by Helen Sanders, Editor, TMI
Understanding and complying with evolving financial regulations is one of the most challenging aspects of treasurers’ role, particularly for organisations operating internationally. Local, regional and global regulations may conflict or overlap, but an added difficulty is that treasurers are often affected by rules that are not directly targeted at them. As Andrej Ankerst, Head of Cash Management Germany and Austria, BNP Paribas explains,
“Since the global financial crisis in particular, corporate treasurers have had to deal with a diverse range of regulatory developments. Some of these, such as SEPA and EMIR, have a direct impact on processes, systems and reporting. However, just as important are regulations that are not targeted at corporations specifically, but which have indirect implications, particularly banking regulations such as Basel III. Treasurers may be less aware of the detail of these regulations as compliance is not an issue in the way as ‘direct’ regulations would be, but the impact may be at least as significant.”
Furthermore, regulatory change does not happen in isolation, but alongside other developments that may reduce or exacerbate the impact, particularly the effect of low or negative interest rates. The key for treasurers is to keep up to date with regulatory developments, engage with banks, technology partners and treasury associations, and anticipate the implications for their business. As this edition of TMI is being launched at Schwabe, Ley & Greiner’s annual Finanzsymposium event, this article highlights the priorities and experiences of treasurers in Germany, but these are just as relevant to treasurers in other countries and regions.
Countdown to Basel III
Treasurers identify Basel III as the most significant regulatory change on the horizon, even though the obligation to comply is on banks rather than their corporate customers. The Basel III regulatory framework was first agreed in 2010-1, but it has been subject to a number of revisions, clarifications and timing changes, which has made some treasurers complacent about the impact until recently. Although Basel III aims to increase the resilience of the banking sector by specifying minimum capital and liquidity ratios amongst banks, clients are inevitably affected as banks revise their operating model, and therefore their solutions and pricing. The official implementation deadline is now 2019, but banks are implementing sections of the regulation at different rates, and some treasurers are already observing changes in their banks’ offerings, pricing and relationship demands.
One of the most immediate and significant areas in which Basel III affects treasurers is liquidity, with implications on solutions such as notional pooling and bank deposits. Steven Lenaerts, Head of Product Management, Global Channels, BNP Paribas discusses,
“Looking at the liquidity coverage ratio (LCR) under Basel III which is now taking effect, different sources of liquidity have different value to a bank. For example, corporate deposits have more value (particularly when part of a cash management structure) than a financial institution deposit where the runoff rate is perceived to be higher. The difficulty, therefore, is to balance banks’ regulatory obligations with their clients’ liquidity and investment needs.”
In practice, two types of deposit (from non-financial corporations) are attractive to banks and will therefore be better rewarded: firstly, deposits linked to operational flows, and secondly, deposits of above 30 days, that allow banks to demonstrate that they are able to sustain a period of 30 days of market stress. As Lothar Meenen, Head of Trade Finance and Cash Management Corporates Germany, Global Transaction Banking, Deutsche Bank says,
“Under the new liquidity standards, the quality of banks’ funding is very important, and banks generally do not derive much value from non-operational cash; rather, they need to ensure that deposits are comprised of operating cash, or held over a longer tenor to comply with liquidity rules.”
He continues,
“This creates considerable challenges for corporates with surplus cash to invest. It will no longer be an option simply to leave balances on accounts or in deposits that should be invested in the capital markets.”
The elusive 30-day tenor
Some treasurers, particularly those for whom accurate cash flow forecasting is difficult, are likely to find it difficult to invest beyond 30 days. Some are likely to consider other instruments such as money market funds (MMFs) although these are also affected by regulatory change, initially in United States but ultimately in Europe too. However, many are taking this in their stride, particularly given the wider challenges of generating a return and avoiding erosion of capital in a low or negative interest rate environment. As a result, some are starting to review investment policy and segment surplus cash into different investment categories (e.g., short-term, core and strategic cash), but many others have not yet proactively addressed this issue. Andrej Ankerst, BNP Paribas summarises,
“
Basel III, together with the prolonged negative interest rate environment, is prompting treasurers to review their investment policy, as they still need to generate a return on surplus cash. At the same time, they still need to manage issues such as counterparty risk, so there are multiple elements driving investment policy. To do this, treasurers are analysing their liquidity timing needs more precisely, and determining the most appropriate investment options to meet these timing needs, such as term deposits and funds. At BNP Paribas, our Corporate Deposit Line is dedicated to supporting treasurers to find the right investment instruments to achieve their yield objectives whilst managing risk at an acceptable level.”
