Global Treasury Management Practices in an Uncertain Market

The financial crisis of the past two years has had a profound effect on global treasury management practices. In an environment where financial and economic uncertainty has become the norm, treasurers, along with their executive management and boards, have realised that relying on traditional treasury policies and practices will not foster a safe environment for growth. Companies are taking a fresh look at overall treasury strategy and structure, seeking to rationalise the way business is conducted globally while considering the effects of recent legislation, the growing importance of counterparty risk, and the likelihood of a volatile future.

For organisations to achieve a sustainable competitive advantage in the global marketplace, treasury operations must follow emerging best practices in the key areas of treasury centralisation, bank relationships, and treasury technology.

Impact of the Global Financial Crisis on Treasury

With the collapse of Lehman Brothers in September 2008 and all that followed, corporate treasury groups found themselves in the spotlight. Calls from executive management, rare in the past, became daily, even hourly, events, with questions about counterparties, balances, investments, access to credit, and access to internal sources of liquidity. Although the intensity has declined, treasurers continue to focus on challenges that have always been within their purview but have been magnified many times over by the crisis and downturn. These include:

• Counterparty risk – assessing, monitoring and managing the company’s exposure to counterparty risk across banks, investment intermediaries, and other business partners.
• Credit – access to adequate sources of external credit, both at the corporate and business unit level.
• Liquidity – optimal access to liquidity tied up in working capital and/or spread across multiple counterparties. The tightening of external credit has exerted ever-greater pressure on companies to focus on enhancing working capital as a source of liquidity.
• Visibility – real-time or near real-time visibility to the company’s liquidity globally. It is critical to know where balances are, both from a counterparty risk perspective as well as from a liquidity management perspective. Monthly or weekly reporting of bank balances from decentralised foreign subsidiaries is no longer an acceptable practice, and in some cases the magnitude of the exposure has led to near real-time monitoring of balances across the globe.

Recent research jointly conducted by Financial Insights and Treasury Strategies presented in the following chart show these and other issues as top of mind for the participants.

In the fourth quarter of 2008 companies took tactical steps to address their most immediate concerns – counterparty risk and access to credit:

• Investments were moved out of ‘riskier’ instruments and into shorter-term government securities or even into cash deposits at the stronger banks.
• Balances were moved daily among banks to avoid concentrations with banks perceived to be at risk.
• Unused credit lines were drawn on to build up liquidity to weather the crisis.
• Current credit facilities were confirmed or new facilities negotiated.

With the passing of the immediate crisis, companies have focused on longer-term, strategic solutions to their challenges. The impact these initiatives are having on best practices across treasury centralisation, banking relationships and treasury technology follows.

Treasury Centralisation Initiatives

From the largest multinationals to mid-market local firms, companies are restructuring treasury operations and banking relationships in response to the global recession. Companies have more aggressively rationalised global treasury structures and banking partners, re-evaluated their liquidity structures, and are pushing to further centralise operations to better control cash and free up as much working capital as possible. At a growing number of large organisations, increased demand from the board and executive management for greater visibility to global cash has meant that real time global visibility to cash is now a standard business requirement.

The financial crisis, coupled with global expansion, has increased the need for centralised structures and tools. The rapid expansion of companies into developing markets through either acquisition or internal growth has created a multitude of disparate systems and processes. Companies are centralising to streamline the operational elements of treasury (middle/back office) and to force standardisation of processes as well as enhance control. The highly decentralised cash management model that was at one time satisfactory and somewhat common among large companies is now viewed as unacceptable. Organisations are, in many cases, scrambling to rewrite global policy, reengineer processes, and modify banking structures in order to create a more controlled environment with greater access to cash.

Note that many companies, which have already centralised treasury, are leaving their centralised structures and primary banks in place, but are looking to diversify/add counterparties where funds are held/invested.

Policy enforcement

For many companies, whether decentralised, centralised or somewhere in between, the first step has been stronger policy management and enforcement. Companies have been prompted to adopt policies that emphasise liquidity management, while not compromising the organisational tolerance for risk. Legal entities no longer have the independence from corporate they once had. Participating in company cash pools, once optional, is now generally required from all legal entities. Policy now dictates banking partners for legal entities, along with the maximum amount of cash that can be held with one bank. Many organisations are transferring cash management responsibilities altogether from local offices to regional treasury centres or corporate offices.

Regional shared service centres: greater control

Centralisation of cash management responsibilities at the regional level has been dominant for several years. The business case for centralisation through regional shared service centre (SSC) model has been strengthened by the financial crisis. Centralisation facilitates enhanced controls, streamlined and standardised processes and straight-through processing (STP).

