By Ted Howard
Much as global markets want to forget about Europe, it will continue to drive markets in 2012. Add to this continued regulation pressures and more searching for returns.
Like most years of the financial crisis, the new year continues to be challenged by issues of the preceding one. In fact the 2011 to 2012 transition is, sadly, almost exactly like that of the 2010 to 2011 transition: sovereign debt worries, regulations and the US economy.
But for 2012, we get a slight variation. That’s because with the US economy now seemingly on the mend, it’s now down to the euro’s survival along with regulation (and its impact on banking). And as per usual, lingering in the background since the beginning of the crisis is the now perennial challenge of where to put company cash.
And if those main drivers aren’t enough, there are also the issues of the banking business in general (see related story: “Keeping Tabs on Investment Banking”) and new tax policies (see related story: “Complying wirth FBAR and FATCA”).
Oh! Europa
During the final months of 2011, world financial markets were daily roiled by events in Europe. And by the end of the year, there almost was collective panic attack among corporates and others that some sort of breakup of the eurozone or at least one country exiting—namely Greece—was not only possible but all but certain. Suddenly treasurers and other risk managers wanted to know what would happen to things like financial and business contracts, legal jurisdictions, supply chains and bank accounts if the euro suddenly disappeared or the drachma suddenly reappeared.
Although the scary coverage has died down, in 2012 Europe finds itself in exactly the same position as late 2011; that is, in an uncertain state with the possibility of a breakup or that a country exits, still high.
Already in January the euro is slipping, Italian bond yields are skulking around 7 percent (and Fitch Ratings thinks Italy is the biggest threat to the eurozone); S&P is in downgrade mode, recently cutting France a notch with other eurozone countries also in its sights; Germany is auctioning bonds with negative yields and even Hungary threatens to roil financial markets. Of course Greece is the main antagonist, where the economy continues to deteriorate, so much so that it could eventually sink the 130bn euro ($165.2 billion) bailout that European leaders agreed to in October.
So for 2012? MNC Treasurers concerned with their liquidity and currency exposures to Europe should continue the risk-mitigating strategies begun in late 2011 (see related story here). These include a detailed risk assessment and an exploration of other ideas as to how to best mitigate eurozone risk. As gleaned from several conference calls with NeuGroup peer group members at the end of 2011, these strategies include:
- Reviewing redenomination risks of existing contracts, including currency repayment.
- Reviewing legal language of all financial contracts to see if local or international law presides.
- Revising contract language, where possible, to address revaluations and include transition language in all new documentation.
- Reviewing with CFO your commercial relationships and considering possible alternative supply sources and/or changing your invoice currency.
- Using natural hedges where possible; while this does not eliminate devaluation risk, it can reduce it and there would be fewer financial contracts to deal with.
- Limiting durations of financial contracts so no significant positions exist.
- Reviewing counterparty risk, monitoring CDS spreads; diversifying partners.
- Repatriating in-country cash balances to less volatile regions.
- Checking treasury/accounting systems for ability to handle valuation changes, dual currencies and the reporting.
Given that this is all new territory— both from a legal, contractual and market perspective—the challenges are not easy. The company’s relationship banks can be advisors in this regard, as no doubt they also are preparing for the prospect of a breakup.
Despite all the consternation and wondering whether Europe will or won’t collapse, most observers feel a breakup or even an exit is unlikely. Currently eurozone leaders are hammering out a new treaty to tighten up the financials of the European Union. They feel they are making progress but given the seeming lack of urgency, it’s best for treasurers to forge ahead with their contingency plans.
Regulatory Burdens
While Europe probably takes the prize as 2011’s Theme of the Year award, another theme could be Dodd-Frank Delay. According to law firm Davis Polk, by the end of 2011, 200 deadlines had come and gone and regulators have only been able to meet 51 of them.
Concerning the derivatives portion of Dodd-Frank, the CFTC, the SEC and other regulators have missed 67 deadlines and finalized only 26 rules in 2011, according to Davis Polk (see chart below).
Meeting deadlines for central clearing also looks doubtful. A 2009 G-20 mandate was for all standardized OTC derivative contracts to be traded on exchanges or e-trading platforms as well as cleared through central counterparties “by end-2012 at the latest.” Observers like ISDA have hinted that this might not happen.