Lothar Meenen, Deutsche Bank concurs,
“Corporate treasurers are obliged to consider other investment options, both as a result of changing bank appetite but also of low or negative interest rates. Currently, treasurers investing for less than one year in EUR will receive a negative rate, so they need to segment their cash more effectively, and only keep essential cash invested for less than this. Previously, many companies separated cash for pensions and acquisitions, for example, but the rest was held in the normal treasury ‘bucket’. Now, they need to be far more specific and strategic about when cash is needed, and drive investment decisions accordingly.” [[[PAGE]]]
Investing in new instruments, whether longer-term deposits, MMFs or other investment products such as commercial paper or tri-party repos which are becoming more popular in countries such as Germany, may have transaction management, accounting and risk management implications. Treasurers therefore need to ensure not only that their policies are flexible enough to support a wider range of instruments and tenors, but also that they have the skills and systems capabilities to manage them. As Alwin Harkema, Senior Treasury Sales Officer for Germany, GTS EMEA, Bank of America Merrill Lynch points out,
“Treasury management system providers also have an important role to play in supporting their clients on how to manage, standardise and harmonise reports to quantify the risk on a wider range of instruments.”
Furthermore, the situation continues to evolve, and new deposit solutions from banks are already emerging, such as evergreen and notice deposits. Steven Lenaerts, BNP Paribas notes,
“There is still some fluidity in the interpretation of the regulations, and what the operational impact will be. However, although we are still at an early stage, there will be new banking solutions emerging over the coming months. In addition to investment instruments, the impact of Basel III on liquidity solutions such as notional pooling is not neutral, so treasurers need to maintain a dialogue with their banks to understand the new opportunities that are emerging.”
The wider liquidity challenge
Cash investment is closely connected with liquidity management techniques such as cash pooling, and the right cash pooling arrangements can have a major impact on the amount, location and currency of surplus cash available for investment, as well as funding costs at a group level. There has been considerable speculation about the feasibility of notional pooling under Basel III, but there is still no clear position on this, and banks are adopting different approaches. Alwin Harkema, Bank of America Merrill Lynch, for example, emphasises,
“Bank of America Merrill Lynch offers liquidity management solutions such as multi-currency notional pooling which allows treasurers to offset credit and debit balances in different currencies, and with that create a net balance in one of their preferred currencies. This is just one example of the solutions that are available to provide clients with ways to achieve their targets regarding interest returns, whilst having their banks comply with the LCR requirements in a negative interest rate environment.”
However, some companies are likely to see the impact of Basel III on notional cash pool structures, which may need to be replaced or repriced, as banks are no longer able to offset debit and credit balances. Additional complications may exist for notional cash pools across multiple entities, particularly if they are not fully documented with intercompany guarantees. While notional pooling may continue to be a realistic liquidity tool for some corporations, treasurers need to be prepared for different scenarios, and as Alwin Harkema, Bank of America Merrill Lynch warns,
“Banks have done a lot of work to comply with the LCR, which should give treasurers some assurance of increasing stability and resilience in the industry. Some companies are still persisting in a ‘wait and see’ strategy but this is likely to be detrimental in the near future, if not already. These treasurers should be engaging with their core banks sooner rather than later to determine how LCR compliance will impact their investment and hedging strategies and/or policies.”
