T h e J o u r n a l o f G l o b a l Tr e a s u r y a n d F i n a n c i a l R i s k M a n a g e m e n t

Event risk management

Featured Meeting Summary: The Treasurers Group of Thirty

September Madness: With October Surprises To be Anticipated

By Joseph Neu With madness replacing rationality and base fears trumping risk models as the operating principles in financial markets, treasury professionals are making the best out of hard times. Where to begin? There is so much happening that has never happened or been thought possible, and what is true today may not be true tomorrow. Thus, for many treasury professionals in this financial crisis their response started with a return to base instincts: making sure all the cash they have is safe. This is one reason why cash management banks are talking up new investments in cash visibility solutions (see p. 14). The question then is what besides US government paper is safe as a store of value these days and how do you know (and how do you know you can trust the US government)? With financial institutions failing or at risk of failing, each week, counterparty risk management has gone off the charts in terms of its importance. And finally, as credit markets seize, as they have, first financial institution and then some corporate paper, where does a firm go for funding? It is not merely frightening, it is terrifying, noted one debt capital markets banker, when asked about the current environment. The system is fundamentally broken. If ever cash can be said to trump all other kings, and this is said often, it can be said now. Still, as bad as things are (and they may get worse), treasury professionals that the NeuGroup has interacted with across its peer groups in
Is immediate funding and liquidity an issue? When would it be? Are we over-reliant on short-term funding? How secure is our contingent capital?  Do we have sufficient cash visibility and an

OCTOBER 2008 September Madness

By Joseph Neu

recent weeks have shown that their heads are still in the game and they are working hard to respond in a crisis. Already working intense schedules, the treasury professionals weve spoken with have been burning their candles at both ends, yet they have kept their humor (judging from the reaction to the mock September madness bracket that has been making the rounds, see p. 12). THe Big issues iN focus What follows are highlights from recent discussions with treasury professionals (and bankers) in our network: n Hope for corporate funding. While the situation will worsen and corporate sources of funding, in particular short-term CP and asset-backed sources, are at risk, there is still hope that the crisis of confidence that has caused fixed-income investors to stay away from financial institution paper will not spread in the same way to the nonfinancial sector. While investors with cash, and remember there is still a lot of capital out there, have a flight-to-quality instinct like everyone, not everyone (see below) is going to get all their funds into Treasurys or money market funds made up purely of them (see p. 11). Thus, some may look to diversify into corporate paper. Of course, the front end of liquidity needs to come back before many of the shifts can take place. Still, without liquidity to grease the wheels
Are we comfortable with our insurers?  Are we communicating enough with the Board

September ushered in new extremes to the subprime-inspired financial crisis and treasurers must stay prepared for unprecedented surprises. page 1

Uncle Sam and Fair Value

By Joseph Neu

As the US government steps into so many inactive markets, what will it do to fair value? page 2

Anticipated Exposures
Oversight committees, covenant reminders and dangers in shortselling bans. page 4

Money Fund Concerns

By Bryan Richardson

K e Y Q uestio N s of t H e D aY
and senior management? Do we need an oversight committee?  What communication plan do we have for external analysts, particularly from rating agencies, in response to events?  Have we examined the fair value accounting impact on assets and hedges with non-performance risk in preparation for year-end? What are our upside opportunities?
continued on page 3

Addressing key questions concerning putting excess cash into money market funds. page 11

Banks Investing in Cash Business

By Denise Bedell

emergency plan to repatriate offshore cash?

Where do we put excess cash, safely? How well are we monitoring counterparty risk?  Have we shifted holdings/business to institu-

With renewed appreciation for their transaction services business, more cash banks plan to step up investment in it. page 14

tions with low CDS spreads/scores on our rating matrix?

EDITORs NOTEs
Founding Editor & Publisher Joseph Neu Contributing Editors Anne Friberg, CTP Ted Howard Bryan Richardson, CTP Sandra Shen Advisory Board Andy Nash SVP, Treasurer Ahold Finance Group Mark Rawlins Assistant Treasurer Anheuser-Busch Companies James Haddad VP-Corporate Finance Cadence Design Systems Chris Growney Principal, Director of Sales & Marketing Clearwater Analytics Susan Stalnecker VP Finance, Treasurer E.I. DuPont Co. Peter Marshall Partner, Global Treasury Advisory Services Ernst & Young LLP David Rusate Deputy Treasurer General Electric Company Martin Trueb Senior VP & Treasurer Hasbro, Inc. David Wagstaff Managing Director, US Technology Banking HSBC Securities (USA) Inc. Arto Sirvio Head of Treasury, Americas Nokia Peter Connors Partner Orrick, Herrington & Sutcliffe LLP Robert Vettoretti Director, Treasury and Financial Management Services PricewaterhouseCoopers LLP Adam Frieman Principal Probitas Partners Doug Gerstle Assistant Treasurer Procter & Gamble Susan A. Hillman Partner Treasury Alliance Group LLC Michael Collins Managing Director Wachovia Securities Academic Advisors Gunter Dufey University of Michigan Donald Lessard Massachusetts Institute of Technology Richard Levich New York University The company and organizational affiliations listed above are for identification purposes only. Advisors to International Treasurer are not responsible for the information and opinions that appear in this or related publications and web sites. Responsibility is solely that of the publisher. ISSN:1075-5691 Vol. 15, No. 8 2008 The NeuGroup, Inc. 135 Katonah Avenue Katonah, NY 10536 (914) 232-4068 Fax (914) 992-8809 backoffice@intltreasurer.com www.intltreasurer.com

Accounting & disclosure By Joseph Neu

Is Uncle Sam (Up)Setting Fair Value?

ith the US Treasury having set up the worlds largest distressed asset fund for mortgage-backed securities, after already being in control of the portfolios of Fannie Mae and Freddie Mac, many eyes are on the fair value implications of its next actions. As International Treasurer went to press, not only was the US Treasurys up-to-$700bn Troubled Asset Relief Program (TARP) approved and set to start, but the recovery value on Fannie and Freddies credit derivatives was being set by auction. The latter will put in motion the unwinding of up to $500bn (notional) in credit derivatives naming the two GSEs, now in default. This process, also, will be watched closely by entities needing to fair value illiquid credit derivatives to see if any valid data points are created. Upsetting fair value. Of course, prices set by the US government are hardly fair, since no other market participant enjoys the same borrowing cost advantage and is free from non-performance risk, a tricky part of the fair value equation. So, while on the one hand, the US government is helping to create valuation data points in MBS and CDS, its mere presence in the market upsets price discovery in the purest fair value sense. Plus, it, or more specifically, the SEC now has the option, per the legislation creating TARP, to suspend fair value for any issuer or type of transaction if it determines that it is necessary or appropriate in the public interest and is consistent with the protection of investors. This was a compromise to due process, as many in Congress wanted to nix FAS 157, and perhaps the FASB itself, by fiat. The SEC has been told to study the impact of fair value (FAS 157) and the process of the FASB in creating it and other standards within 90 days of the legislations enactment. Does a counterparty with an option to change the valuation rules count as a fair market participant? And can such a counterparty even participate in an orderly transaction? No definitive guidance exists; but, in a joint statement released by the SEC Office of the Chief Accountant and the FASB Staff on September 30, an effort was made to clarify fair value accounting for assets under duress. The guidance given was that the results of disorderly transactions are not determinative

