Treasury managers have a full plate as cash restrictions continue in place, banks leave and political risk rises in this overly regulated region.
The Latin American Treasury Managers’ Peer Group’s 2016 H1 meeting in April explored how to deal with current market challenges while advancing treasury’s strategic objectives. To deal with government restrictions on cash movement and managing foreign exchange risk that comes with doing business in LatAm, treasurers are focusing on the following:
1) Argentina — Where to Now? Despite current optimism, the adjustment is not over, so companies will need to continue adapting their processes.
2) Mitigating Liquidity Risk. Routine strategies may be working, but success will require managing complexity.
3) Improving Engagement with Business Partners in the Region. Treasurers need to open lines of communication and participation to establish meaningful relationships with business units.
Argentina — Where to Now?
Between December and April, when members met, the new Argentine government had already taken significant economic actions, including lifting currency controls and allowing the currency to lose value. Members discussed how these changes in the currency market were being carried out and affecting their treasury operations.
Key Takeaways
1) Moving cash in and out of Argentina has become easier. The Central Bank of Argentina no longer requests approvals for imports before authorizing a foreign exchange transaction. Therefore, the level of detail that corporates have to submit to get approval is significantly less now. This new environment allows corporates to manage their cash smarter and reduce FX risk, by pooling cash out, funding as needed and leveraging USD-denominated bank accounts when needed. The transactions are cleaner, in many cases eliminating local intercompany lending. Still, it is important to manage FX quotas actively to avoid accumulating cash balances in the country.
LATAM ECONOMIC OUTLOOK
According to Deutsche Bank, most Latin American economies are expected to continueto contract due to low commodity prices and tightened monetary policies tocontain inflation. The bank expects most economies to turn around in 2017, supportedby internal consumption and higher commodity prices, with the downsiderisk being a weak global demand, financial markets volatility and a rise in politicalconflicts in the region. Tough times ahead will affect the business activity in theregion and also keep treasury teams on their toes. The increased political risk willmost likely spill over into the currencies, increasing volatility. In addition, changes inregulations and possible additional taxes could affect the way cash is managed inthe region.
Here’s how LatAm treasury members are currently viewing the region:
| OPTIMISTIC | CAUTIOUS | CONCERNED |
| Argentina | Colombia | Brazil |
| There have been positivedevelopments in Argentina. Thecountry successfully reentered thecapital markets in April, which providedtools to support the furtheropening of the currency market. | Increased external debtdependence (public and private)and risk of a partial anddelayed fiscal adjustmentcould trigger more negativerating actions for Colombia. | The economy continues to contractas the government strugglesto stabilize fiscal policy and restoremarket confidence. The politicalsituation will be one of the keydrivers of the BRL performance,along with China, commodityprices and US interest rates. |
| Peru | Mexico | Venezuela |
| Rising mining production and greaterexport diversification keep Peru inthe lead for performance amongemerging markets. Whatever theoutcome of upcoming elections, thedivided congress will most likely preventany significant policy changesand keep the economic model onthe right track. | The MXN is expected to continueto be affected byswings in oil prices and globalrisk aversion, and Banxicois expected to continue touse interest rates to managethe exchange rate. | On the foreign exchange front, thecurrency has depreciated 34%since mid-March, when the newdual FX system was launched. Thenew FX system could alleviate thescarcity crisis if accompanied by acredible increase in dollar supplyby PDVSA and the BCV. |
2) Foreign exchange hedging is still expensive or not widely available. As the country continues to reduce controls in the foreign exchange market, there might be additional devaluation. In this environment, the companies have to manage their FX exposure actively. In the absence of a deep FX derivatives market, corporates have resorted to alternative strategies, including minimizing exposure or buying real estate — which is a USD-denominated asset in Argentina.
3) Overall, corporates are cautiously optimistic in Argentina. Their ability to repatriate cash has improved. However, the economy’s adjustment to the new normal affected business activity.
Outlook
Members agree that Argentina will remain at the top of LatAm treasury managers’ to-do list for some time. Since then, Argentina has successfully reentered the capital market, issuing bonds for $16.5B that raised enough funds to settle with holdout bondholders and build up international reserves. Following the influx of funds, the Central Bank lifted all quotas to buy USD to pay for imports. While the current outlook is optimistic, companies will need to continue adapting their processes to operate in the new normal.
Best Practices in Cash Forecasting
Member conversation on cash forecasting focused on the procedures, systems and resources available to support this process as well as the accuracy achieved with them.
Most members consider their cash-flow forecasting to be at least satisfactory. The weaker elements of their processes are automation and accuracy, both of which lag behind other regions. One member company uses mainly a direct methodology to forecast cash. The company forecasts cash in great detail, going as far as forecasting by day for the upcoming two quarters. Their process is greatly automated and relies on a system that can match forecast and actuals at the bank account level. The cash is mobilized and concentrated in a cash pool, using the forecast as a reference and just leaving the needed minimal working capital at the country level. Local teams provide forecasting data, and the company’s systems allow it to track variances and identify trends on how conservative/aggressive each team is in its forecasting. Although the individual teams are not responsible for accuracy, treasury relies on executive support to engage the teams and keep them committed to providing timely and accurate information.
The results were impressive, but that level of precision might not be optimal for all corporates. For most companies, there is a cost/benefit analysis that needs to be performed to find the right balance between resources devoted to this process and results based on the companies’ priorities and market conditions.