Review or replacement of existing liquidity structures will not necessarily be a negative experience for many companies, particularly if they can minimise their short term funding needs by leveraging surplus cash more effectively across the business, and therefore reduce the amount of cash that needs to be invested in short term instruments. For companies with a decentralised treasury organisation, or complex intercompany arrangements, implementing alternative techniques may be more difficult, particularly when also taking into account new tax regulations such as Base Erosion and Profit Shifting (BEPS).
Beyond liquidity
The implications of Basel III extend beyond liquidity into all aspects of banking relationships, including financing, as Lothar Meenen, Deutsche Bank explains,
“When Basel III was first announced post-crisis, banks put a great deal of focus on capital adequacy, with considerable success. However, there are still developments under way that have the potential to impact substantially on corporate treasurers. One possible change is the risk weighting on undrawn commitments, which is due to be announced very shortly. This would affect back-up facilities on which many treasurers in Germany rely. These are currently a cost-effective means of providing emergency or short-term financing, and are particularly relevant to German corporations that hold large cash balances. However, the cost and availability of back-up facilities could change dramatically if the risk weighting of these lines changes. While there is nothing definite yet – and even this problem may not arise to the full extent – treasurers need to be prepared.”
He continues by emphasising that treasurers need to be ready to take action should it prove necessary,
“Treasurers need to make sure they have commitment from their funding providers wherever possible, such as back-up lines, which should be relatively easy at present as there is competition amongst banks to provide this type of facility in a low margin environment.”
Changing risk profiles
When looking at regulatory change, it is important that treasurers consider not only what regulatory change does to them, but also for them. For example, Lothar Meenen, Deutsche Bank highlights that while changing regulatory environment has an impact on how banks assess their corporate customers, there are also implications for the way that treasurers assess their banks,
“Most treasurers assess their risk to counterparty banks using either the credit default swap (CDS) rate or unsecured senior debt rating. With countries such as Germany introducing bail-in rules, these risk measures are no longer as useful as they once were, but few treasurers have adjusted their treasury policies so far. Specifically, it is important to consider the difference between the unsecured funding rating and the newly introduced deposit rating. This is a more accurate reflection of most corporations’ risk positions as the primary underlying source is risk stemming from deposits and not from unsecured bond holdings.”
This is a topic that we will return to in more detail in the future, but is important to understand how regulations affect counterparty and market risk. Furthermore, as we have seen, banks’ need to comply with emerging regulations is making some aspects of their business less profitable or more risky in the past, particularly given the size of penalties that have been applied. This in turn is causing some banks to de-risk their business by exiting certain business lines or countries, limiting treasurers’ choice of banking partners for particular services.
The wider regulatory environment
There are a range of other planned or proposed regulatory changes that are also affecting the corporate treasury community. There is not space to describe or discuss all of these in a single article (after all, there are at an initial count over 50 major regulatory developments taking effect over the next two to three years) and some will be subject to detailed consideration on other occasions, such as MMF regulation, KYC and BEPS. Talking to treasurers in Germany recently, however, two issues in addition to Basel III particularly stood out. One is the new EBA guidelines on exposure limits of banks to entities that carry out banking activities that are not subject to normal regulations, known as ‘shadow banking entities’, which are due to take effect in January 2017.[[[PAGE]]]
Shadow banking entities are defined for the first time as (to summarise) those that carry out credit intermediation activities. These are bank-like activities involving maturity transformation, liquidity transformation, leverage, credit risk transfer or similar activities. Although there have been some amendments to the proposed definition following consultation, there remain concerns that techniques such as cash pooling, centralised hedging and in-house banking would be considered as shadow banking activities. Similarly, activities such as leasing and distributor financing that support the operations of the business, rather than being a company’s core activity, would also fall within the shadow banking definition.
