By Geri Westphal and Ted Howard
Most of the challenges treasurers faced in 2010 are still around for 2011. But this is definitely the year to engage.
With apologies to The Who, for MNC treasurers, it’s meet the new year, same as the old year. That’s because many of the issues confronting treasurers in 2010 have carried over into the new year: regulation—both in the US and abroad, an iffy US economy, and sovereign debt concerns in Europe (and municipal debt issues in the US).
There are also bank relationships to keep strong as many financial institutions, some still saddled with toxic loans, continue to deal with the aftershocks of the meltdown. Finally, there is the burning question of investing. Where to put the company’s growing cash pile?
But there are opportunities, like China’s burgeoning yuan bond market and more relaxed FX trading regulations. Also, there appear to be some glimmers of hope—or at least nothing too negative—on the corporate tax front.
Having hustled to keep cash available, manage risks and banks relationships, treasury will likely be called on again to navigate whatever trouble is next.
Economic Outlook
As 2011 begins, the general outlook is one of cautious optimism; and although the economic recession statistically ended in June 2009, most companies and people continue to feel the lingering effects—particularly as it relates to persistently high unemployment. There has been no magic turnaround but rather a slow, sometimes painful crawl toward economic recovery.
Economists predict the second half of 2011 will outpace the first half. US gross domestic product is seen growing between 2 and 2.5 percent until mid-2011 and then picking up to 3.5-5 percent in the second half. Some economists anticipate another round of quantitative easing (QEIII) in the second half of 2011, as they believe the Obama Administration will continue this program until a self-sustaining recovery is achieved, despite political pressures. The US budget deficit will also continue to be a problem. “I really don’t think there will be a huge move in the interest rate curve,” said a treasurer. “But the deficit, and Washington’s inability to deal with it is a sore that keeps festering and sooner or later will spread into the markets.”
Globally GDP for 2010 is forecast to be 4.8 percent, according to the International Monetary Fund, with a decline predicted in 2011 to 4.2 percent. The IMF said growth in emerging markets will continue to be a main driver of the global recovery. These markets will have to find ways to grow more autonomously as demand in developed markets softens. Growth in Eastern Europe, the Middle East and North Africa, will increase while LatAm, Asia and Australasia will slow.
The sovereign challenges in Europe dominated headlines in 2010 and will continue to be a source of concern into 2011. Portugal, Italy, Ireland, Greece and Spain (PIIGS) will continue to add concern and volatility to the markets for some time. Belgian political issues, signs of a recovery slowdown and proposed rule changes that will force investors to take a hit in cases of bank failures also weigh on the region.
A treasurer at a US multinational said sovereign debt was top a concern. He worries that Europe’s problems will become more contagious and spread to the US. And due to the current fragile condition of US state municipalities, he said, it would be a chain reaction. In such a
scenario “the second or third quarter could see Moody’s or S&P placing the US on credit watch,” the treasurer added.
Regulatory Tsunami
Dodd-Frank. Most agree that Dodd-Frank legislation is the most sweeping change to financial regulation in the US since the Great Depression. So sweeping in fact that it’s been compared to a tidal wave: “The biggest single threat to job creation facing us today is a regulatory tsunami of unprecedented force,” according to Tom Donohue, the president and CEO of the US Chamber of Commerce.
Wherever one’s feelings lie, regulation is coming and fine-tuning of these regulations will continue into 2011 with various agencies writing rules for higher capital requirements, tighter liquidity, heightened scrutiny on credit worthiness of borrowers, and uncertainties in the derivatives markets, all outcomes of the new regulations.
While most treasurers as end-users think they are exempt from new derivatives rules—that is, central clearing mandates—the rule-writing process bears close scrutiny. The good news is that the rule-writing now will take place in a more business-friendly environment with Republicans in control of the House. Several, including Alabama’s Spencer Bachus, Virginia’s Eric Cantor and Minnesota’s Michele Bachmann all want changes if not outright repeal.
For treasury, it will be critical to keep an eye on (and a supportive voice for) Rep. Bachus, now head of the House Financial Services Committee, as he continues to push for rules changes governing the use of derivatives. In December both he and Oklahoma Republican Frank Lucas (who is to head the House Agricultural Committee) voiced their concerns about the margin requirements for end-users.
“It is critically important that the commercial end-user exemption from requirements of Title VII be implemented in a manner that is consistent with congressional intent,” the two lawmakers wrote in a letter to the Treasury, the CFTC, the Fed and the SEC. “[It’s been made] clear that margin requirements should not be applied to end-users.” So to do otherwise would “defeat the purpose of the end-user exemption.”
End-user margin requirements are also something treasurers should keep a very close eye on. This is because the language in the final Dodd-Frank legislation did not fully extend the corporate end-user exemption to margin requirements. And CFTC Chairman Gensler still indicates his desire and belief in his authority to impose margining on end-users.
The rule-writing must be complete by July 2011, which has regulators working at a fever pitch, particularly the CFTC, which is going from a relatively small agency monitoring a $40tn futures market to $300tn in OTC derivatives. The CFTC is also beset by resource challenges—its funding is in question now that Republicans are in control of the House —and disagreement among commissioners.
“I worry not about the direct consequences [of the regulation on my company] but the indirect ones via our banking partners,” said the treasurer of a US consumer products company. “Costs are going up and I am still curious how my banking costs will go up as well.”