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when measuring fair value. The concept of a fair value measurement assumes an orderly transaction between market participants, the statement continued. An orderly transaction is one that involves market participants that are willing to transact and allows for adequate exposure to the market [emphasis added]. Given all that is happening, the SEC might want to just call all transactions too disorderly for 157, at least for a while. The FASB wont give in. It may have to, because the FASB is slow to see the writing on the wall. Having promised further clarification, on October 3, the FASB staff released proposed guidance FSP FAS 157-d (Determining Fair Value of a Financial Asset in a Market That is Not Active) for comment (until October 9). In an example depicting how to fair value a CDO in a market that has become inactive (disorderly), the proposed amendment sort of makes clear that judgments are OK in determining fair value. And, one way to read it is that management can make its best guess using all available information (internal models, recent market inputs, broker quotes, etc.), so long as it shows its assumptions. For many, what this will mean in practice is that fair value is whatever regulators or the government says it is. Indeed, more than a few bankers are already expressing the idea that, going forward, fair value means you mark down the asset any way you want so long as regulators dont object. But at least the FASB can take comfort in the fact that such valuations can still be shoehorned into their FAS 157 principles. For non-financial corporates, the situation may not yet be so arbitrary, but if auditors, analysts or rating agencies come after, say, the holdings of distressed agency paper in your excess cash portfolio, the push-back should be the same: this value is our fair guess given this, that and the other thing; plus, it is consistent with what bank regulators are allowing at my bank. Update on FAS 133: While the FASB is issuing advisories refuting reports that FAS 133-R has been scrapped, it is hard to see how it can apply fair value any further to hedge-, in particular swap-accounting, with all the noise about its adverse impact on credit markets.

TVA
September Madness, continued from page 1

money cannot move. Thus, treasurers should take a long hard look at how much they are relying on CP-funding, what they need, and if they need X, they should lower expectations to Y and be prepared to make up the difference. The same holds with other debt issuances, including asset-backed issuances and convertibles. AB issues should be structured extremely conservatively and with terms tailored to lead investors. Plus, with so many arb investors being sidelined by curbs on short-selling and their own liquidity constraints, the uptake on convertibles wont be there. n CP back-stops and new credit pricing. While CP backup lines are likely to be there so long as they are with well-capitalized institutions, going forward most providers will re-price them severely. Banks have realized that this steady business, similar to other types of mono-line insurance, represents a substantial concentration of risk. CP back-stops are probably just the tip of the iceberg with regard to banks reconsidering how they price credit. It may just take a few weeks or months before credit bankers whose natural instinct is to say yes, will be forced to say no to even their best customers. And when the CP-backups stop, or get correctly priced, the CP market wont be the same. Indeed, bankers would like to set expectations now for draw rates derived from CDS spreads. n New credit line commitments hard to find. Several treasurers we have spoken with noted that they are looking for additional credit line commitments (some to replace Lehman) or in expectation of a reduction in commitment from BofA/Merrill. Unfortunately, these treasurers report, there is not much appetite out there at the moment. The one exception mentioned seems to be Japanese banks, which have gone

from some of the worlds worst credit providers to the worlds best in just over a year. In addition to new commitments, treasurers are also looking to reallocate credit commitments based on counterparty concerns, either their own or their credit insurers. Problems with credit commitments should become an ongoing theme as banks are forced by market conditions, or regulation, to stop treating their balance sheets as a loss leader. Whether banks are used as contingent capital or as part of a draw-down, term-out approach to funding, the cost is going to go up. n Watch the rating matrix. Once the funding/liquidity questions are answered, the most important activity for treasurers is monitoring counterparty risk. Almost everyone is talking about their own internal ratings grids, or dashboards (see example on p. 15). These are used to monitor counterparty risk using some combination of changes in CDS spreads, expected default frequency, changes in market cap, changes in rating agency rating, rating outlooks, VAR changes, change in fair/notional value and a variety of other inputs. Every firm seems to be using one with various levels of sophistication. Treasurers are watching them religiously to track counterparties on everything from FX trades to derivative overlays on their pension portfolio. Another matrix of concern is the web of bank affiliates that an MNC deals with around the world. One treasurer we spoke with noted concern about getting explicit parental guarantees from banks for their overseas affiliates. A few noted having provisions already in place in their ISDA agreements to cover this. Their bank counterparties, meanwhile, are clearly also monitoring counterparty risk ever more closely. Banks have added contingency risk, since in the current

As a further sign that firms are stepping up efforts to reduce rating agency fees (see IT, September 2008), we have seen treasurers and their investment managers query each other about their investment policy positions on high-quality paper that is rated by just two of the major agencies (i.e., Moodys and Fitch, but not S&P). Most said they would. Would you invest in me if . . . ? Thus has begun a whole series of new what-if questions that treasurers are asking of each other and their investors to determine how relevant ratings have remained in the current environment. Notably, in responses to the two-of-three rating question several treasurers noted that their answer was at least partly driven by their increasing reliance on Expected Default Frequency and Credit Default Swap indicators, as opposed to ratings. How long before investment policies go from two of three major rating services being required, to none?

