment rate drop below 5 percent? Meanwhile, the Fed is content with its failure to reach its inflation target because it sees wage inflation as a precondition of goods inflation, and announcements by retailers suggest the former is imminent.
3) No more advance notice. The plethora of information the Fed has provided the market in recent years about its intentions will end after the first rate increase. Following that, the Fed will move rates when appropriate and not according to a pre-ordained schedule. The market tends to overestimate where rates will go in the future, except when rates are rising and then it underestimates.
4) FASB reconsiders hedge accounting. FASB is reconsidering the hedge-accounting model and “partial-term hedging.” International accounting standards, Amol said, now allow companies to aggregate positions to get the exposures they want, a solution FASB will likely consider. Clark said getting hedge accounting treatment for acquisition financing is possible only if the debt offering is not contingent on the acquisition.
OUTLOOK
Most T30 participants foresaw shifting to more floating-rate exposure. Whether the Fed will increase rates depends largely on the outlook for unemployment and inflation, with recent Fed communications indicating the former is dropping rapidly. The Fed is fine remaining below its inflation-rate target, because announcements by major companies about increasing employee wages suggest wage inflation is coming. The Fed will no longer detail its intentions.
CONCLUSION & NEXT STEPS
Corporate treasurers face a range of external issues that can impact the company as a whole, and those issues aren’t going away anytime soon. In most cases, preparing a plan of action to deal with major developments and unanticipated events when they arrive is the
most effective course to assuage investors and regulators.