The near-collapse of global financial markets is still fresh in the minds of many boards and executive management. Decentralised structures no longer support the need for greater security and control over financial transactions. Companies are using this unstable business environment as an opportunity to modify outdated treasury structures that lack centralisation. The move from local treasury management to regional, more centralised, treasury centres gives management an opportunity to standardise processes and eliminate inconsistent working capital practices at local offices. The creation of best-in-class treasury centres that have a working capital-driven, more strategic focus improves the bottom line, through the implementation of best practices in a tightly controlled environment.

Banking Relationships

The economic crisis has had a significant impact on the way in which corporates think about, manage and select their banking relationships. Counterparty risk moved front and centre as did access to credit. Within their group of credit providers, companies continue to select solution providers based, first, on ability to meet service requirements, followed by pricing. Counterparty risk guides the level of balances and/or investments maintained with each bank.

Counterparty risk

Corporate treasurers are focused on counterparty risk, as evidenced by the aforementioned recent research conducted by Financial Insights and Treasury Strategies. Volatile conditions within the global marketplace have increased awareness of risk management across all levels of the organisation. The focus has sharpened on core treasury activities such as cash positioning, payments and bank relationship management. These core activities are now treated as crucial components in the calculation of total counterparty exposure.

Companies are taking precautionary measures in a number of areas, both internally and externally, to minimise counterparty risk. As companies restructure current or expand banking relationships to mitigate counterparty risk, they are:

• Monitoring current and potential banking partners more closely.
• Developing new, stricter guidelines for selecting banking partners or reapportioning business among current banking partners.
• Rewriting counterparty risk policies that reflect a more risk-averse attitude towards transaction banking.

Data from the same survey referenced above indicated that 41% of companies have already increased counterparties to mitigate risk, and 15% are planning on increasing counterparties in the near future. Companies working in a region where treasury services can be fully managed by one provider are now using multiple providers in order to reduce the possibility of a catastrophic collapse in treasury operations if a primary service provider fails. The additional counterparties typically address investment, debt and foreign exchange (FX).

Note that while counterparty risk is top of mind for treasurers, it is a surprisingly un-sophisticated process at most companies, where it is largely managed with manual processes and tools (spreadsheets).

Access to credit

With the tightening of credit markets, banks are looking to receive services in return for the credit they underwrite. As a result, treasurers have to structure their banking relationships and operating services proportionate to the credit commitments of each bank. Increased activity in the credit market, resulting from banks reassessing risk appetites and companies seeking to secure credit in an uncertain marketplace, has led to the realignment of many credit relationships. Companies have been quick to remove treasury business from those banks that have been unwilling to award credit or have recently removed credit. More often than not, the list of prospective treasury partners during the RFP process will be limited to those banks willing to provide credit. Companies will frequently address credit directly in this process, often requesting banks to specify their willingness to commit to participation in a credit facility, should treasury services business be won. Although the recession has begun to wind down and there has been some free up of credit at financial institutions, it is unlikely that companies will deemphasise credit when selecting treasury service providers. New or enhanced credit relationships represent opportunities for expanded liquidity relationships.

Managing and selecting banking relationships

Credit provision and counterparty strength are clearly critical bars for banks to pass before they become a transaction services provider or receive the opportunity to bid on transaction services for a company. However, the economic crisis has influenced the solutions companies are seeking, and along with counterparty risk, determines where they leave their excess balances/investments each day. Companies continue to select transaction service banks from among their credit banks that best provide required services / solutions at attractive prices. However, the economic crisis has shifted the focus more powerfully to those services that:

• Provide optimal visibility to and access to liquidity (web-based solutions and/or SWIFT).
• Enhance controls/reduce risks (provide reporting, visibility, transparency).
• Facilitate STP.

Companies are increasingly turning to those banks that demonstrate:

• Innovation and long-term commitment to the business.
• Ability to comprehensively cover a region through their own branch network and/or seamlessly through partner banks.
• Best-in-class customer service and partnership.

RFPs are regularly used to rationalise and streamline operating banks. However, during the downturn, there was a noticeable retrenchment as:

1. Companies looked to retain their banks and focus on managing balances and investments to adhere to counterparty risk policies.
2. Companies waited to see how banks would emerge from the crisis.

Companies focused on fundamentals and took steps to extract more value from existing banking relationships. Banking leaders are emerging from the crisis that are focusing on innovation and investing heavily in transaction banking. These banks intend to be ‘end-game’ providers and are well-positioned to help companies address their challenges.

