by Helen Castell, Senior Reporter, TXF
As uncertainty over the future of US trade policy, regulation and taxation, and the UK’s Brexit negotiations inject volatility into foreign exchange (FX) markets, corporate treasurers are under more pressure than ever to make fast and accurate risk management decisions.
But according to findings from last month’s Citi Treasury Diagnostics report, while most corporate treasuries have mature risk management programmes in place, many are not nuanced or nimble enough in how they manage risk on the currencies that have most power to upset their earnings.
So, at a time when the expanding role of treasurers means they are already being pulled in various directions, which risks should top their priorities, how important is automation, and why is now the right moment to ask for additional tech spend?
Geopolitics
The damage that currency moves following the UK’s Brexit vote and Trump’s election inflicted on corporate earnings proved a wake-up call for many corporate treasurers. “Surprisingly, people didn’t hedge very well for Brexit,” says Mark O’Toole, vice president of commodities and treasury solutions at treasury and risk management software vendor OpenLink. “They just wanted to trust the polls and nobody was trying to come up with a strategy to the downside.”
Similarly, too few corporates were prepared for the roughly 15% slide in the Mexican peso against the dollar following Trump’s victory. Then, as corporates started rolling out their quarterly or full-year earnings, they blamed losses on currency moves that they didn’t hedge for, he notes. “Clearly, companies weren’t stress-testing, which is what we encourage all our clients to do,” adds O'Toole.
In the last 12 months, however, treasurers are becoming more strategic in that regard. Geopolitical risk has a major impact on markets - as exemplified by Brexit, Trump’s election and tensions between China and the US - and is a key focus in ABB Singapore’s corporate risk management, according to country treasurer Christopher Emslie. It also changes fast, so ABB Singapore assesses its risk management strategy each month to ensure it remains robust.
Taxation and regulatory risk
US border taxes or changes to the corporate tax code could have particular consequences for both domestic treasury teams as well as offshore corporate treasurers, says Erik Johnson, director of risk management solutions at Citi.
Corporates are now studying the possible consequences to existing balance sheets, to capital investments or potential capital investments, and to existing lending profiles.
They are also questioning how changes to natural offsets to the debt markets for foreign currency earnings – ie dollar debt against dollar earnings – could affect how they manage US dollar earnings streams back into, for example, the eurozone, he adds.
Taxation changes will be a key risk priority for treasury in 2017, according to Declan McGivern, EMEA head of the treasury advisory group, Treasury and Trade Solutions, at Citi.
The OECD’s base erosion and profit shifting (BEPS) proposals, likely to be in force by June, will change all double-taxation agreements that treasury rely on for the inter-company pricing of instruments like loans, deposits and foreign exchange. This comes on top of the EU Anti-Tax Avoidance Directive, adopted last June.
At the same time, individual countries have unilaterally introduced rules on transfer pricing and interest deductibility that will impact portfolios of loans, and the foreign exchange hedging on them. The possibility of tax cuts in the US could meanwhile create a long-term need for companies to collapse currently separated cash pools into a single pool.
Combine the above and some companies may need to change their entire underlying supply chain, including the location of the treasury centre and principal companies, how they distribute and ultimately where they pay tax, McGivern says.
“Given that inter-company lending changes on a daily basis, how do you create the capacity in treasury to ensure that on a local, regional and global basis you’re not suffering from any tax leakage or breaking any local legislation?” he asks.
Companies need to ensure therefore that they build enough “bandwidth” in treasury to be nimble as the tax landscape solidifies.
Growing uncertainty about US tax policy means lots of money is being kept on the sidelines rather than invested as capital expenditure, and this can present a risk to corporates throughout supply chains, says Alejandro Fernandez, finance manager at Bunge Latin America.
The possibility of US interest rate hikes is another subject of concern for Bunge. Higher US rates could trigger capital flight from markets to which Bunge sells its commodities and affect the competitiveness of markets it sources from. “That’s one of the things we need to continue to monitor very closely,” he says.
The scrapping or renegotiating of existing trade agreements such as NAFTA – and even the imposition of tariffs – creates further uncertainty that treasurers need to stress-test for, says O’Toole.
Corporates should monitor such developments closely, analyse how decisions could impact them and explore how they might be able to hedge the downside, he advises.
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Liquidity and credit risk
Liquidity is always a risk factor for corporates, and increasingly so at a time when large customers are not paying as quickly as they should, says ABB Singapore’s Emslie. “Cash is becoming more and more important.”
Commodity prices are often more volatile in the first 100 days of a presidency, notes Fernandez. And while Bunge itself fully hedges its exposure to prices, this can affect liquidity further down its supply chain and increase the credit risk it is exposed to.
