ROUNDTABLE DEBATE: With prevailing geopolitical and market uncertainties, what steps can treasurers take to mitigate financial risk and optimise cash valuations?

Noel Hillmann: What are your top three cash management risk challenges, as it relates to your role as a corporate treasurer or partner to corporate treasurers?

Tortsen Honnes: Von Ardenne is an equipment producing company with large international reach in both Asia and the U.S. Our cash flow risks are mainly inherited from these regions but nevertheless we are a centralised organisation meaning that most of our production is driven inside our home base in Germany.

We export huge equipment, machines for coating production processes and collect most of our cash from contracts with our customers. We use standard instruments like the letter of credit to secure our cashflow risks in most of our export countries. We also have subsidiaries in the US and Asia.

In certain countries, the availability of classic trade finance instruments is decreasing due to political risk or trade restrictions.

Due to our export focus, currency risk is also one major cashflow risk to tackle. Certain countries (especially in Asia) lately implemented laws and regulation to further restrict currency hedging. In those cases, we try to engage with our customers in those countries and with our subsidiaries to find the best way to mitigate our risks.

Joakim Flinck: We are a business to business focused manufacturer and our main market area is around the Baltic Sea and northern Europe, which makes life slightly easier than it sounds for Torsten!

From a strategic standpoint, credit risk management is still an important issue. We still get insurance on our receivables and when it comes to cash flow management, we have a team focussed on collections who also have a focus on efficient working capital management within the company.

We have also centralised our treasury function five years ago, to be handled in Lithuania. One reason for this was to stay at the forefront of efficiency and make sure that we maintain the standardised, harmonised processes that we have built to ensure that we get the efficiency gains from centralisation and good technological tools that we have invested in.

More pragmatically about cash management risk, we have seen an increased risk of fraud in different forms, with fake invoices and so forth. This is something that we want to keep an eye on in the future, particularly as there will be more digital payment channels and to ensure we minimise counter-party risk.

Another challenge we face in today’s environment, as we are mainly Euro based and are experiencing the Nordic’s negative interest rates. This adds an extra twist to cash management, as some of our banks are charging us money for having money in the bank account!

Christian Debus: The threat of various forms of fraud is an issue that has significantly increased over the past 2 years. Fake President cases are the most prominent in the media but the entire process from master data to bank communication is at risk. In fact, attempts to manipulate master data are the most frequent incidents and much more sophisticated than simply sending fake invoices with the wrong bank account details.

In addition to that, increased compliance with sanction lists and anti-money laundering laws, avoidance of bribery or other legal requirements constitute a serious challenge that need monitoring of cash transactions. Ignorance of all bank accounts of the group companies and insufficient governance of bank account management, decentralised payments in foreign subsidiaries and heterogeneous or outdated bank communication systems, are weaknesses that need to be tackled.

Tighter regulation and increased risk of fraud are leading to a much more complex KYC-process. Banks ask for hundreds of data making the process of opening and maintaining bank accounts cumbersome and tedious.

In addition to that service offering and service quality of banks vary over time which requires treasurers to evaluate their portfolios of banks relationships in regular intervals and to reduce the number of banks and bank accounts throughout the group.

Diverse data formats for transactions are impeding centralisation of payments processing so treasurers have to look for banks that are able to handle standard formats.

Adding to this are changing laws and regulations that change the rules for cash management and payments. Treasurers in Europe have been troubled by the EU Payments Directive and the regulation of money market funds. China tends to change the rules for cash pooling and international payments. So, the second top challenge is the management of bank relationships and direction of their transactions.

The third top-issue follows from the first two: the setup of systems for centralised cash forecasting and cash management as well as payment processing and intercompany netting. These systems are prerequisite for transparency, safety and efficiency. A timely and comprehensive view on the current position and future development of cash, central monitoring and processing of payments, transparency over all bank accounts in the group and improving the cash position, cannot be achieved without capable IT-systems.

Of course, the troubles of negative interest rates should not be forgotten.

