Published: May 01, 2010
The Greek government’s inability to repay part of its EUR300bn in May has resulted in a European crisis as the EU and IMF were compelled to construct a bailout package of EUR110bn over three years, the largest financial rescue package in history. The effects are likely to be both long-lasting and to extend far beyond Greece. Not only has Greece been forced to implement harsh austerity measures, seen a cut in credit rating and a sharp decline in investor confidence, but the country’s funding difficulties are proving contagious across other countries with similar funding deficits such as Italy, Spain, Portugal and Ireland. While it may be tempting to believe that companies without significant activities in these countries will be largely immune to the crisis, this is not the case. The degree of exposure to the so-called ‘PIIGS’ countries (Portugal, Ireland, Italy, Greece, Spain) amongst foreign banks, and the impact that the crisis has had on euro volatility, means that all companies need to review their risk, irrespective of whether they have direct activities in these countries.
The emergence of sovereign risk
The 2008-9 crisis emphasised the importance of counterparty risk, and according to a PricewaterhouseCoopers study published in May 2010, 80% of treasurers are now actively engaged in managing counterparty risk, compared with fewer than 40% before the crisis. However, the current European crisis also illustrates the significance of sovereign risk. This is generally an indirect risk; after all, with some exceptions, most corporations do not have long-term exposures to foreign government debt. However, the downgrading of Greece’s credit rating to ‘junk’ status, an affliction that could also hit other vulnerable countries, will have an impact on the credit rating of counterparty banks domiciled in the relevant country. Furthermore, a number of banks have been reported as having significant exposure to PIIGS economies. While it is difficult for treasurers to determine which banks are most affected, it is important to review the company’s panel of banks to ensure that it is sufficiently diversified.
Money market fund exposure
Another way in which corporates may be exposed to sovereign risk is through their money market funds (MMFs). During the global financial crisis, many treasurers sought investment security by investing in government MMFs, i.e., funds that invested primarily or exclusively in government debt. As the immediate crisis eased, investors started to move away from government MMFs and returned to prime or ‘credit’ MMFs, reflected in a fall of over 25% in the use of government funds over the past year, but there is still over EUR15bn invested in euro-denominated government MMFs, and a number of MMFs will include some government debt. It is therefore important for all investors in MMFs to review the investment portfolio of their funds to ensure that the company is not exposed to any unwanted sovereign risk. While MMFs only invest in short-dated debt and longer-term debt within 90 days of maturity, it should be remembered that the crisis in Greece was triggered by the government’s potential inability to repay its debt in May 2010 which could have affected both long- and short-term debt. Treasurers need to establish a clear policy with the board that outlines the company’s risk/reward approach. For example, while some banks will be offering more competitive returns, this should be balanced with a realistic view of risk to ensure that exposure is managed before, not after, market crises hit the headlines.[[[PAGE]]]
The volatility of the euro and potential instability of PIIGS economies means that many companies are seeking to reduce their exposure in these countries and to the euro more generally. Looking first at foreign firms with significant cash flows in southern European countries, there may be pressure internally to ensure that cash is repatriated quickly in case it becomes difficult to move funds out, as happened during the Argentinian financial crisis. Consequently, liquidity structures such as cash pooling that enable treasurers to manually or automatically sweep cash balances to a central account become more important. Companies with their concentration accounts in a country with higher sovereign risk may also seek to relocate these accounts. Under SEPA, this is now significantly easier to achieve as companies have the ability to locate their euro accounts in any Eurozone country.
Companies with their concentration accounts in a country with higher sovereign risk may seek to relocate these accounts.
In addition to minimising cash held in vulnerable countries, companies with a non-euro base currency are concerned about currency volatility and are seeking to reduce the level of funds held in euro. This requires an effective liquidity management strategy both to forecast payables and receivables accurately and to align the currency of these cash flows as far as possible to reduce the amount of surplus funds in euros. To do this, treasurers need to take an active role in financial supply chain management, a trend that started pre-crisis but for which the business case has become more compelling as companies seek to maximise operational and cash management efficiency. In addition, treasurers should be focused on centralising and converting surplus funds into their base currency using techniques such as cross-border sweeping and cross-currency pooling.
The first step in managing liquidity and risk management in the light of the crisis is to achieve visibility over cash across the region. Although this may appear straightforward in theory, the reality is often quite different. According to participants in Citi’s peer benchmarking initiative Treasury Diagnostics, over one-third of respondents stated they have visibility of only up to 75% of cash balances, i.e., they lack accurate, timely access to information on 25% or more of their cash balances (fig 1). During a period of high volatility and constrained liquidity, this lack of visibility of a material portion of cash, which is often located in higher risk countries, could have a serious impact on borrowing levels, cash management strategies and the amount of cash available for investment. Furthermore, it becomes very difficult to assess and manage risk accurately if the company’s cash position and exposures are unclear. Although visibility over short-term investments is generally higher, with one-fifth of treasurers reporting that they lacked visibility of over 25% of investments, according to our analysis, treasurers can realistically be seeking best-in-class performance of more than 95% visibility of both cash balances and short-term investments.
These statistics illustrate that there is still some way to go amongst multinational corporations to achieve the degree of control over cash that is required to implement an effective liquidity and risk management strategy. While the situation within each company is different, there are a variety of reasons why treasurers still struggle to achieve visibility over cash in all locations, currencies, entities and bank accounts. For example, fragmented cash management banking relationships and balances, lack of treasury control and oversight over business unit accounts, and multiple electronic banking systems that are not managed centrally and may be difficult to integrate with internal systems all impede efforts to view and access cash. One of the key ways of addressing these challenges is to centralise treasury activities in some form, such as migrating treasury and cash management operations from business units to global or regional treasury centres, implementing cash pooling, and/or establishing central oversight of local accounts. Bank relationships should ideally be rationalised to create a diversified but selective panel of banking partners, and connectivity to these banks established either through a multi-banking arrangement using innovative technology provided by a bank such as Citi, or through a channel such as SWIFT.
These techniques will be familiar to most treasurers – and indeed, the majority of multinational corporations will have implemented them to some degree. However, the global financial crisis and the current turmoil in Europe have demonstrated strongly the need to refine liquidity management techniques, enhance centralisation and ensure that technology is in place to achieve visibility and control over the final, critical portion of the company’s cash. By doing so, treasurers will be in a better position to flex their operations to changing market conditions and protect the company’s cash flow and risk position against excess volatility and the impact of unforeseen events.
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