RatiNgs Matter Less

continued on page 12

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aNTICIPaTED EXPOsUREs
Risk management

More Internal Oversight Needed?

s companies grapple with the fallout in the financial marketplace, they are evaluating all aspects of their treasury operations to determine how they can better insure they wont be stung in the midst of a hornets nest. Investment-, FXand credit policies are all being reviewed for exposures. But in addition to these activities, perhaps in reaction to politicians calls for more regulation the role of an oversight committee is also being considered. While many large companies have various committees, including risk committees that provide oversight and guidance to the activities of investing, foreign exchange and credit, surprisingly, many other large companies do not. The purpose behind such an oversight committee is simply to provide review and guidance for the most critical areas of a companys financial risk exposure. It can act as an internal regulator, or a simple control over those conducting such operations who might get lost in the trees and fail to see the forest. The role and dynamics of these committees can vary widely. But they generally consist of a handful of senior finance people who are required to meet on a periodic basis to review the status and direction of the operation and quite often provide reporting to the board of directors or at least the CFO and CEO. A quick review of best practice A few best practices items have arisen from a recent e-mail exchange among members of one of the NeuGroups peer groups, including: n Board Authority. Have the board of directors officially establish the committee with a clear mandate and level of authority. We have board-deputized committees for both investments and currency hedging stated the assistant treasurer of a large technology firm. n Develop a governing document for the committee. In order to ensure that the committee does not lose sight of its purpose and expectations, a charter
4 International Treasurer / October 2008
n

document is helpful. The document should address key components of the committees purpose, authority and accountability. As an example, the Ford Foundations charter for its investment committee covers three basic categories: Mission Statement (what their broad purpose is), Organization (who and how they operate) and Roles and Responsibilities (the details of their duties). n Get the right people. Common participants for committees of this nature can include the treasurer, CFO, controller, head of tax, and head of internal audit. We have an investment committee consisting of CFO, treasurer, controller, and head of tax. The committee reviews the investment portfolio policy only and provides guidance, noted one assistant treasurer of a large MNC. n Require regular meetings. A requirement to meet at established intervals will ensure the responsibility does not get lost in the busy schedules of the committee members. We are required to meet at least quarterly but in practice it is usually 2-to-3 times per quarter, stated another assistant treasurer from a global technology company. n Consider specialized committees and schedule according to their needs. Different areas of risk may need to be addressed in a specialized way and on a different schedule. They may also need to adjust to changing dynamics in the marketplace. A senior treasury official of one large technology firm related: We have a credit committee that meets monthly to discuss investment credit lines with the treasurer. We also have a formal hedging committee that meets quarterly comprised of the CFO, the treasurer and an assistant treasurer, to discuss hedging policies/strategies and review any current hedging program in place. n Or, consider an all-in-one committee. With the right people, knowledge and commitment, a single committee covering all risks may be an appropriate approach. There is also benefit to looking at risk holistically rather than in silos. One assistant treasurer commented: Our company has an executive risk management and capital committee comprised of senior finance and operations

executives that meets at least quarterly. The committee regularly reviews investment, FX, insurance, and other financial risks as well as certain capital spending proposals. With investment fraud and failure in the news almost daily, there should be comfort in knowing that a group of seasoned finance professionals are collectively monitoring the risks for the company. Theres wisdom in numbers.
Cash & working capital

Know Thy Covenants

s liquidity continues to evaporate amid a widening and pernicious banking crisis, there have been reports of corporations drawing on their credit lines now as a rainy day fund for situations that may arise later. A recent story in The Wall Street Journal suggests this is happening, and names companies, such as General Motors and consumer goods company Jarden, that are drawing on these lines for fear that a bank may withhold it or be unable to deliver the funds down the road. While this may or may not be a great strategy, experts remind firms to check the covenants first. Thats because banks are looking for any excuse to charge more for credit or even to close a facility (see IT, April 2008). BaNks Have tHe power Despite its considerably weakened state, the bank sector still holds the upper hand when it comes to credit. Basically, for many banks, survival is the primary directive, and they accomplish this by preserving cash. This means that corporations shouldnt give their banks any excuses to deny credit. Corporations ought to be careful because... most agreements give banks a lot of flexibility to in effect call the loan even if there isnt a default, said Bob Wrobel, counsel at law firm Day Pitney. Its better in this environment to keep your good guy image with the bank and dont play hardball because there are an awful lot of provisions in the normal loan

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aNTICIPaTED EXPOsUREs
agreement where either they can find a technical default if they want to or even without a technical default they could do things like change credit limits and things like that. Mr. Wrobel added that these provisions have been built into loan agreements for years but have rarely been used. But these are different times now so it is best that corporations play by the book. StaYiNg straigHt Most companies intend to play by the book when it comes to tapping their credit lines; however, most treasurers review their agreements only about once a year. Whats worse, according to Jim Simpson, managing partner with Corporate Finance Solutions, is that many firms do not have a review process. This was confirmed by the survey he conducted with Bruce Lynn of the Financial Executive Consulting Group, where about 40 percent of 150 companies polled said there was no formal review process to manage debt covenants, whether financial or non-financial. Messrs. Lynn and Simpson also surveyed banks, asking them what they do with firms that come to them revealing theyve breached an agreement. Many say that if you come in and surprise us with a breach, well charge you fees, well increase your spread and some say they may even pull the line, according to Mr. Simpson. So in the current environment it is critical to have agreements studied and buttoned up. For those companies that have a good communication with their bank and understand their debt agreements really well, banks are more than willing to work with you, Mr. Simpson said. Dont go to the banks after the fact and say Oops! because you may pay. Give it Time Messrs. Lynn and Simpson also suggest that companies that know they need to draw on their lines alert the bank ahead of time. Gone are the days where you call the bank and get the funds the same day. The big question is Will the bank have the money when [a company] wants it, Mr. Simpson said. The problem could be that when a bank goes out to its syndicate banks to satisfy a $1bn loan, and it might be the case in this environment where only half of them come up with the money. And if they cant meet your drawdown request, theres nothing you can really do, Mr. Simpson said. Anecdotally Im hearing of banks who are being asked if they can get the money in three days but are telling customers they can get it to them in a week and a half. RaiNY daY fuNd A good idea? Whether or not more companies will draw on funds from their relationship banks just to have it remains to be seen. But given the current crisis and widening spreads, it probably doesnt make sense. There are a number of issues doing this, particularly the negative cost of carry, said Mr. Simpson. Hypothetically, youre borrowing from the bank at maybe 5 percent and what are you going to do with it? Youre going to invest it. But where do you go to invest? In the current environment, the best a company may do is 2 percent, Mr. Simpson added. So its costing you 3 percent to hold that cash. This strategy might make sense in certain situations -- perhaps if youre a net borrower trying to cover payroll, etc. But it is not a good idea if you think the company might face going out of business. The bank can still try to get its money back.
Capital markets

Chinese market regulators chose to announce the start of a trial to test margin trading and short-selling of shares amidst moves by the US and the UK to shut shorts down. In its announcement, the China Securities Regulatory Commission (CSRC) made no reference to its countertrend timing, but did note it as a move to introduce new vitality into its financial markets, the FT reported. In the works since 2006, the timing of the trial is likely more a political shot across the bow. The short-selling, margin-trading experiment in China will be carefully controlled, and only made available with carefully selected brokerages, so shortselling hedge funds are not likely to all pick up and move to China soon. Still, with talk of the global financial epicenter starting to move from New York and London, China is planting another seed for people to start thinking more about the relative position of capital markets in China. Where to the shorts, there to the market.
Counterparty risk

Are Hedge Funds Next?