Mitigating Liquidity Risk
There are many ways in which treasury managers can stay on top of liquidity risk. Deutsche Bank discussed how a regional treasury center and supply-chain financing are two of the tools most widely used in the market place. Most peer group members (70%) manage their LatAm treasury operations using a regionally centralized approach, with treasury strategy determined and executed at a regional center with minimal or no participation of local finance teams. In line with this structure, 70% of members manage their cash at a regional treasury or shared-service center. Deutsche Bank’s cash and trade specialists said popular strategies for managing and mitigating risk are working, but there are some caveats.
Key Takeaways
1) Regional treasury centers with the strategy set at the corporate level. Most members follow this overall structure with variations that include having treasury personnel in certain countries or leveraging local finance resources. This kind of organizational structure is critical to mitigating liquidity risk because it allows the treasury team to stay on top of the regulatory realities of each country as well as market conditions. Also, it allows them to handle or stay in close communication with the employees or company subcontracted to manage paperwork and requirements at the local level. On the other hand, having a regional strategy mandated at the corporate level helps to leverage standardized process and systems, among other benefits.
2) Supply-chain finance as a tool to manage liquidity. Some members are already using supply-chain financing to provide liquidity to their suppliers. Deutsche Bank increasingly sees SCF as a trend in the marketplace. However, there are local customs or restrictions that reduce its effectiveness in certain countries and preclude corporates from participating, such as the prevalent use of checks in Chile, the use of postdated checks in Argentina or the unavailability of non-recourse in certain markets.
Outlook
The diversity and disparity of regulation in Latin America, as well as different market practices, adds another level of complexity to managing liquidity in the region. In the short term, there is little hope for structural changes that would simplify doing business in the region. Long term, it is critical that corporates and banks keep advocating for regulations that allow for better flows and controls.
How to Stay in Front of Capital Requests
One member company’s current approach to evaluating and executing capitalizations in the region has focused on moving away from being reactive to being proactive. The introduction of the Organization for Economic Cooperation and Development’s base erosion and profit shifting (BEPS) rules forced the company to rethink its processes for permanent inter-company funding. The resulting process considers tax and legal compliance, financial and accounting results and operational performance. Additionally, each regional credit committee reviews the funding needs of each entity. However, there are still funding needs that are being handled on a more reactive basis. The establishment of this process and the credit committees has been a step in a long-term strategy that includes setting up an in-house bank. The process relies on financial analysis, a credit rating model for each entity and a market-based debt pricing methodology.
For all treasury in a region as complicated as Latin America, the value of the treasury-legal-tax partnership — especially with the implementation of BEPS — is enormous. The more these groups work together to support the business and understand their mutual dependency, the more successful they will be in proactively looking at issues.
Improving Engagement with Business Partners in the Region
Tension between business units and treasury stems from their apparently separate missions: Business units focus on maximizing the operating income, while treasurers focus on aspects that move the needle below the OPINC line, like an efficient use of cash, the cost of capital and FX volatility impact. But both share the overall objective of maximizing shareholder value. Members exchanged practical advice on ways to increase trust and understanding between treasury and the business units, including the following:
Key Takeaways
1) Deliberately expand your network. Regional treasurers should make an effort to get ingrained in the regional network. Making yourself available to participate in the finance leadership executive team as an advisor will give you access to the right contacts on the business side and will allow you to stay on top of the business initiatives affecting treasury and offer prompt support. Also, key to expanding your network is to meet every country manager and finance and business leader in the region and make sure you are included in every relevant distribution list.
2) Help the business see your point of view. When appropriate, share with the business your list of top projects and priorities, including the impact that those might have on their operations, and explain how they bring value to the shareholder. The annual strategy meeting is a great forum to share your thoughts. You should also keep them updated on a regular basis — monthly or quarterly — on your progress and share, as appropriate, dashboards on key treasury metrics that might be relevant to them.
3) Set clear boundaries. Make sure there is a clear understanding of your partnership and what falls under your responsibility and theirs. For example, depending on your treasury organizational structure, you might not want any banks engaging with the local finance teams. If you make your case based on why this makes sense from an overall relationship management perspective and are responsive to their banking needs, there will be fewer chances that your local partners try to go around you.
Outlook
Open communication and engagement are key to showing the business units that treasury shares the overall objective of maximizing shareholder value. This is no small task, especially with limited resources and urgent matters requiring the attention of treasury managers, but it is critical to the long-term success of the company.
A Regional Perspective on TMS Implementations
Although treasury management systems may be taking a bit of a backseat to cash management and bank relationship management, it’s still high on the list of member projects and priorities, with some 36% of members currently at different stages of a treasury management system implementation. Here are some things they suggest treasury keep in mind for TMS projects:
- Build your requirements from the bottom-up. The more comprehensive the requirements, the higher chance of success for the project. Regional treasury teams are important to building bottom-up requirements.
- Connectivity is a project in itself. Con-necting multiple banks into a TMS for reporting is a significant effort, more so if the treasury system will manage disbursement.
- Implementing a TMS is a full-time job — not a side project. In an ideal word, the project should be entrusted to someone who can understand both treasury and IT (external advisors can help if you don’t have the internal capabilities). Since it will be hard to have a dedicated person at the regional level, the treasury lead will need to rely on regional treasurers.