Published: October 12, 2011
Liquidity became the watchword of treasurers following the global financial crisis. As liquidity became more constrained yet critical to business survival, the role of treasurers who take responsibility for liquidity management became more prominent. Similarly, while yield was for many, the top priority in their investment strategies, counterparty risk became a key issue as companies increasingly recognised that no counterparty is ’too big to fail’ and traditional means of measuring were proved to be inadequate.
Consequently, while objectives have not necessarily changed but merely increased in importance for the respective company since the crisis, treasury has taken on a more prominent role, and their status in the company increasingly recognised. This article looks at some of the factors that are influencing the breadth and complexity of treasury, and some of the ways in which treasurers are navigating through what is often unchartered territory.
In addition to the elevated role of treasury within many companies, macroeconomic changes continue to have a major impact on its activities. Increasing globalisation, for example, means that few companies, including small and medium enterprises, can afford to maintain a purely domestic focus, both for sourcing or consumer markets. This increases the complexity of treasury’s role, as liquidity, currency, counterparty and geopolitical risk become increasingly complex.
Some economists suggest that Korea is set to join what is rapidly becoming a small club of AAA credit rating countries within the next decade.
With China now the world’s largest exporter and the second largest importer, no company can ignore the opportunity that the country presents for accessing suppliers or customers. With increasing liberalisation of the reminbi (RMB) (see Simon Jones’ article in this Guide), the RMB will soon become a major trading currency. While this process is being closely controlled by the authorities in China, the direction of change is clear and decisive. Treasurers therefore need to consider the implications of a new trading currency on their imports and exports, and work with procurement and sales to design an appropriate and integrated sourcing, sales and financial management strategy. Companies that take early opportunity of RMB liberalisation have the opportunity to create competitive advantage by aligning RMB assets and liabilities and enhancing their ability to do business in China.
Likewise, foreign companies looking at opportunities in Brazil will find plenty of challenges along the way. Heavy regulation, complex tax rules, infrastructure issues and currency controls can create considerable barriers. Despite the challenges, the opportunities and growth potential of the region cannot be overlooked. The current regulatory requirements surrounding trade finance which are often seen as one of the main barriers could soon be relaxed and coupled with the efforts on the part of the Brazilian Government to allow the Brazilian real to become freely convertible, the appetite to further increase business with Latin America is set to grow. Again, without a synchronised strategy between procurement, sales and treasury, the full potential of the various opportunites the region might offer might not be realised.
The other half of the BRICs, Russia and India, are also seeing an incredible amount of focus and investment. In addition, despite being a developed country, South Korea has been growing at a speed comparable to Brazil. Some economists suggest that Korea is set to join what is rapidly becoming a small club of AAA credit rating countries within the next decade.
As procurement and sales in many multi national corporations will look to take advantage of these ’emerging’ opportunities, will the treasurer be equally optimistic while facing the challenges of managing an extensive cash portfolio that will require deeper risk mitigation against foreign exchange, trapped cash and a robust investment policy? [[[PAGE]]]
Globalisation and the continuing importance of the emerging markets has other implications too. As companies’ value chains extend on both the buy and sell sides, treasurers and their colleagues in procurement and sales need to ensure that the total value chain, both physical and financial, remains robust, which often involves financing solutions such as supplier or distributor financing. These financing programmes require an international banking provider with the necessary geographic reach, local expertise and breadth and solutions to reach suppliers and distributors globally.
Gaining access to the right financing and risk management solutions at a global level requires a banking partner with a broad range of products.
Globalisation also results in a multitude of pressures on a company’s major trading currency, increasing currency volatility and exacerbating the need both to establish a strategic sourcing and sales policy, and to determine a suitable approach to currency hedging. While there will often be some natural hedging, treasurers need to be confident about complete access to information to ensure that these are robust, and there are likely to be some currency exposures for which no natural hedge exists.
These ongoing developments have illustrated the importance of integrating trade and cash from a risk management, liquidity, strategic sourcing and sales perspective. Consequently, multi national corporations are increasingly seeking to establish single platforms, standardised interfaces and improved communication across the relevant departments to streamline cash and trade and ensure greater cohesion. Under the proposed terms of Basel III, trade transactions will have a 100% risk weighting, which will make trade instruments such as letters of credit unattractive to banks. Fortunately, discussions are continuing with the Basel committee on potential changes to Basel III to reflect the short-term liquidating nature of trade. Treasurers, though, do need to prepare for the fact that appropriate risk and funding measures are in place to support current and future import and export requirements.
Another important factor in ensuring that cash and trade are closely co-ordinated, and that the physical supply chains are aligned from end to end, is ensuring that performance metrics are appropriate. Currently, there are a wide range of metrics or KPIs (key performance indicators) used in treasury, covering aspects such as cash and cash flow, interest income and expense, funding cost and maturity profiles. However, some of these KPIs could be developed further. For example, while cash flow forecasting is not an objective in itself, an accurate, timely cash flow forecast is an essential tool for liquidity and risk management. In many cases, there is still considerable progress that needs to be made in this area.
Traditional working capital metrics, such as days sales outstanding (DSO), days inventory outstanding (DIO) and days payable outstanding (DPO) cannot be considered in isolation, but all three have an impact on working capital and the cash flow conversion cycle, and need to be combined to create an overall view of the financial health of the business. With greater awareness of counterparty risk too, this may also be an area on which treasury performance is measured. While there is no standard set of metrics that can, or should be applied to treasury, it is important that these reflect the overall needs of the business, and are aligned with the objectives of other departments to avoid conflicting goals.
Technology also plays an important role in creating internal alignment, and enabling treasurers to achieve their liquidity and risk management objectives. For example, eBAM (electronic bank account management) is an initiative that automates processes that are prone to error, audit difficulties and operational and fraudulent risk. Technology provided by banks, treasury management system suppliers and ERP vendors is also facilitating shared service centres, and regional or global treasury centres to support centralised, consistent financial processes, visibility of information and decision-making. The costs of implementing SWIFT have decreased significantly over the past few years and as a result, it is now back on the agenda in treasury operation discussions. Effective integration of systems, processes and data is key to the success of this, leading to a greater focus on standardisation of formats and aligned payment methods, as we see in SEPA for example.
Gaining access to the right financing and risk management solutions at a global level requires a banking partner with a broad range of products. To leverage these products successfully requires a bank that can also advise on macro and industry trends, and recommend solutions based on an analysis of a company’s needs, constraints and aspirations, and expertise from working across the wider industry. This is the approach we take at J.P. Morgan, and we have invested heavily in acquiring and developing the right skills and expertise, as well as creating an innovative and comprehensive portfolio of solutions.
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