Published: June 01, 2010
In this interview, the fourth in the series, we continue our exploration of AkzoNobel’s treasury transformation project, spearheaded by Group Treasurer Peter van Rood. In this edition, we build on some of the financing experiences that Peter shared during the second interview, including AkzoNobel’s approach to both internal and external financing, featuring Peter together with Brune Singh and Harry Blok, Director of External Markets and Director of Corporate Finance respectively.
How was your financing organised when you embarked on your treasury transformation project in 2007?
AkzoNobel manages three types of financing: intragroup loans (debt/equity), bank lines and capital funding. In 2007, the various funding components of the business were far less integrated than they are today. External funding had been remote from treasury, resulting in a process disconnect, and reflecting too the fact that that treasury’s role was predominantly operational at that stage. Since then, we have aimed to make our financing strategy and execution more coherent. From the point of view of internal financing, we were focused primarily on the execution of loan documentation, with a predominantly reactive approach to intra-group funding.
As we discussed in the first interview in this series, one of the key elements of our treasury transformation was to expand the strategic focus of treasury as well as to optimise its operational efficiency. Therefore, as part of our treasury vision, we established a funding objective to secure sufficient financing for the business at the lowest possible cost. One element of this was to position our capital structure to support our strategic activities.
As part of our treasury vision, we established a funding objective to secure sufficient financing for the business at the lowest possible cost.
Our capital funding objective is quite simple: ‘to ensure adequate financing of the businesses and their legal entities against lowest possible cost for the group’. Two years ago, market access was a far more significant issue than it is today, not only for long-term financing but our financial flexibility was also limited by constraints in the commercial paper market. During that period our focus was on refinancing our maturing debt, at the peak of the market crisis; today, the emphasis has shifted to protecting our capital structure in a heightened risk environment whilst enhancing our funding efficiency - a relative shift within the execution of our objective from securing funds to efficiency of funding. Following the crisis, we were expecting strong market volatility to continue for some time. To mitigate this, we have increasingly sought more creative ways of sourcing finance to alleviate concerns about constrained market access in the future. As it turned out, we have seen the market environment recover more quickly than we expected. This in turn triggered us to become proactive in refinancing our debt, looking for favourable opportunities before maturity. It included us seeking other windows for accessing capital beyond our traditional EUR investor base, so we are now considering public markets in the United States, and reviewing alternative capital markets such as private placements. [[[PAGE]]]
As part of our ongoing conservative approach to the financial markets, we are proactive in looking at our leverage levels and structure to ensure that it is fit for the economic environment we face. Therefore, we model various risk scenarios and seek to understand clearly our capacity for absorbing bad news, the results of which we feed into our risk management agenda.
A primary objective today is to be able to maintain an investment grade credit rating throughout the peaks and troughs of the market cycle. This influences how we make decisions on capital structure and how we balance the need for reducing the cost of debt with maintaining financial flexibility. It manifests itself in the relative reliance on short- over long- term borrowing. The latter comes at a cost, particularly when the markets are disjointed. This year, we have been focused on deploying surplus liquidity to help increase the efficiency of our debt structures and improve the condition of our balance sheet, whilst ensuring that we continue with our conservative approach to investment.
The crisis and its aftermath have emphasised that access to the markets is not constant, and companies need to plan for changing market dynamics. This is essentially a ‘point in time’ risk where many variables are changing at the same time. Over the past 18 months or so we have seen the value of maintaining a conservative approach throughout the crisis and maintained a strong rating. In contrast, in 2005-6, the value of a company’s investment grade credit rating was less clear; today, we are reaping the benefits of our approach. AkzoNobel was a strong A-credit, one of the strongest in the industry, but since the crisis, this has fallen to BBB+ as a result of a reduction in the generation of operating cash. While our volume of sales has fallen, this is sustainable over the longer term, but we have given considerable thought to our leverage relative to our capital.
