Treasury Outsourcing in Africa
For many years outsourcing was regarded as a cost-effective, risk-reducing solution for aspects of corporate treasury operations such as the provision of back office management and hedge accounting services. The outsourcing approach was publicly and actively recommended by several leading treasury consultancies, but after an initial surge of action and growth the concept never really took off in Europe and North America.
The primary reason was cost/benefit performance. The costs of supporting what were perceived to be appropriate minimum levels of redundancy, control and security overheads for treasury outsourcing organisations were found, in practice, to be very high. In part, this reflected the fact that it was primarily large global banks offering treasury outsourcing services. The real costs of providing treasury outsourcing were found to be quite prohibitive by many outsourcers; consequently many of them pulled out in the early 2000s.
One exception was provided by the specific outsourcing demands of some US companies, which found outsourcing some or all of their European treasury operations to be an attractive, cost- effective solution. This is because it has been proved in many such cases to be more cost-effective to follow the outsourcing route, as opposed to setting up a physical European treasury centre, staffing it with the requisite local treasury professionals, and managing and supporting it.
South Africa’s Outsourcing Story
In contrast, treasury outsourcing has become a thriving business in South Africa, primarily due to the success and structure of the country’s economy and from a management culture that has always embraced the value of outsourcing many non-core business functions.
There are many South African companies with annual turnover in excess of US$50m which have grown strongly in recent years and whose success is accompanied by increasing levels of treasury risk exposure. These organisations range from the traditional mining and agricultural sector businesses to manufacturing, industrial and service companies. Many of them run sophisticated finance departments; but the in-house finance team may lack sufficient expert treasury knowledge, or the company may not have the budgetary resources to establish and operate a fully professional treasury department.
Many of the key drivers encouraging such organisations to focus on treasury originate from the 2008 global financial crisis. Some tough lessons learned from the crisis have since translated into today’s understanding of best practice operations in finance departments. The new insights relate to such disciplines as management of exchange rate risk, liquidity, debt and investment portfolios and counterparty exposure.
Exchange rate risk is a chronic concern in South Africa, primarily because of the continuing volatility of the rand (ZAR) and the impact on the profitability of foreign trade transactions. Finance departments are likely to find that they will benefit from outsourcing foreign exchange (FX) risk management and the construction of expert hedging programmes to secure the value of earnings, profits and any offshore assets.
Many companies will also benefit from outsourcing the execution of FX trades to specialists, who are fully focused on obtaining the best available rates through their understanding of this most demanding market’s rapid rate shifts, as participants react to actual or potential changes in the underlying technical and fundamental drivers and psychology. It may also be attractive to outsource compliance with the Reserve Bank’s exchange control regulations. Outsourcing may also be seen as a cost-effective way of handling the related back office administrative processes, such as deal conformation issuance and matching, settlement across the appropriate bank accounts, accounting and the generation of the required reporting. Outsourcing part, or all, of the exchange rate risk management function will provide a way for the corporate to enjoy the key benefits of professional front, middle and back office treasury services, securing a key element of the organisation’s profitability.
Similar cases can be made for outsourcing treasury functions, including cash and liquidity and debt and investment portfolio management, in cases where the costs of doing so internally are becoming prohibitive. Management scrutiny or audits will reveal the scale of the financial risks – and should issue red alerts when these are found to reach unacceptable levels. The option of a relevant outsourcing solution will provide the necessary professional services, cutting or eliminating many of the financial and operational risks, enhancing control and transparency and supporting the required administration functions, reporting and regulatory compliance.
Many specific risk situations could provide the necessary catalyst in adopting outsourcing for a given treasury or finance operation. One common occurrence is growing awareness of the consequences of inefficient cash management practices, which inevitably lead to poor visibility and usage of the organisation’s internal cash resources. This can result in squeezed liquidity, credit deterioration, increased borrowing costs and inefficient interest income/expense management. In extreme cases, it will be manifested in working capital shortage around the enterprise, seriously stressing the very viability of commercial operations.