Apart from pension investments, few corporate treasurers are directly exposed to hedge funds as investors, but the fallout from massive hedge fund failures would have adverse consequences for treasury activities, from FX hedging to using CDS spreads. Hedge funds will be hard pressed to earn the returns and fees that they have become accustomed to in current markets (especially if they cannot short sell), and many face redemptions from investors that have lowered their risk appetite. This will eat away certain funds on the margins. All hail, collateral. However, what may keep hedge funds as market participants viable is the extent to which they were required by counterparties to ratchet up their collateral requirements over the last 13-14 months. Since the funds have been posting margin on daily marks over that period, their risk as counterparties and concerns about their liquidity have been lessened.
n

Following Shorts Into China

espite hedge funds pleas to end the short-selling ban, the SEC has only expanded its temporary curbs. At press time, the ban was covering close to 1,000 stocks, 15 percent of total US listings, ranging from manufacturers and information technology firms such as Ford and IBM. Other market regulators around the world have followed suit, but have so far limited their restrictions more to financial stocks. Running counter to this trend is China. As the Financial Times reported,

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International Treasurer / October 2008 5

Fall 2008 Meeting

FX Managers Peer Group 2

September 1718, 2008

We would like to thank the participants at the Fall 2008 Meeting of the FX Managers Peer Group 2 for their open dialogue and relevant contributions to our discussions. Your active involvement continues to make the FXMPG2 a highly valued contributor to our network of forums for peer knowledge exchange. Thank you!
The FXMPG2 is a NeuGroup meeting alternative.SM

Sponsored by:

Facilitated by:

THE TREasURERs gROUP Of THIRTY

Spring 2008 meeting briefing

Riding Out the Storm

Treasury Responds to a Changing Economic Landscape
Amid a credit crunch, rising input prices and an increasingly relevant offshore vs. onshore liquidity picture, treasury practitioners met in May 2008 at a Standard Chartered Banksponsored meeting in Chicago to discuss ways to meet these challenges, including: 1) Find ways to better utilize offshore cash. With liquidity at a premium and cash piles growing offshore, firms are looking to put internal capital to work. Key Takeaway: Align treasury and tax planning, including the use of tax-advantaged vehicles that help improve offshore capital use. 2) Make the most of limited opportunities to access credit and debt markets. Treasurers need to be proactive in taking advantage of all windows of opportunity to access funding. Key Takeaway: Re-assess the tradeoffs between various types of debt; i.e. bank lines vs. debt issues or short- vs. long-term debt, etc. 3) Shift risk-management priorities due to increased risks. More must firms reconsider their strategic exposures, resulting in new ways to mitigate supply-chain risks and costs. Key Takeaway: Rising input prices may require fundamental business changes, while increasing expectations to manage risks with more available hedge tools. 4) Dont exceed your cash investment mandate. Resist yield temptations that will trigger Board fears of headline risk. Key Takeaway: Be sure to have the expertise to identify risks in your cash portfolio before they result in earnings surprises.
Sponsored by:

Maximizing Funds in Light of Offshore Cash

With the increasing need for liquidity and uncertain debt markets, T30 members were looking again to solve the puzzle of how to best tap offshore cash, tax efficiently, and address their domestic liquidity deficits effectively in debt markets. KeY TakeawaYs 1) Look to alter repatriation tax penalties. In this regard, as one member noted, a key challenge is how to bring money back without tainting tax deferrals. This firm has repatriated some cash and changed its effective tax rate percentage in the process in order to repatriate more. Going forward, the repatriation analysis increasingly needs to factor in the remaining offshore cash and how you can take the pressure off that cash becoming tainted [under APB 23]. 2) Tax-treasury coordination as important as ever. Another member reiterated his recommendation that treasury bring in a highly qualified tax person to help manage this delicate balancing act. And it helps if that tax person reports to treasury, as in his case. He informed the group of a recent meeting he had with a peer member where he learned that they had 12 tax people in treasury. They report to the tax director, but their whole mission is treasury, and one of the things they are charged with is increasing utilization of

offshore cash without tainting the deferral. 3) Watch out for accounting challenges on interco loans. An interesting issue that one member firm ran into in conjunction with a merger was the different accounting views the two merging firms had on interco funding in foreign currencies. If the loans are characterized as long-term, according to the firms treasurer, you dont have to hedge the FX risk on the cash flows. It is OK to make payments, but you want the [principal] amounts to look large so they dont look like they can be paid off in a year or two. But the auditors of the company his company merged with said that these were short-term loans, he noted. So you may have to sell auditors on the idea that they are long-term. Also, external debt can offset the interco loan if the affiliate receiving the loan is not profitable and cannot repay the loan (if characterized as long-term). 4) Bank-line pricing OK. Several members reported being pleased with pricing on recent credit facility negotiations with banks (though most of those pleased were not renegotiating after February). For example, at one firm, where the major funding issue is bank lines to help cover compensation, treasury was able to increase the credit facility at pricing levels similar to three years ago and we are happy with that, the treasurer noted.

Many US states are and looking to find revenue by

practically bankrupt

attacking [corporate] tax-favorable structures.

T30 member

Facilitated by

For more information: www.NeuGroup.com

2008 The NeuGroup. This information is sourced from the Treasurers Group of Thirty.

PEER INsIgHT: T30

ReacH out to taX autHorities However, while dearer credit may not always show up in pricing, it will certainly show up in other aspects of bank relationships. 5) Still, certain credit departments may flag you. Pricing aside, certain members reported that banks participating in a facility got cold feet when asked to re-up due to the increased sensitivity of their credit departments to protecting hard-hit bank balance sheets. This experience was most common for members that tried to do something from February on, particularly when they were looking for term out options. For example, one firm faced a credit department red light from a bank in mid-March, when it was looking to term out its facility from one to five years. One large bank in the facility, representing some 17 percent of a $350mn-plus facility said no. That amount for "used to be a rubber stamp." 6) Timing is critical, so be proactive. Anecdotes like these underscore the importance of timing in renegotiating credit terms. In the current environment, treasurers have to anticipate credit needs and negotiate proactively. One member who presented on his revolver negotiations made this point about seeking credit when it is not perceived as needed: At first glance, it is hard to see why [our] firm with 80 percent operating margins would be all that concerned with its revolver. Whats more, the firm has very low debt and is currently only halfway through its share repurchase authorization. However, it was planning ahead of its liquidity needs and wanted ample funds on hand to move forward with any M&A activity that would help it grow. So when the firm looked at liquidity in its capital structure, it took a 10-year horizon and started planning its liquidity needs using Monte Carlo simulation. These simulations resulted in a high level of confidence that it would meet its funding requirements over the next few years. It has modest CAPEX expenditures driven by spending on its HQ expansion and related infrastructure. Projected cash flow, existing cash and revenuebarring any issues, such as a patent problemshowed creditors a high probability that it would avoid a liquidity event, which is also why the firm has been deploying cash to buy back shares. CONCLUSION: It's more important than ever to assess your funding needs. Several members reported being in the debt markets recently in hopes of shoring up liquidity in the midst of an ongoing credit crunch. The majority of members felt fortunate that they had gone into the debt markets last year. The importance placed on having critical funding needs addressed reflected members expectations that debt markets would be on a rollercoaster over the next 18 months, meaning any new funding would need to be timed to increasingly volatile market windows or creatively sourced.