Treasury Technology

As companies address their challenges brought on by the financial crisis and identify internal and external solutions (e.g., refined banking and liquidity structures, treasury centralisation, etc.), there is an inevitable and necessary focus on technology. Technology is a critical element of these solutions, whether addressing visibility to and access to liquidity, tracking of counterparty exposures, or standardising and automating processes.

A recent joint survey of 46 corporations/multinationals in the US, conducted by Wall Street Systems and Treasury Strategies, found that companies are spending on technology despite tight IT budgets because technology is crucial to the treasury solutions needed in today’s environment. As outlined in Figure 4, these 46 corporations had many of the same concerns identified in the Financial Insights and Treasury Strategies 2009 Key Trends Research. They also identified the need for better cash flow forecasting and provided additional context/insights around each of their concerns.

Treasurers can turn to multiple treasury technology solutions to partially or fully address the above challenges. A range of treasury management systems (TMS) are available, along with ever more sophisticated bank web solutions, and niche technology solutions for FX, hedge accounting and derivatives valuation. Some of the technology solutions available to address these challenges are highlighted below and discussed in more detail in a recent gtnews article by Laurie McCulley, Treasury Strategies, ‘Optimal Treasury Technology for Changing Market Conditions and Evolving Organisations.’

• Counterparty risk – TMS and niche provider solutions are evolving to help track and report more comprehensive counterparty risk exposures, moving beyond the traditional derivatives exposures to also include balances, investments, deal settlements and un-utilised credit facilities.
• Cash flow forecasting – tighter credit markets and liquidity concerns are driving the demand for better cash flow forecasts, including more accurate inputs and access to historical data. Corporate treasuries are looking to their TMS to facilitate a cash forecast that includes a seamless integration of financial transaction flows, operational cash flows (accounts payable, receivable and payroll) across a short-term and medium-term liquidity planning horizon. TMS solutions have added functionality to facilitate the integration of enterprise resource planning systems (ERP) data as well as tools for subsidiary reporting of forecasts.
• Visibility – visibility includes both the ability to quickly access cash balances/liquidity and to report on those balances by bank/counterparty. Banks provide visibility to global account balances via proprietary web channels and to multiple banks via multi-bank reporting solutions.
• SWIFT – to simplify that access, more organisations are leveraging SWIFT connectivity to gain visibility throughout the enterprise. With more options than ever before for connecting to the SWIFT network – direct infrastructure, shared infrastructure through a service bureau and internet connectivity via Alliance Lite – companies can make the case that visibility comes at a lower cost than it did previously. Additionally, the SWIFT infrastructure facilitates the rationalisation of current banking structures, as it provides a single pipeline through which all bank information is channelled. SWIFT thus eliminates the requirement for multiple local banking connections that may be costly and difficult to access.
• Reporting – the latest versions of treasury technology, both TMS and the more sophisticated bank solutions, provide customised dashboards/enhanced, ad hoc reporting.
• Accounting/regulatory compliance – some TMS solutions, as well as niche providers, offer hedge accounting as well as derivatives valuation software solutions. As organisations seek to expand their capability to comply with derivative valuation and risk of counterparty default, there is an increasing focus on system functionality for accounting. TMS and some legacy bank platforms have long been able to interface to general ledger systems for treasury transaction accounting; now, more bank online systems offer STP for treasury accounting.

A final note on technology: the crisis has forced the hand of many companies who had delayed investments in treasury technology solutions/enhancements to outdated solutions to move forward with those investments with a far greater focus on the qualitative business case than the quantitative business case.

Conclusion

Treasury management needs and practices have evolved as a result of the financial crisis and downturn. When the financial crisis hit, organisations quickly realised that traditional treasury practices were not sufficient to address their needs. In order to address and support the challenges brought on by the crisis, as well as the ongoing challenges of globalisation, companies had to take quick measures to ensure their assets were safe and that they had adequate credit and access to internal liquidity. Decreased risk tolerances, coupled with increased legal requirements such as Sarbanes-Oxley, have resulted in a shift toward more centralised treasury operations. Companies have turned to their current and/or new credit providers to support new banking and treasury structures and to technology to support enhanced visibility, controls, STP and reporting.

A critical factor in determining how successful firms will be as they expand globally will be how well treasury adopts best practices to maximise working capital efficiency and minimise risk. Those organisations that acknowledge a need for change as a result of the financial crisis and act to make change will be in the best position to thrive during the recovery.