Peer Insight: The Latin American Treasury Manager’s 2014 Winter Meeting
Venezuela shows no signs of settling down and Argentina is continuing to develop in a similar direction.
There is no shortage of challenges for Latin America treasurers and the winter 2014 agenda reflected what’s on many treasurers’ minds: recent events in Argentina and Venezuela, a look at cash management and banking in some of the smaller countries in the region, working capital and cash mobilization, and also an assessment of the banks member companies use and how well they serve their treasury needs. Here are some further details from the meeting:
1) Working Capital, Cash-Flow Improvement. In a tighter credit environment, the increasing sophistication of customers is coinciding with more companies coming to market to provide supply-chain finance (SCF) services; in some countries, like Mexico, there are even government-sponsored companies offering factoring.
2) Venezuela Taking More Than It’s Giving. Cutting and running is a scenario that is being discussed more and more but many are not there yet. Instead, business growth is curtailed or operations decreased in response to slow CADIVI approvals and a hostile environment for commerce.
3) Argentina: Grab Your Venezuela Playbook. To survive and meet the requirements of laws and regs, companies adapt to less economically ideal treasury and business practices via changes in intercompany lending terms and currencies, policy changes vis-a-vis local investments and inventory levels, and a transfer of some manufacturing to local facilities for export-import balancing.
4) Latin America Bank Assessment. The inconsistent scores by some banks with different customers highlight the need to streamline processes, have good systems and agreements in place and to maintain constant communications and tracking of key service items. After all, the bankers themselves come and go.
Working Capital, Cash-Flow Improvement
Supply-chain finance is still a work in progress for many. Factoring of receivables is appealing to free up credit lines when there are overdue invoices to collect. Some members discourage factoring but offer pre-payment discounts instead.
KEY TAKEAWAYS
1) Two trends support SCF. In addition to tighter credit, the sophistication of customers is coinciding with more companies providing SCF services. In Mexico, for example, there are two or three government-sponsored companies offering factoring now.
2) Pooling is done where it can be done. In Mexico, local and dollar pooling can be done. One member noted that you don’t necessarily need to pool locally first before pooling cross-border; there can actually be less documentation involved to pool entities separately.
3) Brazil’s transfer pricing rules build up cash. A member company using a cost-plus model of 5 percent now needs to comply with a 15 percent profit margin, which will cause cash to build up there.
4) Brazil is expensive to do business in; is it profitable? Because of a high regulatory and tax burden, the cost of doing business is high. Sometimes tax incentives help but if tax incentives are the only way to stay out of the red in Brazil, then what?
5) Cash as collateral instead of litigation guarantees? By mistake, one company’s local staff in Brazil posted cash collateral instead of letters of credit for litigation. If you have cash, it may not be such a catastrophe, as you are entitled to interest on it. Interest accrues 15 percent per year on L/Cs, after all. But if you want the cash back to put a guarantee instead, the court needs to approve it.
OUTLOOK
With KPIs on working capital coming into sharper focus when the credit taps are turned off, it is a continued priority for treasury to watch for ways to speed up collections and the cash conversion cycle. But customers are increasingly savvy and will not pay their bills faster with nothing in return. SCF providers are stepping in with solutions that can spread the benefits across the supply chain. Many member companies have already or are preparing to take advantage of such services in select countries or region by region.
Venezuela Taking More Than It’s Giving
Venezuela continues to take up proportionally more time and effort for less than proportional rewards. A steady decline in economic growth, business-unfriendly government, slowing oil revenues and tight FX controls make for disappointed treasury folks, and after the meeting the situation continued to decline with escalating violence and protests.
KEY TAKEAWAYS
1) A devaluation by any other name… Despite expectations that a devaluation was on the horizon, on January 23, rather than a devaluation announcement, FX rules were changed such that travelers, e-shoppers, some importers and airlines, among others, were no longer eligible to purchase dollars at the official 6.30 rate, but would instead need to buy on the SICAD weekly auctions, the allocations for which were to increase to $220 million per week (SICAD rate was around 11.3 and later rose to close to 12). Already high, the black market rate went higher still and hit the high 70s (the PPP rate at the time was estimated at about 14-20), while shortages of basic goods remained, and price controls by way of rules limiting profits kept merchants in check. Following additional protests and violence, the black market rate rose ever higher.