With more cash being thrown off from offshore operations, MNC liquidity has also become more vulnerable to changes in tax rules and interpretations thereof. While this is another reason for tax and treasury coordination, members stressed that it is also a reason to enter into dialogue with tax authorities in key markets so that they know what might be coming and can figure out how to address the changes. Canada, for example, has fundamental tax changes every few years and big changes are coming this year. China is also on many radar screens. Dialogue can be extended to advanced negotiation. For example: A key area of concern for many members is with transfer pricing, particularly that concerning special incentives US firms have with China, which the IRS is investigating. Being proactive is critical. One member firm participates along with 30-plus companies in a compliance assurance program (CAP), whereby the IRS audits the tax books in real time and signs off on them.

Percentage of respondents increasing the amounts of funding from key sources

Tapping offshore cash CP LT debt issuance Asset sales Non-$ debt issuanc ex-US Structured finance US term debt issuance ex-US WC ex-US Bank financing 25% 25%
Source: NeuGroup Peer Research 2008

FUNDING SOURCES ON THE RISE

50% 46% 35% 33% 33% 29% 29%

8 International Treasurer / October 2008

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PEER INsIgHT: T30

Responding to New Risks: Rising Prices
Members have continued to express their fears that the economy will continue to decline as inflation risk continues to rise. While at the time of the meeting, inflation was just starting to come on the radar screen after a period of deflation, key retailers were expecting inflation to become a larger issue by the end of the year. Other members concurred, pointing to rising labor costs in places like China, where as consumers they also have more money to drive up the price of consumer goods globally. Their demand for better living standards will also boost commodity prices, which was viewed at the meeting as already having impacted oil and agricultural goods. KeY TakeawaYs 1) Familiarity will bring finger-pointing. As more investors, from private equity to pension funds, become familiar with commodities as an asset class they are likely to raise their expectations regarding how firms manage commodity exposures, and investors will not allow them to blame commodity price increases as a reason for earnings surprises. Along with investors, rating agencies are becoming increasingly focused on firms ability to mitigate financial risks, which now includes commodity risk. Many academic studies showing how risk management benefits share price multiples for companies point to risk management efforts as a reason one company performs better than its peers. The most common examples are found with FX, but commodity risk is becoming more common, such as airlines and the management of jet fuel exposure. Unfortunately, as a few members noted, some of the finger-pointing may come from efforts to hedge. Because of the way FAS 133 forces firms to account for commodity hedging, more hedging strategies (compared with FX) must be marked to market and thus can generate significant noise in the P&L for companies with large exposures. The problem will intensify when commodity prices fall. 2) Get treasury involved to focus on liquidity risk and controls. Despite the accounting and short-term earnings pressures, most members conceded that managing commodity risk would make economic sense. To manage it successfully, however, treasury should be involved either directly or indirectly. What dooms most commodity programs is liquidity risk, thus commodity risk management should not be buried in procurement, which is not part of a firms day-today liquidity management. Also, members noted that if you compare the processes and procedures surrounding risk management activities at most firms, you will find good ones around FX and interest rates, but fewer around commodities. ISDA agreements, for example, tend to leave out provisions for commodity contracts. 3) Consider as an investment asset class. With more and more investors turning to commodities, treasurers might also consider them for pension or even cash portfolios. As commodity markets grow and deepen, there is an increasing array of more standardized, index-based products that make it easier to participate in the asset class while being diversified in terms of contracts and counterparties. One decision is how much to tie commodity exposure on the investment side to agricultural commodities versus energy or metals. Different index products will let investors mix and match depending upon their view. Investors worried about the volatility generated by hedge funds and other speculators should note that the futures markets, as one member pointed out, are increasing their limits and margin requirements in order to curb speculative activity. Going forward the liquidity constraints on speculators will be more of a challenge and the exchange-traded markets, in particular, will become friendlier to volatility-averse corporate investors and hedgers. CONCLUSION: With unprecedented rises in commodity prices and renewed fears of inflation, member firms were also reprioritizing their risk assessments. Gone are concerns about being under-leveraged, having been replaced by worries about available liquidity; and without access to ready capital, cash investment losses, and rising input costs loom larger. If the top line stalls due to a further economic decline, more firms will be under pressure to manage rising input prices, including hedging commodity risk. In so doing, they will become more like their Asian counterparts, whose appetite for managing risk seems
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n

One session at the meeting discussed trends in ERM and FX portals. The key ERM theme was customization: how firms choose to integrate risk to be managed under an ERM framework should be determined by what best fits the culture of the company, not some standardized, best-practice framework that is onesize-fits-all. The same can be said for who leads it. For example, of the members at the meeting with ERM programs, half said it was being led by internal audit and half by treasury. For the FX portals discussion, practitioners revealed that they are looking beyond FXall. The reason behind this trend is that, perhaps in part as the novelty of electronic trading and STP have worn off, the focus has shifted to value for money, or purely cost. The two leading alternatives on the FX side appear to be 360T and Bloomberg.