Regulators’ progress hasn’t been helped by politics. For instance, the CFTC’s has severe budget woes. Earlier in 2011, the White House requested $308mn for the CFTC in its fiscal 2012 budget—a big increase from its previous $202mn budget. But Congress effectively froze the agency’s budget in December, giving it just $205mn. However, in a deal struck in mid-December, the CFTC reportedly will get an additional $10mn for staffing.
So what’s in store for 2012? Dodd-Frank and Basel III, the two 800 pound gorillas of the regulatory world, will continue to hold sway.
In the US, there will definitely be some rule finalizations from US regulators, but the slow pace is expected to continue. “We expect to see several key final rules in the first quarter, including the all-important entity definitions and the end-user exemption from mandatory central clearing,” said Sam Peterson, Senior Advisor, Derivatives Regulatory Advisory Services at Chatham Financial. “We’re still waiting on the final rule for margin requirements for non-cleared derivatives, although it’s now expected that this won’t be released until after the G-20 has come to agreement on standards” for them. The G-20 meets in Mexico in June.
Mr. Peterson said that treasurers should keep an eye on the US Treasury Department, which has yet to finalize its proposed determination exempting FX forwards and FX swaps from most of the regulatory requirements. Another important issue, he said, concerns the treatment of inter-affiliate or intra-group transactions and what regulatory requirements will apply. “The timing for this is not clear,” he said.
The CFTC also proposed phasing in the implementation and the enforcement of four regulatory requirements—central clearing, trading, and documentation of and margining requirements for non-cleared trades. Based upon the type of entities entering into the derivative transactions, these requirements will likely be phased in over the course of the first half of 2012.
Basel III is the other big ape. Its liquidity and capital requirements will start to really sting banks in 2012. That’s because although the rules don’t start to kick in until 2015, banks dealing with the crisis have been encouraged to begin complying now—if they hadn’t already in 2011. One bit of good news is that the Bank for International Settlements, the entity writing the Basel rules, recently said banks will be able to dip into the liquidity buffers during times of stress.
For treasurers, the new buffer requirements will surely raise the cost of doing business as banks pass on the cost to their corporate clients. That’s because all of the necessary reengineering of bank balance sheets will likely create credit scarcity; thus corporates can expect to pay more for bank credit. This will eventually force treasurers toward disintermediation and down more attractive funding paths. These will include tapping capital markets and squeezing all they can out of working capital enhancement projects.
This is already happening in Europe where banks are weakest. There, companies are bypassing banks altogether, according to the Financial Times, and raising cash via the bond market.
Cash and investing
For several years now corporate cash and investment managers have been straining to find suitable places to put company cash. In 2011 corporates started to break out of their risk-averse stances and in 2012, this will continue.
“I think much of the ‘put the money under the mattress’ strategy has abated,” said Chris Growney, director of sales and marketing at Clearwater Analytics. He said this was basically because companies cannot sit on low return accounts forever and interest-rate levels are likely to remain low for some time.
As a result, Mr. Growney said many companies are outsourcing money in separate accounts and taking risks on the margin but not at the core. This is particularly true of companies that are cash-flow positive. For them it is important “that the investments are diversified because current assets plus the forecast free cash flow ensure a lot of money will be tied up in extremely low-yielding investments.”
In general Mr. Growney said, companies are exiting mutual funds and going into separate accounts, which can have a range of product types, but are generally the traditional corporate cash investments such as short-term government, corporate and some asset-backed products. “Rotation to separate accounts is both a focus on better control and visibility, and on transparency of the investments,” he said.
At several NeuGroup peer group meetings in late 2011, treasurers were told they might improve returns by using non-MMF mutual funds and exchange traded funds. Nonetheless, the focus will remain on not losing money.
“People hate getting zero returns, but it’s still better than negative returns,” said a treasurer at US MNC. Despite this view, his company was exploring new assets, including euro commercial paper—”A1, P1 and F1 only.” This provides liquidity “and a few basis points,” he said. “And every basis point is precious in this (low) rate environment.” The treasurer was also looking into “seasoned bonds,” for instance, a 10-year note with 18 months to maturity.
These explorations will continue, with the overall goal, as the above treasurer noted, “to be able to get your money back from wherever it’s been put.”
So just like last year, 2012 will be a challenge to treasurers, as they continue to navigate the choppy waters churned up by the chaos of the financial crisis. Regulation and finding yield will occupy much of their time while a teetering
Europe will a remain a looming presence in the background.