A second area of focus amongst treasurers in Germany (and across Europe) is ESMA’s review of EMIR, the first version of which was implemented in 2012. Treasurers and their technology vendors have already invested substantial resources in compliance with these rules. However, ESMA’s recent report on the use of OTC [over the counter] derivatives by non-financial counterparties suggests that every derivative transaction should be subject to a clearing threshold irrespective of whether it is conducted for hedging or other purposes. Currently, risk-mitigating derivatives are excluded from this threshold. ESMA notes that large corporations have sizeable derivative portfolios are not subject to the clearing obligation, and secondly, the classification of risk-mitigating/non-risk mitigating derivatives would be difficult for smaller companies to apply, and for supervisory authorities to monitor.
However, many corporations have expressed the view that the current challenges with EMIR reporting are its complexity and inconsistent implementation across EU member states rather than a fundamental problem with classification. Instead, treasurers are asking for more support to help member states to implement appropriate supervision rather than removing the distinction between risk mitigating and non-risk mitigating derivatives. The effect of these changes on non-financial corporations would be greater cost and complexity in risk management, which is likely to deter treasurers from mitigating risks, potentially endangering rather than enhancing financial stability.
A positive regulatory perspective
While many of the greatest regulatory concerns are those where corporations are subject to unintended consequences or high cost of compliance, it is important not to ignore situations where new regulations lead to benefits and opportunities: after all, the general aim of new regulations is to increase confidence, efficiency and transparency. An example of a major regulatory change that offers just as much for treasurers as it impacts on them is SEPA. While many treasurers in countries such as Germany breathed a sigh of relief once they had completed their migration to SEPA credit transfers (SCT) and direct debits (SDD) they should now be looking beyond compliance to take advantage of the opportunities to harmonise and centralise payments and cash management, as Steven Lenaerts, BNP Paribas comments,
“One key regulatory change that should not be ignored is SEPA. Although companies have completed their initial migration, many still have significant progress to make in capitalising on the investment they have made in SEPA compliance, and leveraging the advantages of harmonisation, such as simplifying account structures and centralising cash management activities.”
As with Basel III, there is a tendency to ‘wait and see’ in anticipation of future developments, but Andrej Ankerst, BNP Paribas advises that treasurers and finance managers are better off acting now,
“Now that the core SEPA instruments have been defined and are in use, there is now progress being made on developing and refining SEPA further, such as instant payments, but these initiatives are still based on the core instruments, and solutions are most likely to be directed to specific payment users or purposes, rather than fundamentally affecting existing payment instruments.”
Now that SEPA is bedding down, a range of associated developments are emerging which would have been very difficult to achieve in a fragmented, pre-SEPA payments environment, including areas such as authentication and security. As Steven Lenaerts, BNP Paribas demonstrates,
“There are other, less widely publicised regulatory developments taking shape of which treasurers need to be aware. For example, eIDAS, which aims to provide a harmonised environment and legal certainty for electronic signatures between market participants in Europe takes effect on 1 July 2016, and will therefore support corporations’ standardisation and efficiency objectives, but adoption will take place at different speeds in different parts of Europe. There are also EBA discussions underway with regards to strong customer authentication and secure communication under PSD2, which will be very important for corporations given bearing in mind the growing cybersecurity risks.”
The corporate role in avoiding unintended consequences
Regulations that are intended to create transparency and mitigate risk in the banking sector often have unintended consequences for corporations, particularly treasurers, who are experiencing growing compliance costs, diverting resources from other investments. At the same time, however, regulatory change should also create opportunities for harmonisation, efficiency and transparency. Although there are some treasurers that are actively engaging with banks and regulators in regulatory consultations to ensure that negative unintended consequences are minimised, this remains a minority. National treasury associations have an important role in representing the interests of their members, which in turn can work effectively in tandem through bodies such as European Associations of Corporate Treasurers (EACT). In Germany, many DAX treasurers are members of the Deutsche Aktieninstitut (DAI) which has an influential treasury working group to review regulatory proposals, assess the potential impact and provide a platform to co-operate, share resources and co-ordinate responses. The key is that treasurers are proactive and collaborative in working with their local association for this representation to be compelling and authoritative. By doing so, treasurers are in a better position to influence rather than simply comply with regulations, and maximise the benefits and opportunities.