ERM & FX Portals

International Treasurer / October 2008 9

PEER INsIgHT: T30

SupplY cHaiNs & liquiditY issues

Investment Management with Internal Capital Needed

insatiable. One member company took peer group colleagues through some of the lessons his firm had learned in dealing with cash investments during recent turmoil. over-collateralized and money good, the mark-to-market losses were there and the resulting impairments would have impacted earnings, so it was better not to hold them. You learn the value of a skilled technical person, the treasurer noted as an outcome of the crisis. They can save you a lot of money, if you have a lot of cash. Taking this lesson to heart, members should ensure they have the personnel in place if they want to seek extra yield in anything other than squeaky clean paper. The problem will only get worse as FAS 157 gets implemented and firms consider how they will price an asset class before they consider allowing it in their portfolios. 3) Liquidity needs also driving capital preservation incentives. Weighing the risks in the current environment along with liquidity needs, the company was also adjusting its investment policies to shorten duration. Like other members it was also looking at changing its allocations toward conservative assets like time deposits and agencies and even dropping asset-backed holdings altogether. The company has most of its liquidity offshore, cash that it may move onshore, as it has done recently; so it has also been rethinking the idea of core cash being onshore and more structured excess cash for the offshore portfolio. CONCLUSION: It's never a good idea to wait until the Board's attention is diverted in your direction to start getting prepared. Have a skilled team that understands this and one that is also able to navigate the market and prep your portfolio for possible worse times.

KeY TakeawaYs 1) Boards wake up to investment portfolio in a crisis. One of the clear lessons from the problems in fixed income securities brought on by the mortgage crisis, according to the firm's treasurer, is that Boards will suddenly start to take an interest in the risk in corpoKeY TakeawaYs rate cash portfolios, and their main focus will 1) Note the pressure be seeking to avoid headline risk. While on smaller suppliers treasury can take numerous steps to educate and buyers. As bad as the Board on its investment policy and the it is for T30 members, mandates it seeks to balance yield enhancethey should fully conment with risk/earnings volatility, much of sider the impact of this will go out the window in a crisis, so it is actions to squeeze their balance sheets on best to err on the side of risk mitigation. suppliers and buyers, 2) Having a technical person on the particularly small- and investment management team who undermiddle-market enterstands this is critical. The treasurer credits prises (SMEs). his investment manager for being experi2) Take credit risk enced enough to be on top of news that into account across the affected key investments in the portfolio and size spectrum. While SMEs are hit the hard- get the companys money out before they were hurt. Being a good technical manager est, credit risk should also means he understood the corporate be a consideration across the spectrum of investment dynamics, including Board sensisuppliers. tivity to headline risk. For example, the com3) Banking partnerpany had in its portfolio significant exposure ships under accountto equity-linked paper that went from AAA ing scrutiny. The to single-B in three days. The dynamics of viability of bank facthe waterfall meant that some tranches were toring/inverse factoronly getting 40 cents on the dollar if sold ing-related programs immediately. While on a hold-to-maturity in the US have come into question and may perspective, the company's positions were
end up back on the balance sheet as debt.

Given the liquidity and funding concerns of the member firms, and the economic pressures being felt on their suppliers, it stands to reason that more treasuries should consider reviewing their firms supply-chain finance initiatives.

T30 Conclusions & Next Steps

While all the members had been responding in various ways to the credit crunch and softening economic situation, all agreed that they will have to be more proactive going forward with all aspects of managing the balance sheet. Capital structure leverage clearly is no longer the topic du jour, as one member mused. And while buybacks and dividends may be impacted by tax rate changes after the election, that does not mean members can simply allow their firms to de-lever and
n

To LearN More
Contact: Joseph Neu 914-232-4069 jneu@neugroup.com or Sandra Shen 203-353-1151 sshen@neugroup.com

hoard cash. Treasurers will face major questions if they sit around and do nothing for four years and watch 40 percent of their balance sheet become cash, this member noted. NeXt MeetiNg
The following topics have been suggested, so far, for the next T30 meeting: Credit markets: where to we go from here? M&A on their effect on treasury Treasury benchmarking: whats world class.

10 International Treasurer / October 2008

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INvEsTmENT MaNagEmENT
Risk management by Clearwater (see IT, September 2008) is very attractive but it only includes two funds reporting once or twice per month. n Are bank funds or independent funds better in a crisis? When investment managers consider the relationship approach to being careful they say they get much better service from independent funds. This may have something to do with the way they are compensated: they are motivated by the portfolio results and not just new asset growth. However, some treasury investment managers believe that there is more counterparty comfort in going with bank-owned funds, particularly if they favor institutions showing the lowest CDS spreads or deemed too big to fail: e.g., Citi, Wells Fargo and JPMorgan. Burned by the lack of bank support in auction-rate securities auctions, however, some fear a similar support failure could also result should banks be called upon to support the NAV of their money market funds as they grow larger. n Will settlement risk concerns curb portal use? As rate shopping has grown less important, the convenience of MMF portals has given way to concerns about settlement risks as money funds close and investors seek redemptions. With a portal there is one more layer between you and the fund. Another disadvantage to portals is the lack of daylight overdrafts, thus an investor needs to get out of one fund and collect his money before purchasing another fund. n Where to go for safety and returns? With US Treasurys paying almost nothing, money fund investors are looking at government-backed agencies or abandoning paper from the financial sector altogether. One option is corporate paper, in particular the purer industrials. But the opportunities are limited due to the lack of qualified issuances, particularly in shorter durations. For instance: Caterpillar recently issued for 3-5 years at 300 bps over T-bills, but what cash investors want are terms under 360 days. If you can find industrial paper inside a year, its a pretty safe bet, noted one treasury pro. Hey, if every cash rich corporate would invest in another less fortunate ones short-term paper, then maybe the corporate sector could keep itself going until the banks start lending again.
n

Top MMF Concerns for Treasurys IMs

By Bryan Richardson Nuts and bolts issues for treasury investment managers in an intensifying crisis in money markets. While waiting for the US Congress to pass a plan to rescue both credit and money markets, treasury investment managers at non-financial corporations discussed some of their key questions concerning money market funds in a NeuGroup-facilitated conference call. Here are some of those they sought to address in the aftermath of the Reserve Primary Fund breaking the buck. n What are the details of the government decision to insure money-market funds? The US Treasury Department and Federal Reserve announced a number of programs in September, including actions aimed at stemming the flows out of money market funds perceived to be at risk. The objective of the insurance program to be put in place was to stem the tide of fund outflows in a panicked flight to quality without creating competition with bank deposit insurance. According to Evergreen Investments, the insurance program would be put in place for one year to guarantee payment to investors in a participating money market fund should the net asset value (NAV) fall below one dollar. To help protect funds from dipping below a $1 NAV, the US Federal Reserve would provide a lending program to enable banks and other financial institutions to purchase highquality asset-backed commercial paper (ABCP) out of money market funds. There are a few important details about Treasurys insurance program that treasury investment managers must be aware of: 1) the program is voluntary, so investors must ensure that their funds are participating to benefit; 2) the program is limited to 2a-7 funds and excludes government and agency funds; 3) while the insurance has no cap, Treasury will cover the shortfall in NAV only when a fund has been determined to be liquidated; 4) there is no coverage for anyone investing in the fund subsequent to September 19. Many money fund observers believe that once major 2a-7 funds start to participate, all will avoid the perception that their holdings are not money good. ICD, a prominent money market fund portal, plans to highlight which of their participating funds have the insurance. n Should cash investment managers focus on shopping for new money market funds or watching each of the individual holdings in the cash portfolio? While some cash investment managers were busy shopping around for the best safety/rate combination, others were focused on the relationship element with fund managers to pull out any problem assets from the portfolio. For many, shopping for new funds has been a frustrating exercise in trying to shoehorn cash into Treasury-only funds that are increasingly reluctant to take it. The alternative is a careful approach based on building a strong relationship with their money funds managers and a corresponding comfort level that they will do the right thing in periods of stress. Doing the right thing means they are going through a painstaking review with corporate clients monthly (or even weekly) to ensure that no SIV-holdings or other non-pure assets have sneaked into some funds though the back door. This process is too time-consuming to be applied to too many funds. Plus, cash investment managers that take this approach will have little time left to shop for new funds. We spend more time on the credit of individual names in the external portfolio. There is no time to research new funds, cited one treasury investment manager. Better fund transparency would help, but while fund transparency is important and advantageous, it is very time-consuming to review the myriad of holdings within the many funds a large company may own. The transparency tool offered

