Published: May 01, 2010
In the 2010 PwC Global Treasury Survey we examine treasury’s reaction to the financial crisis, covering both the initial collapse of liquidity and the economic downturn that followed. Were treasury teams prepared, how effectively did they respond and what are the lessons for the future? With the impact of the crisis thrusting treasurers into the spotlight, how has this attention affected their influence and status within the business and how can they capitalise on the opportunities this presents?
This article contains highlights of the survey. A complete version of the survey report is available directly from PricewaterhouseCoopers.
John F Kennedy once noted that the ‘Chinese use two brush strokes to write the word crisis. One brush stroke stands for danger, the other for opportunity. In a crisis, be aware of the danger, but recognise the opportunity’. Kennedy’s perceptive observation would provide an apt description of the current state of the treasury profession.
Dealing with the crisis, including the impact on funding, liquidity management, commodity price volatility and financial counterparty risk has provided the sternest possible test for treasury teams. Yet it has also brought the work of treasury to the forefront of the boardroom agenda and therefore created a once-in-a-career opportunity to raise the status and influence of the treasury within the business.
This year’s PwC Treasury Survey has aimed to understand how the global financial crisis and subsequent economic recession have affected the treasury function. Were treasurers prepared? How did they react during the crisis? What will be the new shape of treasury post-crisis?
We are very grateful to the 585 individuals who responded from 26 different countries across all five continents. These respondents represented 330 multinational companies covering all sectors and with turnovers ranging from less than EUR1bn to over EUR10bn. [[[PAGE]]]
A brief examination of the elements of the crisis shows that this crisis was a challenge for treasury more than most. It began with a sudden and catastrophic restriction in access to liquidity, a key element in the treasurer’s remit. This was then followed by a global panic which saw the financial crisis spread into the real economy, resulting in huge drops in previously record-breaking commodity prices and dramatic shifts in once stable currency pairs. Again key financial risks the treasurer is responsible for.
Despite the huge pressure they faced during this time, most treasurers saw this as their greatest opportunity to push their issues to the top of the corporate agenda. Nearly 80% of participants believe they now have the board’s attention and more than 70% have seen their reputation for adding value increase throughout the business.
The survey shows that many treasurers were prepared, at least in part, for the effects of the crisis. However, few would claim to be sufficiently prepared in all areas and all have derived lessons. For the most part these lessons were not new techniques or methodologies but rather a rise up the priority list of long-established ‘best practices’.
Cash is king againWe have all heard the mantra ‘cash is king’ throughout our careers but it seems many in both corporates and banks had neglected some of the best practices in cash and liquidity management in favour of more exotic activities (perhaps including derivatives, structured bonds and M&A services).
This situation has now been reversed. As access to liquidity has shrunk the number rating cash management and working capital management as highly important has increased significantly (Figure 2), from 35% pre-crisis to over 70% during and after.
Corporates have re-learned that having too much debt from any one source and with the same maturity may be more efficient to structure and negotiate but results in a serious concentration risk. Many corporates are now not only diversifying this risk across counterparties, markets and time periods but are also holding more excess cash as their ultimate back-stop facility (Figure 3). [[[PAGE]]]
For many years both corporates and banks have spoken of the importance of their long-term relationships, often based on an understanding that whilst funding is provided now, other more exotic (profitable) business will follow. The crisis tested these relationships to the extreme and in many cases they failed.
On the technical side many treasurers have been reminded of the importance of negotiating and monitoring loan documentation and covenants. These were used in many situations to withdraw funding when it was needed most. On a more philosophical level, many treasurers woke up to just how important their bank relationships are (56% rated these as highly important pre-crisis compared to 84% during the crisis) and are now questioning just what type of relationship they have.
The survey shows that most corporates now want that long-term relationship more than ever, but see that the banks are moving to a more transactional focus.
It may be possible to have both to some extent, but this will require more transparency and detailed monitoring (including balanced scorecards) on both sides to ensure the relationship stays mutually beneficial, and hence robust, in the long term.
Linked to a bank’s willingness to grant funding is of course its own financial strength. While it has long been known that in theory a major bank could collapse, few treasurers believed this was sufficiently likely to lead them to actively monitor the resulting risks.