2) Slowdown in CADIVI approvals noticeable. There was agreement that CADIVI payments had slowed down in the three or so months before the end of January 2014. For example, one member company’s sales benefited from subsidized prices making their product inexpensive to buyers, so sales are good, but the company noticed a slowdown, too. As a result, the general concern is increased overall risk to the company and worry about whether the government will ever be able to clear the debts that have accumulated.
3) Keep taxes and statutory accounts up to date on all legal entities. In order to access both CADIVI and SICAD dollars, a company needs to have separate LEs, and whichever one is bidding for SICAD has to have declared taxes in the previous period. Only after it has had some revenues and profits and paid some tax can it attempt to bid for SICAD.
4) Determine if there is a point at which dividends must be declared or they are lost. There was some uncertainty on whether filing CADIVI requests for dividends can disqualify you from future CADIVI approvals and how much delays in dividend declarations matter. One member noted that if her company has a delay in filing, it submits letters explaining the situation so as not to risk losing the qualification. Check with your advisors.
5) Change the business approach and work with the customer. Venezuela requires a different mindset to keep business going. A member company has decided on a plan to abandon direct sales and instead substantially increase inventories, spare parts, etc., and essentially act as a broker to its customers by collecting bolivares from them and wait for CADIVI approvals to get dollars out. However, this adversely impacts global KPIs both for cash flow and working capital, and the company is not taking any new orders until CADIVI approvals are received. How long is this sustainable? At some level, the intercompany balances to the company’s Venezuela sub go over an agreed level and become so high that drastic decisions are needed. Meanwhile, a good relationship with the supply chain and customers is important so that solutions—however temporary—can be worked out to keep going.
6) Leverage relationships with local flagship companies. Is it possible that local pressure on the government can aid in clearing some of the CADIVI approvals to keep the companies in business for a while longer? It’s worth a try. The alternative is that if a business shuts down, the government could expropriate the assets.
7) New SICAD rules: How will it work? At the time of the meeting, not a lot was clear about how the new SICAD market (SICAD 2) would work. SICAD 2 was supposed to boost the supply of dollars (with support from China and Russia) and limit government interference on trading. But according to more recent reports, the latter hasn’t been the case. The mechanism was not supposed to be subject to foreign exchange rate bands nor limit amounts to be purchased. However, the Central Bank of Venezuela has established a band at VEB 48-52 per dollar.
OUTLOOK
Companies in Venezuela are slowing down their business operations and limiting their growth in response to the business climate and increasingly slow CADIVI approvals. It is becoming a harder and harder decision to stay in business and not just cut and run. Recent developments may indicate the country has hit bottom and that, perhaps, there is light at the end of the tunnel and hope for reforms.
Argentina: Grab Your Venezuela Playbook
After a steady depreciation of the peso over the past several years, the Argentine government devalued by way of less market intervention the week before the meeting, allowing the rate to hit close to 8 pesos per dollar (the blue chip swap rate hit close to 11 and the black market rate higher still).
KEY TAKEAWAYS
- Leverage local currency to minimize intercompany payables. The different local business sectors for one member “share” their local balances to settle interco payables. To get more money out, they also pay the parent more for imports (within acceptable transfer pricing limits).
- Change the rules. Normal rules don’t apply if you want to stay open for business in a country like Argentina, where sudden import restrictions can disrupt business.
- Produce locally. To meet import/export balancing requirements and associated reduced import authorization, some lines of products have been shifted to be locally manufactured in Argentina; this also allows some exports to help with the balance. The problem sometimes is the quality of raw materials available locally, so this decision needs to be made carefully (local assembly of parts produced elsewhere is the “safer” route).