It is undoubtedly expensive to maintain a higher rating, and the decision to establish a capital structure to maintain this rating needs to be taken only where it supports corporate strategy. For AkzoNobel, we believe it is an important expression of our financial conservatism to maintain a BBB/A- rating. To do this, we remain close to the rating agencies to understand how they view both sector developments and specific AkzoNobel issues. Where we have an alternative point of view we engage with them and are therefore positioned to respond to potential changes in rating they are contemplating to some degree pro-actively.
Our banking group remains an important source of long-term financing, but the dynamics have shifted. Before the crisis, bank debt was relatively cheap and readily available. As the risk environment has evolved, with the prospect of further regulatory changes, we need to plan for potential future reductions in market access and increases in the cost of bank financing. Furthermore, both through our own focus on optimising our banking group as well as through the focus developed by banks, more emphasis is to be placed on establishing a transparent wallet-sizing methodology. The potential fees that banks can extract from ancillary business, such as transaction banking, need to be factored into future treasury and bank relationship strategies. As a result of this, the proportion of bank debt compared with other forms of financing is likely to change. Going forward we will need to be creative in how we source, deploy and re-deploy capital such that we maintain optimal financial flexibility.
In this environment, our aim is to maintain a strong, stable banking group that allows us long-term access to credit. Through the allocation of new mandates our banking group will see a natural development towards a new equilibrium. This is in itself as it should be. The fit with AkzoNobel that existed in the past cannot be assumed to continue without constant calibration and adjustments. Such an approach allows us to refinance the rollover of a revolving credit facility in a variety of ways. One way is refinancing a maturing credit facility early, another is to secure adequate interest well beyond maturity due date. The latter can create competitive tension, especially if combined with an overall reduction in the required facility. [[[PAGE]]]
Although AkzoNobel has a centralised approach to treasury management, we work in around 84 countries and often with multiple legal entities. We need to make sure that each of these is adequately financed. As our Cash Wheel illustrates (figure 1) our aim is to attract capital centrally and flow it through the business according to each company’s needs so that we can manage capital access on a consolidated basis, rather than by diluting through multiple market access points.
The corporate finance activities require a multidisci-plinary approach, with participation of legal, tax, control and treasury.
The corporate finance activities require a multidisciplinary approach, with participation of legal, tax, control and treasury. Our aim is to optimise our business unit funding by ensuring that this is conducted efficiently and effectively. To do this well, we need information on country-specific treasury and fiscal regulations as these can impact cross-border sweeping or the repatriation of funds through loan and deposit activities. There are various ways of addressing this, such as reviewing the situation in each country on an individual basis and assessing how a central strategy, such as establishing intra-group loans from our Netherlands entity, could be executed. In AkzoNobel we have been building a central financing database that captures corporate finance critical information. This has allowed us to be responsive to economic and business changes whilst respecting the local conventions within each country. Around 30% of the countries in which we operate are either closed or partially closed to traditional forms of intercompany financing, including China, Brazil and India. This high percentage underscores the importance of having a consistent insight into these local regulations.
The pricing of intragroup loans is another important subject. While in the past the tax authorities did not always pay a great deal of attention to this, concentrating predominantly on the flow of goods and services as opposed to financial transactions, there is a renewed focus on this transfer pricing area. Hence we need to ensure that intragroup loans are priced on an arm’s length basis to make sure that local interest is tax-deductible.
Historically AkzoNobel sourced capital predominantly from western markets since these are typically the deepest and most liquid. The credit crisis and the turbulent growth in emerging markets over the last few years have challenged this model. These market dynamics create new opportunities that AkzoNobel may want to tap into. For example, one objective is to ensure that interest costs are tax-deductible. The rules for this differ across countries and there may be opportunities to seek financing locally on attractive financing conditions. Another reason to borrow locally is that it allows for a reduction of the net investment exposure AkzoNobel faces. These benefits have to be weighted against the often still higher interest rates that are being charged locally. Capturing this information at a central level, in a corporate finance database is valuable. It helps to identify and realise opportunities by enabling us to monitor the variables that affect our planning on a consistent basis.
To be given the mandate to fund a company of the size and global presence of AkzoNobel is a privilege. These are exciting times with many changes, both in financial markets as in regulatory conditions. To look for the optimal way of structuring this funding is therefore exciting for any true treasury or corporate finance professional!
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