Asia and Greece are expected to sour the end of 2015, so regional cash pooling and change management are good areas to focus on and learn from.
The spring ATPG meeting focused on some serious changes that members are facing: splitting businesses, acquisitions, divestitures and implementing a regional cash pool while tangling with a tax team with different priorities. These and other goings-on are all taking place as 2015 shapes up to be a challenging year.
1) Revamping the Treasury Function in Light of Corporate Change Events: Splitting into two separate businesses is a painful change management process, and given the “tsunami” of tasks to get done, job one is to keep up employee morale.
2) “Solve My Problem” — Regional Cash Pooling Case Study: Establishing a regional liquidity management structure requires strong collaboration among one’s legal, tax and accounting teams. Corporates can leverage bank advisory services to navigate through the fragmented regulatory landscape in Asia, but navigating tax is another matter.
3) Economic Update: Deutsche Bank Foresees Tough End to 2015: 2015 is indeed a year of caution for all. Spill-over effects from China are unavoidable for Asia.
Long-term Versus Short-term Cash Holdings
ATPG members shared strategies for favoring — or at least balancing — long- and short-term cash holdings.
A member company with business focusing on ingredients and agricultural commodities, among other lines, has observed that tax authorities are starting to look at the nature of cash holdings in cash pools. Big daily fluctuations in cash pool balances are good, while stable cash pool balances for longer term are seen as long-term financing instead of short-term cash pooling, and thus different interest rates should apply according to tax authorities. Practitioners in the group agreed that it may be wiser to follow another member company’s example of keeping the long-term funding arrangements as separate intercompany loans with more vigorous internal credit rating assessments documented to support arguments for arms-length pricing. Meanwhile, any positive short-term cash pool balances can be invested out from the cash-pool header account. Some members just invest this in plain bank deposits, some consider local money market funds such as JPMorgan MMF in China, ICIC MMF or HDIC MMF in India. Other members swap local currency cash to USD to upstream to headquarters.
Revamping the Treasury Function in Light of Corporate Change Events
One treasury director described his company’s treasury function revamp as it splits two businesses into two separate public companies, which occurred in July of 2015. An aggressive timeline of eight months has forced the company to be focused on needed change management activities and taking the strategy of “lift & shift” and “optimize later.”
Key Takeaways
1) The game plan. After a six-week planning stage, the blueprint for this change management was created. The first rule applied was that they cannot increase headcount. With one business needing more treasury support in the area of capital markets, while the other business is more reliant on treasury support in the area of payments and cash management, the treasury leadership had to re-align its team strength of 40 people globally into two fully functional treasury teams to support the differing needs of the two separate businesses. The tactical approach was to centralize treasury as much as possible in one location for each business in order to manage with the same headcount. Thus, there was the need to dismantle the three treasury centers located in Luxembourg, Sao Paolo and Singapore and leave only two people in Asia and two in the LATAM in countries, where there is an absolute need for local presence to support the business.
2) Organization design. As the team designed the new treasury function, significant effort was focused on splitting up treasury systems, the balance-sheet and working capital to support the two future standalone businesses. The investment book and securities book has to be split and allocated into two separate parts. It was understood that regional treasury centers would not exist and instead a centralized pool of resources would prevail. But there was practical concern about how to support the businesses in different locations across different time-zones. To resolve these concerns, management adopted a new matrix model to ensure that both local back-ups and global back-ups exist to manage follow-the-sun operations.
3) Building the knowledge base. Clear documentation of all processes and activities is absolutely critical to build “institutional knowledge” within the organization to facilitate local back-up and global back-up arrangements. The member is thankful that two years earlier his team re-documented all their treasury SOP (standard operating procedure) manuals.
4) The show must go on! Given the tight timeline for the company split, everyone is expected to raise any concerns, issues or problems immediately, and the practice is that no decision-making can be withheld for more than 24 hours. This is the speed and decisiveness adopted by the executive leadership team.
Splitting into two separate businesses is a painful change management process, and given the “tsunami” of tasks to get done, it is important to keep up employee morale. HR retention benefits do help to keep the teams together.