- Change of interco billing currency. One member company used to invoice the subs in ARS with hedging done at the sourcing companies, but it is switching to billing in USD, with no hedging at the sub level because of the cost. Another is considering the opposite switch.
- Exceptions to policy, again. Giving an exception to corporate investment policy by investing the local cash in time deposits is how one company (somewhat) mitigates the impact of inflation.
- Use the cash to upgrade. Expanding capex (to build additional manufacturing capacity, warehouses, upgrades in offices, etc.) is how one member company supports the export requirements, as that is more in keeping with the company’s normal business. (Other MNCs have been known to exports goods that are unrelated to their normal business, such a car company exporting wine).
- Negative equity is, well, negative. Some companies are faced with negative equity in Argentina and need to rectify this. For some, it may affect their ability to bid for government contracts, for example. One member company parent provides, in essence, a comfort letter/full support letter. Another member company (which has a plant in Buenos Aires) historically has “topped up” just enough on an annual basis. But the situation is not getting better— which at least in theory should force a serious discussion about business continuity. The thing with negative equity but is if the company has not made a profit in three years, the government can shut off operations, according to one member.
- So can you capitalize interco debt to reduce negative equity? That’s one way of doing it, but because the interest deduction can only occur when the debt is paid, not when it is accrued, you forgo the deduction.
- Sometimes a local bank helps—and sometimes not. Sometimes local banks will help get things done more efficiently and with lower costs simply because they know the market better than global banks. A global bank may also have other channels at its disposal. The local banks will expect more business in return for a little help. Some global banks are also being more aggressive in this area, but the local banks tend to take a shorter term approach.
- Royalties/technical assistance fees are OK but not dividends. One member reports that her company books royalties and TA but have been advised to not even declare dividends. Others have not been similarly cautioned.
- Sending money in—only if you have to. If you need to fund operations locally, look at local loans before funding by interco loans; this is due to the 30-percent one-year bank reserve requirement or “encaje”/non-interest paying escrow that would apply to foreign funds.
OUTLOOK
MNCs with presence in Argentina are seeing their businesses forced to adapt to changes they would never undertake were it not for the increasingly arduous and arbitrary rules that are mainly meant to protect foreign currency reserves and thus the government’s margin to operate and stabilize the political environment.
Latin America Bank Assessment
Member discussion on bank assessment raised several considerations.
KEY TAKEAWAYS
1) Local banks have a shorter horizon. Local banks can be more short-term transactional, while global banks take a longer-term global view of the entire relationship.
2) Consider “joint business plans” with your key banks, and have SLAs. Negotiate certain points that will be tracked on a scorecard and have a meeting once a quarter.
3) Who is good at documentation? That can really make a difference in troublesome countries.
4) Ask about bank fees. Bank fees are usually debited before they are invoiced, and members who do ask about them are routinely told they are the first to do so. This is never true, so don’t hesitate to bring it up with your banker and ask for documentation, and preferably, to be invoiced and not debited.
5) Go to lunch with your banker—and bring your local peers. Consider taking your local corporate peers with you and have lunch with a banker—with many voices in the room, changes may come sooner.
OUTLOOK
Bankers come and go. Streamlined processes and good systems are important to ensuring continuity and good service. In addition, good agreements, frequent communication and appropriate tracking tools should minimize disruptions.
Conclusion & Next Steps
The exceptions are becoming the rule in Latin America. First and foremost, Venezuela requires a whole different mindset to muddle through in the hopes the country changes its political path and embraces more market-friendly reforms over time. Then came Argentina where the Venezuela playbook is increasingly deployed and companies accept exceptions to policy on everything from working capital KPIs and intercompany lending terms to significant changes to business operations, such as local manufacturing. Is Brazil next? Despite its potential and good growth for many MNCs, the taxes and regulations continue to add to the cost of doing business there, to a point where one more tax change might make the whole enterprise unprofitable. These are significant challenges that trickle down to treasury’s level and impact the processes there.
Spring Meeting:
June 2-3, 2014 in Miami, Florida.