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International Treasurer / October 2008 11

TVA
September Madness, continued from page 3

Credit risk can be tracked in a variety of ways (see below): 1) Create a betting pool. Borrow from a sports book (left; and perhaps assign probabilities from the bets made) 2) Create a dashboard. The sample from Royal Dutch Shell (right) combines: Credit Default Swap pricing, used to reflect current risk perceptions in the market. Many treasurers use daily quotes (or calculate default probabilities) to compare relative risks. A Statistical Approach including current market value of company assets. Moodys KMV predictive modeling, for example, includes asset volatilities, equity price and credit data history. Enhanced Ratings: Current ratings are still a valid source of credit assessment, however, they are slow to change; thus ratings outlooks should be part of the risk picture.

Two Takes

illiquid market, trades are more likely to have turned against clients. n Staying with AIG. Many treasurers noted that they have significant insurance coverage with AIG. All those we spoke to about this said they were planning to stick with AIG for now. One company renewing recently noted that it asked for and received a ratings trigger that allows it to replace AIG without penalty, however. There were also some questions being asked about New York allowing asset shifts to the holding company, which AIG made before the government bailout and the scrutiny surrounding this. Given the D&O coverage AIG provides, treasurers who negotiate it sounded confident that key concerns are likely to be assuaged at the Board level as their Board members communicate with those at AIG. n Non-performance risk and other fair value accounting a looming nightmare. Given the ongoing accumulation of non-performance risk, and confusion surrounding the (a)symmetry in the recognition of a bank counterpartys nonperformance risk versus the corporates own, treasurers are not looking forward to accounting in line with FAS 157 at year end. The list of fair value accounting concerns does not end there.

They extend from the FX hedging portfolio, to impaired assets in the investment portfolio, and on to the derivative overlays used to manage pension funds. Treasurers at non-bank firms will likely be joining their bank treasury peers in calling for relief from FAS 157 (see p. 2). n Offshore cash questions. In a carryover from peer group meetings the NeuGroup conducted in the spring (see IT, September 2008 and p. 7), treasurers have reported continuing questions from rating agencies concerning offshore cash and more serious discussions with senior management and Boards regarding repatriation. Near-term expectations for an HIA 2.0 have lowered, if anything; though the recent IRS relaxation of rules on borrowing from offshore affiliates (from a 30- to 60-day window) is encouraging. n Communicate, communicate, communicate. Internal communications are on the rise, becoming more frequent and more detailed, according to treasurers. This is in line with crisis management 101: the more communication the better. One treasurer we spoke with noted that the latest monthly report on treasury activities to the Board was the longest it has ever been. Other senior treasury professionals noted

T W O TA K E S O N C O U N T E R PA R T Y R I S K M O N I T O R I N G
SEPTEMBER MADNESS
Goldman Sachs / Berkshire Hathaway Wachovia / Citigroup Merrill Lynch (bye) Merrill Lynch / Bank of America Washington Mutual / JP Morgan Chase The Bailout Fund / The U.S. Congress Barack Obama / John McCain Washington Mutual / PNC Mortgage JP Morgan Chase / Bear Stearns The Queen of England / Northern Rock HBOS / Lloyds Morgan Stanley / Mitsubishi Barclays Lehman Brothers / Barklays
Courtesy of Spumonti

The U.S. Congress

Bank of America

JP Morgan Chase

Countrywide / Bank of America The U.S. Federal Reserve / AIG Wells Fargo (bye)

The U.S. Federal Reserve

The Queen of England / Lloyds

FHFA / Fannie Mae

FHFA FHFA / Freddie Mac

Freddie Mac (bye)

12 International Treasurer / October 2008 For additional information visit iTreasurer.com

TVA
making senior executive or Board-level reports on the day of each new crisis and issuing followups three days after. ERM risk committees were also cited as a communication clearinghouse that has proven useful. More firms are thus considering oversight committees of some kind to provide internal governance (see p. 4) and coordination of compliance with new and existing policies and procedures in response to the crisis. TVA , CYA, or SOL Effective communication, working hard to answer the right questions and staying in good spirits will only carry treasurers so far, however. Arguably the value added by treasury will never be higher for most firms than it is right now. And, it is moments like these that separates: 1) The TVA treasurers who have added value to their firms by working with the CFO to be in a position to weather a perfect financial storm like this one; 2) The lucky CYA treasurers that can cover their backsides fast enough to stay in their jobs; and then there are 3) The SOL treasurers who just will be shown door (along with the CFO) once senior management and shareholders realize that they positioned the firm poorly from a capital structure and liquidity standpoint. Our hope is that most of the treasury practitioners reading this, and certainly the ones that participate in The NeuGroups peer network fit into the TVA category. But, not all treasurers will. Perhaps what is terrifying capital markets bankers is the belief that the capital structure problems that brought down certain banks, including too much reliance on short-term funding to cover leveraged asset positions, will start taking down non-bank corporates, starting with those with large finance companies. As one market observer noted, this situation is going to shed a light on weak treasury managers and their CFOs. Unfortunately, there are many of them that have shown themselves to have a relatively unsophisticated understanding of financial structures and have put their companies in an extremely compromising position. As some of the compromised get caught out, outside of the financial sector, this will put even more pressure on all treasurers to get ahead of the curve by communicating convincingly that they are not in a similar position to peers in trouble. Capital (most especially cash) will help. Libor iN TraNsFer PriciNg
Transfer pricing is of growing concern to treasury (IT, August 2008), and LIBOR volatility and spreads over Fed rates are wreaking havoc on MNC efforts to set revenue-neutral transfer pricing on interco loans. In a session at the recent EuroFinance, Philippe Vyncke, a partner in PWCs Belgian tax consultancy noted that firms can: 1) Play it safe and stick with the policy document rate, e.g., the 1-month local-currency LIBOR, no matter its gyrations; or 2) State that the rates are temporarily irrational, and use a reasonable rate to be set by treasury, e.g., the prior months 30-day average rate. The latter approach will invite the ire of auditors and taxmen, so take extreme care to document the approach and why a change has been made.