Noel: Treasurers and cash managers we spoke to in research stated a strategic aim of their organisation was the releasing of and safeguarding cash in overseas territories. How are corporate treasurers dealing with this issue in a way that minimises operational complexities and costs, given the current geopolitical uncertainties?

Torsten: We finance our group entities on a central level through intercompany loans. We always tried to keep the cash inside our subsidiaries at a low level. As cash backup, we have bank facilities in place. They can be used to fund operations in special countries, where foreign investment is restricted.

We use something called a cross border sublimit with one of our financing banks, so they have a branch in Shanghai and they provide the loan as a cross border supplement to our subsidiary. However, they will put the debt on our credit line here in Germany.

Joakim: Reducing the operational complexity and costs as well as minimising the risk of not being able to make payments where needed, is something that you must balance.

We are not in such jurisdictions where we would expect to get cash trapped. However, we also operate in Russia and we did take measures there when sanctions were put in place to safeguard our local presence and capability to maintain making payments.

Given that we are operating in northern Europe around the Baltic Sea we have put in place automated cash pools with concentration to the treasury accounts every day.

Due to the fact that we have centralised treasury functions and payment making, we have put in place a strategy where we have two banks in every country and we also have two separate systems; a main cash management system as well web banks where we are able to upload payments and files. This helps to ensure that we are able to centralise the cash because we have the tools to make sure that we are capable of making payments in all reasonable circumstances.

Christian: Again, centralisation and transparency are the basic requirements to deal with these issues. Transparency on where the cash is sitting and how much will be needed in future enable the treasurer to avoid excess cash which might be at risk as well as the risk of not meeting cash demand. Cash pooling and intercompany financing as well as payments on behalf and reduction of bank accounts, reduce the cash located in foreign countries.

However, this does not avoid all problems. Cash pooling and payments on behalf do not work in all jurisdictions. Many companies are struggling with the challenge to transfer the excess cash generated in their sales entities in some countries – especially China – back to the treasury centres. Relying on local funding is a way to avoid sending cash abroad, as well as reciprocal lending and some other ways to mitigate the problem. But one will have to live with the fact that the measures applied in Europe do not work throughout the world. Yet, this is a business decision where a treasurer should indicate the risks associated with this, but he will not be in a position to solve the problem.

When it comes to safeguarding cash, I can only repeat what I have said before. When we are reviewing the reasons or threats to payment, fraud in most cases, we find that subsidiaries in foreign countries with decentralised cash management processes and systems pose by far the greatest risk.

Noel: Given capital requirement pressures faced by counter-party banks (BASEL III), what alternative risk management options are the panellists exploring and see other corporate treasurers exploring, for hedging their financial risks? Why and what has been the experience to date?

Joakim: If you look at the financial risks we are facing, like currency risk, we are doing small scale hedging. Our biggest exposure is really translation risk that cannot be easily hedged. We are doing some transactional hedging and we have done this in the traditional form with traditional banks. We have also looked at other options and platforms as well as with parties where you have some limit or collateral based trading. What we have found is that we have reasonable pricing with the house banks that we use. This also means that we have very efficient settlements because we are hedging the actual cash flows, then we are getting in and having to sell those into the market anyway.

From this position, the most efficient way thus far has been to continue with the setup of house banks.

If you look at interest rate risk, we have also hedged this with our house banks and the parties providing those facilities to us.

We are aware of other emerging options but there haven’t been any compelling enough terms for us to consider changing the way that we work.

Christian: During the discussions on the impact the EU-regulation might have on their business – especially the clearing requirements under EMIR and the CVA-charge under the Capital Requirements Directive – many treasurers have pointed out the negative impact that this might have on their risk management strategies. Avoiding hedging of financial risks would be detrimental to the goals of the regulation because it would increase the risk instead of reducing it. Fortunately, there have been exemptions granted to corporates and we do not observe significant changes in the hedging strategies for forex or interest rates.