In the wake of the crisis the probability of a major bank collapsing is perceived as higher and the impact of this risk is now better understood. The lesson companies have learnt is how devastating this impact can be. More subtly though, treasurers have realised that banking counterparties do not necessarily need to collapse to withdraw funding or other services. [[[PAGE]]]
The survey shows that this is one of the areas where best practice has evolved the most as a result of the crisis. 82% of respondents viewed counterparty risk as either medium or high priority during the crisis and saw this continuing post-crisis.
The tracking of counterparty risk has evolved from monitoring credit ratings (which many now believe are too slow in reacting to changes) to looking also at more real-time indicators such as CDS spreads, equity prices and bond yields. In addition many are also now calculating their exposures not only on a nominal basis, but also based on fair values and potential future exposures.
Shift from standardised to active financial risk managementThe survey showed that practices in the area of financial risk management, particularly FX risk and commodity risk, have had to evolve to cope with the extreme market conditions and the fluctuations of their underlying business exposures.
In both areas the survey shows not only an increase in hedging of these risks but also a move towards a more active hedging approach away from more standardised, mechanical approaches (Figures 7 and 8). It appears that such standardised approaches were found to be insufficient to deal with the volatile, and sometimes imperfect, markets during the crisis. [[[PAGE]]]
Interestingly, the stated objectives of FX risk management vary significantly based on company size. Clearly this is affected also by the breadth of the shareholder base and whether companies are quoted or not (Figure 9).
Treasurers will increasingly be adding value by combining their in-depth knowledge of market forces with an active partnership with the business, thereby determining the optimal hedging strategy and timing.
Accounting standards: help or hindrance?More than a quarter of participants believe accounting standards did not actively contribute to the crisis, though around half feel they did not help and a further 20% that they are to blame. Nearly 40% are not applying hedge accounting, believing it is either too complex or causes too much of an administrative burden. The percentage of companies applying hedge accounting varies significantly according to size (Table 1).
Treasurers face significant changes in financial reporting in the wake of the crisis. It will be important to ensure that the new standards on hedge accounting help to ease the complexity and administrative burden. Companies should actively engage in the debate and comment process. As to the controversies around Fair Value accounting, it can also be argued that without Fair Value accounting, the underlying causes of the crisis would have taken longer to surface.
As our survey confirms, treasurers have faced a whirlwind of challenges in the wake of the financial and economic crisis. However, most of the steps needed to safeguard firms from risks and losses are features of prevailing best practice, rather than particularly innovative. So why weren’t they implemented?
The survey underlines the importance of setting clear priorities and smart management of resources. They will be equally important in enabling treasuries to make the most of the prominence within the business and ear of the board they now enjoy. [[[PAGE]]]
Funding remains top of the treasury agenda. Devoting as much time as possible to this continuing challenge will clearly be critical. This includes looking at how to manage funding under a range of different scenarios. As the survey confirms, treasurers will also be looking at how to manage existing relationships more effectively, while diversifying funding options and opportunities. However, they will need to address the priorities further down the list in Figure 10 to achieve these objectives.
Investment in the re-design and implementation of more efficient and effective cash management structures can pay dividends by making more cash available for use in the business and reducing the need for borrowing. This involves a combination of systems, organisational improvements and bank account restructuring. Cash management solutions are becoming more sophisticated and operable across borders – combining these with payment factories and in-house banks helps make best use of available cash.
New tools and technology provide no clear advantage in themselves and indeed their implementation is generally complex and costly. However, they are essential in efficiently supporting almost all other areas of improvement:
The ranking of key issues faced during the crisis is naturally headed by the immediate challenges of cash, funding and liquidity management (see Figure 11).
However, when asked what lessons have been learnt from the crisis, the answers are subtly different, providing interesting pointers to the direction of the treasury profession (see Figure 12). [[[PAGE]]]
The crisis provided a wake-up call for risk management, liquidity risk in particular. While not alone in being lulled into a false sense of security about the boundless availability of credit, treasurers should perhaps have been more aware of the underlying threat, and are now determined not to be caught out again.
Across the board, risk management is destined to become more proactive and sophisticated in the wake of the crisis. In particular, the crisis has shown that mechanistic approaches that follow the markets do not always work, especially in illiquid or unbalanced markets like some commodities. Instead, effective risk management demands a close knowledge of the dynamics of a particular market rather than just the underlying exposure.