Outlook
This speedy implementation serves the company well, as it ensures that fewer people will be “lost” along the way, and the united workforce feels the euphoria of reaching the desired state swiftly. It is important to ensure that soft skills are shared among employees, and that everyone feels comfortable about performing well in their future jobs. This builds camaraderie, bonds, and the corporate culture in the new standalone businesses.
Supply-Chain Finance
ATPG members discussed their approaches to and tools for supply-chain finance based on their corporate goals.
One member company currently offers a vendor discount program for early payment to all vendors regardless of the creditworthiness of the specific vendors. The company is pushing this program because it is a better use of corporate cash. There is also a good argument to keep the procurement team out of the SCF equation and have them just focus on negotiating the purchase price to prevent vendors from passing discount fees back into future purchase prices. Another member company, however, has given its regional treasurer an objective to revamp their program to offer dynamic discounting, which reflects different discounting rates depending on credit rating, size of transaction flow, and discount tenor.
Aravo (a cloud-based software for supplier lifecycle management, covering risk, performance and compliance aspects) is the go-to tool for a member company in offering payment discounts to vendors. In support of Obama’s initiative to help small businesses, which is called Supplier Pay, the company has been very successful in offering supplier payment discounts in the US, but they are not seeing similar demand in Asia. The company’s Purchase-to-Pay team owns this program initiative, with treasury only involved in the payment aspect.
“Solve My Problem” — Regional Cash Pooling Case Study
One ATPG member company is currently managing cash in Asia Pacific on an individual country basis. The company has local in-country cash pools in USD and local currency in Hong Kong, Singapore, Australia, Malaysia, and Japan for multiple legal entities. Cash sweeps to a header account in-country. Surplus cash, where possible, is lent out to two global treasury companies in Europe by manually arranged intercompany loans. The company plans to set up a regional liquidity structure to concentrate USD and local currency cash to the bank accounts of two treasury entities on a daily basis. The first phase will start with HK, Singapore and Australia. The second phase will include Japan and other more restricted countries. The company’s objective is to eliminate the many manual intercompany loan transactions and make the process automated, and secondly to optimize liquidity management.
Key Takeaways
1) Concerns on permanent establishment. When a local treasury team manages offshore accounts of a global treasury entity, this may raise tax issues about permanent establishment. However, these concerns can be easily addressed by documenting appropriate service level agreement (SLA) between the parties involved. It is worth the time and effort to create a proper framework of SLAs covering all parties (business unit, subsidiary, treasury center, global treasury entity) in a liquidity management structure.
2) Notional pooling. The company’s auditors, KPMG, are not fond of notional pooling structures because this can gross up the balance-sheet significantly, which is deemed undesirable. The meeting sponsor, Deutsche Bank has seen many companies achieve effective set-offs in accounting for notional pooling structures. During discussion, one practitioner said his company has a multi-currency notional pooling structure with Bank Mendes Gans (BMG), covering many fully owned subsidiaries globally, in which there is a parent company guarantee and right of set-off clause. The rumor from some banks is that Basel III will make this type of liquidity management product unsustainable in the near future, as capital requirements under Basel III make it too expensive to operate such notional pooling structures, according to Deutsche Bank.
Outlook
Establishing a regional liquidity management structure requires strong collaboration among one’s legal, tax and accounting teams. Country regulations with regard to inter-company lending and set-off rights are also important considerations. Many banks today have comprehensive liquidity management products with decent reporting capabilities, and are willing to provide the advisory service to tackle one’s internal battles with colleagues from legal, tax and accounting departments. Whatever the case, one’s tax department should not be privileged to unilaterally veto decisions, otherwise “perhaps it is time to change your internal tax person!”
ASEAN Hedging Opportunities
ASEAN is a region with several restricted currencies, and thus FX hedging opportunities exist in both the onshore and offshore markets. Deviation between the onshore and offshore market arises from counterparty credit risk and microeconomic demand-supply dynamics in the segregated market place. Therefore arbitrage opportunity through currency basis risk exists from time to time. Bryan Morales, Director, Corporate Treasury Sales for Global MNCs from Deutsche Bank, introduced the concept of hedging a basket of countries, rather than individual country exposure. An ASEAN basket of derivatives, for example non-deliverable forward (NDF) option with USD strike, can be customized to cover one’s combined exposure in Singapore, Indonesia, the Philippines, Malaysia and Thailand. This idea was met with a lukewarm response from members, as the risk and booking location of such a derivative instrument was a concern. In cases of extreme foreign exchange volatility, the fixing basis cannot be determined. Plus, the market participation for such derivatives is heavily skewed, with banks being all sellers and corporates being all buyers, which can be unnerving.