However, the uncertainty continues regarding the MiFID regulation of commodity derivatives. As the capital requirements under the Basel regulation ramp up over the next few years, we will have to wait and see if any significant impact on the terms of hedges will evolve.

To some extent, corporates can rely on the fact that a bank will consider pricing of deals across the entire customer portfolio and cross-subsidising the various types of transactions. Therefore, monitoring bank fees and calculating shares of wallet as well as keeping up competition between the banks a treasurer deals with, renders transparency and helps to keep the cost as low as possible. It is no wonder that tools like Vallstein have evolved that enable treasurers to assess and benchmark their bank fees. Collecting competitive quotes for derivatives or money market transactions via the technical platforms available, should be standard in every treasury centre with more than an insignificant volume of deals.

Noel: For those organisations who are using hedge accounting practices, how could the use of FX futures benefit their hedging activities?

Christian: In my view, corporates will not be inclined very much to use futures instead of Over-the-Counter (OTC) forwards, swaps or options. One reason for their reluctance to switch to exchange traded products are that they usually match their hedging strategy to the underlying risk which requires tailoring of volume and maturity. The second reason is the clearing and margining requirements which usually go with futures. The potential advantages of better terms are currently not observable, because the capital requirements for banks do not yet take full effect and especially large corporates use competition between their banks to obtain favourable quotes and check these for market conformity with their systems.

However, this inclination towards OTC trades might change with the increasing cost of hedging driven by financial market regulation as well as an evolving futures market that fits the requirements of corporates. So, our advice is to closely monitor the development, enhance ability to check market conformity and monitor banking fees included in the quotes.

Noel: How have your banking relationships changed because of ongoing regulatory changes and what impact is this having on your organisation?

Joakim: In this sense, we are not comparable to other mid-cap companies, because of our ownership base. A private equity company owns us – CVC Capital Partners – which means that we have a fairly high leverage position.

The changes I have seen over the past year, have been connected to regulations and the capital requirements for the banks. There is a division between the risk appetite that was there, with the more traditional house banks having a lower tolerance to risk taking than was previously the case. This means that when we have done business with our house banks we have to separate the traditional funding, which goes more through investment banking partners as opposed to banking partners who are not in that space. This kind of separation can be noticed.

Torsten: We use traditional bank hedging for all those risks that Joakim mentioned, with interest rate and FX being the most important.

We did some approaches but they were more operational, so we tried to figure out whether, particularly in the more exotic countries, it is better to decentralise the hedging in some scenarios Therefore, in Asia, the local financing people do certain FX buy transactions on their own.

For the whole group, the risk would be low, because they don’t have the big nominals that would make a big impact on the group balance sheet but the operational costs, if you take the effort of carrying this out on a centralised level, would be high.

Due to the regulation that was in place, we swapped to making sure that all the cash flows to our subsidiaries will be in their domestic currency, so we have a natural centralisation and risk hedging operation. This is facilitated on a centralised level with our banks.

Christian: Corporate treasurers evaluate their banking relationships not only based on the cost of hedges but on the entirety of their interaction with a bank. With regard to regulation, the service level of banks have troubled quite a number of treasurers, especially with regard to trade reporting under EMIR. On the other hand, some banks have been increasing their service offering especially in transaction banking and we can see treasuries changing their cash pools, payment transactions and other cash management business from one bank to another.

Liquidity in the derivatives market – especially with regards to commodities - has declined due to regulation. This happened either because banks are trying to reduce their risk positions or because they have stopped offering deals because they lack profitability due to greater regulatory cost.

Of course, monitoring creditworthiness of counterparties has become a standard exercise for corporate treasurers and the results of stress testing and the effects of the regulation on the stability of a bank have an impact on the volume of business a treasurer will put at risk with a specific bank.

Therefore, we find that the rigour as well as frequency in which treasurers review their bank relationships and conduct bank selection projects has increased. As a result, the aim is to reduce the number of bank relationships and bank accounts to concentrate the business they do and improve the level of service and attention they obtain.

Noel: Thank you all for sharing your thoughts on this topic.

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