The crisis has also shown that the past is rarely a good guide to the future and therefore scenario planning will need to be broader and more rigorous in looking at the worst case possibilities and how they might interact.
The speed at which the financial markets spun into freefall, particularly after the collapse of Lehman Brothers, underlines that relying solely on credit ratings as the basis of counterparty risk management is too slow. Forward-looking markers such as CDS spreads and potential future exposure calculations are essential. However, CDSs themselves can be an illiquid hedging tool and therefore firms may need to take a more pre-planned structural approach to risk diversification.
The sudden squeeze on funding shows that counterparty risk is more than just the threat of bankruptcy, but also the possibility that funding and support may be withdrawn. Many treasurers have learned the hard way that cosy personal relationships that may work in good times can easily break down when market conditions deteriorate. The relationship with the bank is a business arrangement, not a marriage, and therefore it needs to be more transparent and carefully monitored to ensure it remains mutually beneficial.
The underlying lesson is that there is no substitute for proper skills and resources. Treasuries tend to be comparatively small departments. This meant that many did not have the time or manpower to apply best practice when it was needed most.
In the past, companies wanted a small and cost-focused treasury operation, in which efficiency was judged by monitoring potential errors, frauds or excesses in areas such as derivatives dealing. As a result of the crisis, boards now realise that the real risk is what a treasury is not doing, possibly through under-resourcing, rather than faults in what it does do. The focus therefore needs to be shifted to what risks are not visible and what vital links to the business could be improved. Moreover, the use of hedging instruments like derivatives does not remove the need for a good understanding of the markets and an ability to manage financial risks
[[[PAGE]]]
Once the crisis recedes, what will be the primary focus of treasury teams ?
It would appear that while funding is at the top of the agenda now, this is perceived to be a temporary blip (see Figure 13). Presumably, once treasurers have taken on board the lessons learnt about funding during the crisis, they can resume their focus on the core business of risk and cash management.
The high rating afforded to ‘partnering with business’ is equally interesting. Boards and treasurers themselves now realise that the function needs to integrate with the business to really understand and manage the financial risk dynamics of the enterprise. This comes at a time when boards and business teams have also begun to recognise the full value treasury can add and therefore provides a unique opportunity for the advancement of the profession. However, grasping this nettle will require additional resources, more integrated systems and a more collaborative and commercially-minded approach.
The future: most promising developmentsThe crisis has opened up further opportunities for cost savings and more effective risk control. The areas where participants see the greatest scope for development and improvement can be divided into cash management (shown in red in Figure 14) and risk management (shown in green in Figure 14).
Participants look forward to improvements in cash flow forecasting, working capital management and bank relationships management, which are in turn linked to a second wave of expected improvements in supporting technology and organisational structures. Technology and processes in the form of in-house banks, payment factories and SWIFT connectivity are seen as promising new areas, which should allow increased control, visibility and forecasting of cash.
Participants anticipate an evolution in risk management policies, which could well reflect the more active approach outlined earlier in this article. Again this is supported by developments in risk management tools and technology. [[[PAGE]]]
As Figure 15 highlights, the crisis has won treasurers unprecedented attention from boards and business teams alike. The valuable contribution of treasuries is now better understood, as is the disastrous consequences if they fail.
[[[PAGE]]]
However, this new-found prominence has yet to be translated into investment. Treasurers need to capitalise on what may be a brief window of opportunity. In particular, they should make the case for adequate technology and manpower at a time when budgetary constraints are beginning to ease, but the pain of the crisis and therefore the rationale for investment is fresh in the board’s mind. As they emerge sufficiently equipped, treasuries will then be properly placed to implement best practice before the next crisis looms.
Once again, the authors take this opportunity to thank the many survey respondents for their valuable contribution and for making possible the study on which this article is based.
How Thought Leadership Can Reduce the Cost of Sales by Patrik Havander, Havander & Partners A focused attention on the costs incurred by the global sales and marketing processes is becoming increasingly important for corporate banks and their transaction banking departments. While the client/bank relationship remains vital, research has shown that in fact relationship selling […]