Basel III. Like Dodd-Frank, the coming Basel III will also increase regulatory scrutiny and costs. According to Citibank, several US, European and Japanese banks will need to increase Tier 1 capital by 300bps to attain Basel III standards. This requirement alone will very likely increase the cost of credit for most borrowers. These changes are significant and will change the way banks do business well into 2011.
Nor is the fact that the Basel Committee has created an eight-year implementation period sitting well with some banks. Some have said it will have a negative impact on global GDP growth from now to implementation. The BIS said the GDP impact would be 0.22 percent; others say it’ll be much larger.
Use of Proceeds
US interest rates are expected to remain unchanged in 2011, with the target range of zero to 0.25 percent and rates will remain low as long as unemployment stays high. Economists agree the level of unemployment is the biggest factor holding the economy back right now. What this means ultimately for treasurers is that investment opportunities remain limited.
According to JPMorgan Chase, corporate cash as a percent of current assets has increased significantly since late 2008, rising from 20 percent in 2008 to 27 percent in 2010. According to a Fed study, US non-financial companies were holding $1.93tn in cash and other liquid assets at the end of September, up from $1.8tn at the end of June. So with cash on corporate balance sheets at all-time highs and yields on investments persistently low, corporate treasurers won’t be content with another year of low investment returns.
The increase in risk appetite and the continued pressure for high-yield investments, may lead to the creation of new investment products that could introduce a new level of risk. The repeal of Regulation Q in July 2011 will allow banks to offer interest on commercial checking accounts.
Demand for increased investment transparency and risk management will continue into 2011. Organizations will continue to advance globalization efforts to consolidate and automate treasury processes to improve visibility and control of global cash. Stock buy-back programs also will be busy. Repurchases kicked into high gear in late 2010, with a strong increase in buy back levels in Q3 and Q4. According to Bloomberg News, buyback estimates for Q3 were $79bn, up from the $34bn during Q3 of 2009. Q4 estimates of $30bn brought some to believe 2011 will bring even greater levels to this area of capital markets activity.
According to the New York Times, estimates for M&A activity in 2011 should near the $2.7tn mark, up from 2010’s total of $2.4tn. Some believe the 2011 level could top $3.04 trillion. This comes after hitting recent lows in 2009 with $1.98tn in deals. This is confirmed by many discussions among members of various NeuGroup peer groups, who are bullish in their M&A outlooks.
In addition to balance sheet cash and historically cheap straight debt, both M&A and stock repurchases could also be increasingly financed by convertibles, which many see coming back after a moribund several years.
a relaxed China
For years Western MNCs struggled with cash management in China, with only a few options for doing things like investing excess cash in China.
Fortunately, the Chinese government lately has been accelerating a relaxation of the rules, particularly as they relate to fixed-income securities and more importantly, access to them by foreign entities. In August 2010, McDonald’s became the first non-financial foreign company to issue $29.5mn in RMB-denominated bonds. More significantly, Caterpillar issued a RMB1bn bond in late November that was able to be swapped into onshore RMB for use by its captive finance sub to support Chinese sales. Yet more evidence that China is increasing efforts to provide RMB-denominated assets to financial markets as an alternative to those issued in a weakened US dollar.
Yuan bonds can be a great opportunity to companies that have RMB business, as it allows them to match currency to the debt, which is potentially more efficient than using the FX swap market given future/spot inefficiencies in the RMB. Further to these financing efforts, Chinese regulators in December increased the number of exporters that can use the yuan to settle international transactions from a few hundred to nearly 70,000. Eventually, experts predict, 20-30 percent of China’s $US2.3tn of imports could be done in yuan instead of US dollars.
Tax Changes
By the end of 2010 there was already bipartisan talk of reforming the US corporate tax code. The premise of this consensus was moving to a simpler tax code by giving up certain tax breaks. But coming to any agreement in 2011 will be difficult. That’s because while there is a lot of talk as well as proposals—Wyden-Gregg, Domenici-Rivlin and, Bowles-Simpson (a deficit-cutting plan that has tax proposals), Congress is not likely to go along with much of what the president plans.
“There were a whole series of changes the Obama Administration wanted to make and they ended up retreating from those last year,” said William Cavanagh, a partner and tax attorney with Chadbourne & Parke in New York. “And with the current make-up of Congress, I wouldn’t expect him to pursue them this year. And if he does, I doubt he’d be very successful.”
But Mr. Cavanagh points out that just because the White House might not pursue some of its corporate tax plans (or accomplish them in 2011), the IRS and tax authorities around the world will continue to work together to ferret out tax fraud.
One area of scrutiny is treaty shopping, Mr. Cavanagh said. This is where a company that earns income or capital gains from another country, looks to benefit from a tax treaty between the source country and yet another country. “There is definitely a heightened focus on companies abusing tax treaties,” he said.
Transfer pricing also remains an issue. Just recently Boston Scientific was handed a “notice of deficiency” from the IRS regarding taxes for the company’s Guidant subsidiary. Guidant reportedly ran afoul of the law before Boston Scientific acquired the company in 2006.
With this in mind, treasury should review existing transfer pricing policies as well as those of acquired companies—particularly in a year which may produce pre-crisis levels of M&A. Mr. Cavanagh said it is a good idea to keep this policy up-to-date and to keep the underlying arguments consistent across all the countries. In the past companies have been caught using different arguments in different companies regarding the same liability.
As usual, most must be faced in a world of tighter resources and added responsibility. But with constant improvement in process and technology, and the successes most saw in the aftermath of the crisis, treasury’s lot will should continue to improve this year.