Economic Update: Deutsche Bank Foresees Tough End to 2015
Deutsche Bank’s Asia Chief Economist Taimur Baig gave an eloquent overview of broad economic trends, and voiced concerns about a tough 2015. Winners will be self-sustaining economies like Indonesia and India, while export-driven economies will be negatively impacted, for example, Singapore, Taiwan, and Korea. During this economic cycle China has had a greater impact on Asia, given the more significant intra-region trade flows. It is important to also note that as China opens up more, it can, by its sheer size and scale of market, revolutionize some industries, so it is, indeed, a force to be reckoned with.
Key Takeaways
1) The Bank’s view. Interest rates will rise in 2015, but it’s unlikely to be in June, and more likely in the September-December timeframe. Zero interest rates are unhealthy for the economy, because they allow distortions to exist, e.g. excessive asset inflation, and bad companies stay in business longer because of access to cheap financing. With 2 percent inflation, interest rates should not stay at zero interest rates.
2) Greece causing trouble for Europe. Markets have no patience for the Greek crisis. Mr. Baig gave some possible scenarios:
- Greek government will fail.
- Russia comes to give some small lifeline to Greece – just a public announcement of such verbal assurance, without any real tangible monetary transaction.
- Credit derivative default in the eurozone — the “unknown of the unknown,” and this may have an impact similar to the Lehman collapse in 2008. One year of Greece being shut off from capital markets is more damaging than the same happening in, say, Argentina, which has resources it could sell off to recover.
- The ECB has to step in to manage this risk. Watch out for sharp depreciation of the euro, negative yields in Europe, and refinancing at zero interest rates.
3) Moving the focus to Asia. China is preoccupied with trying to manage its property market blow-up, weaker economic growth and lower corporate profitability across the board. Yet the government continues to speed up its structural reform agenda, which includes interest-rate liberalization reform. We can expect deposit-rate liberalization in China in the near future.
The Chinese bond market is deep and accessible, and foreign investors are now allowed as market participants. Its government is trying to execute a smooth bond swap for the mountain of debt that exists in their economy, i.e., exchange some of the corporate bonds for government guaranteed instruments.
A question on people’s minds is: “Why isn’t the RMB part of the Special Drawing Rights (SDR) at the IMF?” China is trying to establish its own infrastructure bank to compete with the World Bank. The Chinese government is creating a safety net using the debt-swap program to ease through its structural reform agenda.
Weaker growth rates in China plus the Chinese government’s intent to speed up structural reform implies a tone of caution for the Asia region. Given the scenario of US growth increasing, Europe not declining as much, and China slowing, the rest of Asia should brace for negative consequences from these economic drivers, especially for export-driven economies like Singapore, South Korea, Taiwan and Thailand. There will be zero pricing power in manufacturing. Poor exports and risks coming from China will further increase concerns for these countries.
4) Current protectionism. The US is quite protectionist against international trade, and the Fed is very inward-focused for now. Thus they will pursue their policy objectives to raise interest rates, even though every other country seems set on cutting interest rates.
China is also practicing protectionism in its own way by insisting that some products can only be purchased from local vendors. Mr. Baig observed that this behavior can be expected in the energy industry as well. However, he reckons that China would continue to open up the banking industry because it wants foreign capital, and liberalize the healthcare industry to cope with the country’s healthcare needs, which currently far outstrip the government’s resources.
Outlook
With a house of debt in Asia, and huge event risks in Europe, it is indeed a year of caution for 2015. Europe seems set to be in quantitative easing (QE) for infinity. Spill-over effects from China are unavoidable for Asia.
CONCLUSION & NEXT STEPS
Several members of the ATPG are, or have recently been, embroiled in major corporate initiatives such as splitting the company, integrating acquisitions, or both. Others are simply dealing with the ongoing regulatory volatility or simply preparing for a regional slowdown. This ongoing intensity in the region makes the knowledge exchange in a peer group meeting all the more valuable as members offer insight and re-assurance to one another.