In the months since Trump’s inauguration, Bunge has witnessed more demand from its customers for alternative forms of supplier credit – in bigger volumes and more tailored to cover buyers’ full cash conversion cycles, he says.
“We are trying to find solutions for our customers that combine what we can as suppliers provide to the customer and what our banking partners can also help us provide to the customers,” he says. “By combining these two solutions, we can give a value proposition to our buyers of the commodities that will help cover multiple purchases over a prolonged period.”
This gives customers confidence that they “won’t go through these turbulent times” of FX and commodity price volatility without at least having the confidence that they can obtain the commodities they need to keep their supply chain running smoothly.
Follow the risk management rules
To navigate all the above, treasurers need to develop a “rules-based approach to managing risk that is intimately related to the firm’s industrial as well as individual objectives,” says Johnson. “What is your risk, what is the cost, what is your risk profile?”
Once these questions are answered, they can decide which tools, products and benchmarks are required to meet those objectives.
According to Citi’s latest Treasury Diagnostics survey, while corporate treasurers cite managing earnings risk as a core objective, only 13% actively manage it. “Corporates still struggle with earnings surprises” and FX moves are a major culprit, notes Johnson. He points to a lack of transparency and visibility around underlying exposures, which filters into earnings volatility.
Treasurers should take notice of this disconnect between their objectives and how they manage earnings risk and “go back to the drawing board” to choose the right tools and strategies to mitigate that risk, he advises.
Interestingly, simple forecasting error undermines the hedging strategies of many corporates. Trying to identify where and how that occurs is therefore a major priority for treasurers, Johnson adds.
Prioritise your risks
No two risks are equal, but not enough treasurers acknowledge this in their actions, especially when it comes to FX hedging. “Customers tend to treat all currency risk in the same fashion,” notes McGivern. Instead, they should analyse their portfolios to identify which currencies in their portfolio are the biggest contributor to risk vis-à-vis the cost of hedging and focus resources there, says Johnson.
This risk-based allocation of resources is made easier when treasurers operationalise as much as possible of their FX cash management, execution and settlement, McGivern adds.
Automate and centralise
Try and identify therefore which processes can be automated to reduce manual error and labour intensity, advises Johnson.
To manage risk efficiently, treasurers need visibility of all their exposures and the ability to centralise their hedging as much as possible, says O’Toole.
A multinational food producer, for example, could have 40 plants across the world individually hedging their exposure to various commodities. Not only does entering into multiple hedges get “pretty damn expensive, fast” but each commodity will be subject to embedded FX risk – for example if the plant buys wheat in Malaysian ringgit, which is later translated back into US dollars - that the in-country buyer might not take into account, he notes.
OpenLink’s centralised treasury risk management and commodities procurement systems give treasurers visibility into what their commodities procurement teams are doing so they can see their aggregate position across the world in any one commodity and hedge it once.
“That’s very powerful stuff,” O’Toole says. “It gives the treasurer more confidence into the numbers they’re reporting and eradicates any surprises that may sneak up.”
As long as treasurers have that visibility into all their exposures, they can move beyond simple cash management and cash forecasting to do Value at Risk or Cashflow at Risk and scenario analysis or stress-testing, he adds. “If you can reduce the cost of risk, that looks good on liquidity and you can do more with your cash.”
This also comes at a time when the International Accounting Standards Board’s replacement of IAS 39 with IFRS 9 has changed how companies can approach hedge accounting, notes O’Toole. “It opens up a world of possibilities to do more interesting hedges and use more sophisticated instruments.”
ABB Singapore for one would like to see risk management facilitators such as banks and tech vendors help it achieve more visibility across its balances and accounts.
Day-to-day management however remains key, Emslie says. “No one tool could protect you against all risks. It’s just not possible.”
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Push for more budget
As risks mount, “treasurers are being asked to do more and be more strategic,” with risk becoming “front and centre” to the role, O’Toole notes. “They definitely need the right systems to be able to assist with that.”
And as an increasing number of ex-bankers migrate to corporate treasury roles, they bring with them the right experience and skills to use sophisticated risk management tools – and to explain to company boards why they are important, he adds.
Having access to that skill set is also encouraging corporates to take more of their risk management and hedging in-house, rather than paying a bank to develop and execute a strategy for them.
The treasury function has a higher profile currently than it has had for many years, and this trend will continue while risks rise. So as Citi’s McGivern advises, now is a good time to automate treasury and risk management processes – and to push for the budget to do so.
Want to know more about effective FX and liquidity risk management? Come to TXF Amsterdam, where Ion Sclifos, Group Treasurer at Orange Romania, will be giving a risk workshop dedicated to helping corporate treasurers manage the issues.
For more information, including the latest confirmed speakers and how to book, see the event page. A limited number of complimentary passes are available for corporate guests. To enquire, please email [email protected].