Debt portfolio outsourcing can help with the administration of complex facility structures and for larger operations, with the timing and execution of borrowing operations in the wholesale capital markets. The latter may well be an increasing requirement in the near future if bank capital adequacy regulation such as the Basel III adequacy regime significantly (and adversely) impact on the availability and cost of bank borrowing.
Investment outsourcing provides professional services to manage the particular technicalities of the dealing and administration of the placement of surplus cash, in compliance with the organisation’s treasury investment policy.
Counterparty risk management has not been a major factor in the evolution of South African treasury, essentially due to the relative balance sheet strength of South Africa’s banks. However there is growing awareness of the importance of measuring and managing exposures to foreign banking and commercial counterparties. Monitoring, analysing and reporting counterparty risk makes heavy demands on the supporting technology. Outsourcing offerings can offer a cost- effective solution due to the economies of scale of their operations when compared with the costs of developing and supporting in-house risk management tools.
Outsourcing Approaches
Most treasury outsourcing companies in South Africa specialise in providing expert FX market services. IQuad Group, part of Sasfin Commercial Solutions, is one such organisation, providing forex and interest rate risk management to companies and individuals. TreasuryOne offers full service treasury outsourcing, including debt, investment and liquidity management, and differentiates itself by use of IT2’s treasury management system to manage clients’ outsourced treasury operations and to report to clients via the web. TreasuryOne’s chief executive officer (CEO), Hennie de Klerk, comments: “We have seen strong demand for outsourcing, as more and more corporate and company finance departments are seeking the cost and risk management benefits and the competitive advantages of professional treasury management.”
So why has the South African corporate sector been such an enthusiastic user of outsourced solutions? Firstly, the country’s business culture has been open to outsourcing in general for some years, on the basis of ‘why re-invent the wheel?’ Senior South African commercial executives are happy to delegate the performance of specialist business activities such as treasury to trusted and established expert third parties. It also seems that the country’s outsourcing industry has learned lessons from the experiences of treasurers and outsourcers in other parts of the world and has managed to package its offerings to give realisable business benefits at an acceptable price level. Pricing is typically based around the payment of a contractual monthly subscription fee and may be incrementally linked with variables such as business volumes.
Key Business Benefits
There are several valuable business benefits that are sought by South Africa corporates which operate an outsourced solution – or are contemplating the use of one – for part or all or their treasury operations. The primary motivation is generally reported to be gaining the value added through the expert execution and administrative follow-through in the planning, execution and administration of transactions involving relatively complex financial instruments and processes.
By appointing an effective professional outsourcing partner, the organisation seeks to avoid the expense and effort of establishing an in-house treasury operation. In outsourcing evaluations, prospective clients seek proof that significant levels of operational risk reduction, coupled with tangible cost and time savings, can be achieved. The evaluation project will examine critical comparative factors such as client referencing, objective case studies and the robustness of the technology solution used for management of treasury operations and related communications.
Outsourcing Potential for the Rest of Africa
The South African treasury outsourcing business is an obvious potential source of service revenue in many leading economies across the continent. Profitable economic growth naturally amplifies the levels of treasury risk, especially in exchange and counterparty exposures. In the developing economies, it is the rapidly growing companies in sectors such as raw materials, transport and telecommunications that are experiencing higher levels of treasury risk.
It is generally accepted that the evolution of treasury is being held back in many countries by the lack of forward exchange and internal capital markets. The business potential of many economies will surely encourage international, regional and local banks to collaborate and develop such markets. As this evolution occurs, demand for professional treasury management services will surely follow. Outsourcing clearly offers an efficient fast track for establishing professional treasury operations, and it is quite likely that many African enterprises will explore this option in the medium term.
Conclusion
South Africa’s local business climate and culture have provided a fertile environment for the growth of treasury outsourcing services. There seems to be a happy coincidence of the availability of treasury management expertise, the general treasury business requirements of successful corporate and the cost-effectiveness of potential outsourcing solutions.
Should current economic trends be maintained and general regulatory requirements in the region continue to liberalise, the sophistication of treasury requirements will inevitably grow and outsourcing services that broadly follow the present South African model can expect to prosper.