T W O TA K E S O N C O U N T E R PA R T Y R I S K M O N I T O R I N G
C O U N T E R PA R T Y R I S K D A S H B O A R D
FX Deals - Period to Maturity 0 to 6mth Barclays Bank BNP Paribas Citibank Credit Suisse Deutsche Bank Goldman Sachs International Merrill Lynch (B of A) Morgan Stanley Standard Chartered Bank UBS AG Acceptable risk Cautionary risk Higher risk 7 to 12mth 13 to 24mth 15 to 36mth 37 to 48mth 49 to 60mth 60mth + FX Total Invest 0 to 6mth Invest Total Grand Total Moodys Rating Current Aa1 *Aa1 Aa3 *Aa2 Aa2 Aa1 Outlook negative stable negative stable stable stable Alert R G R G G G KMV: Expected Default Frequency 1 Year CDS Spread (bps) 160.7 52.1 418.9 42.7 107.6 650

Aa2 *A1 A3 Aa2

negative stable stable stable

R R R G

102.6 1919.4 76.2 186.7

Numbers indicative only. Template Courtesy of Royal Dutch Shell.

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International Treasurer / October 2008 13

GLOBaL CasH MaNagEmENT

WHat CasH baNks are iNvestiNg IN Bank relations

Recent comments indicate investment in these transaction (cash) services at the following banks: Citi: Focused on improving and strengthening infrastructure, continuing to innovate, and broadening the distribution footprint. Specifics includes TreasuryVision, digital signatures technology and BankingVision (a banking platform to be launched in 2009). Citi Global Transaction Services has more than a $1 billion annual budget. JP Morgan: Recently announced a $1bn plus investment program aimed at the launch of single global treasury platform, expansion of payments offering, financial supply chain, prepaid card expansion, and extension of its online A/R offering. Deutsche Bank: Investing in financial supply chain, including trade and supply chain finance, launched FX4Cash (a cross-border payments and foreign exchange solution) and just announced launch of new p-card business. Budget continues to increase in line with growth expectations. HSBC: Investing in payments infrastructure around SEPA and other regulatory developments, integrated payables and receivables platform (Lionheart), launching an integrated supplychain platform. Recently approved largest budget increase in many years for transaction banking unit. SEB: Investing in liquidity management, cash visibility, customer service platform, and payments infrastructure. SEB also partners with external IT providers to bring new technology to clients, alongside internal investment.

Banks Investing in Global Transactions Businesses

By Denise Bedell With everyone facing a horrific credit environment, the annuity stream from transaction services business has become so deeply appreciated by banks as to warrant new investment. It used to be that product heads of transaction banking services would deliver a healthy and steady stream of revenue to their banks yet get little appreciation from their superiors who encouraged higher returning, albeit riskier business. Today, however, the transaction banking world is in a state of change, as the fallout from the credit crisis, including the most recent round of failures and banking mergers, begins to be felt. As a result, the annuity stream offered by transaction banking (including cash management, payments and trade) is not only being appreciated, it is warranting new investment as other sources of earnings fall from the table. This could be good timing for their corporate customers, who themselves are reeling from the fallout of tight credit markets and the need to balance their external liquidity requirements with the desire to improve the efficiency of internal liquidity resources. A Silver LiNiNg iN tHe Crisis? While no transaction banker welcomes the current market situation, if forced to find a silver lining, it is that transaction banking has become a beacon in the dark waters faced by many banks. According to Andrew Long, group general manager and head of global transaction banking at HSBC, from a group-wide P&L perspective every bank is looking at where they are making revenue and where they are losing money. With a high degree of volatility in earnings, they are looking at what is keeping the ship running. And the answer is transaction banking. For David Conroy, Americas head of trade finance and cash management for corporates at Deutsche Banks Global Transaction Banking unit: Recent events have just made the focus and priority of the transaction banking business even greater. Stable revenues that grow organically are particularly important right now in the financial institution space. Erik Zingmark, global head of cash management at SEB, concurred: Although it is unfortunate that it took the current crisis to show the value of our business, this was probably the single most important thing that has happened to our area . . . a leap forward in how transaction banking is viewed in the bank world.
n

Of course, the renewed interest in transaction services is not driven solely by banks. As David Aldred, managing director, co-head of corporate sales EMEA at JP Morgan noted: Clients have stressed the importance of improving their supply chain in order to access trapped cash, and they are looking for us to help them mobilize cash so they can ultimately make investment decisions around that cash. Never has it been more important for corporates to have that visibility over cash. Realities tHat staNd iN tHe waY While milking more from the transaction services annuity stream at a time when customer demand for it is high sounds great in theory, there are several realities that stand in the way. n Not all banks have capabilities that they can instantly scale up. Because many transaction banking units faced a struggle to compete for internal resources, these resource-intensive units often received only the investment that was absolutely necessary and often required for core infrastructure and compliance needs. Transaction banking has a strong history of annuity earnings, but it requires heavy technology spend which restricts access to a limited number of providers. In addition, there is a limited base pool of expertise in the field, which can limit growth. Thus, more banks will be investing to catch-up to their (remaining) competitors than investing to keep their lead. Any bank that wants to compete must invest in this space, corporates expect us to. We are working with corporates to try and deliver value and the question is what banks will be able to continue to do that as the market continues to evolve and deal with the current situation. David Aldred, Managing Director, co-head of corporate sales EMEA at JP Morgan. Ability and will are two different things. The challenge most of the transaction services organizations within banks face is getting the investment money needed to stay competitive, noted SEBs Mr. Zingmark. To make the necessary investment in transaction banking, he explained requires a longer-term perspective: Over a three

14 International Treasurer / October 2008

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GLOBaL CasH MaNagEmENT

or five year relationship, then you can create good value on that investment. Also, while the situation is changing, there is still the psychological challenge we face to get that complete long-term understanding, Mr. Zingmark noted. This will be doubly important when the current moment passes and internal competition from other areas of the bank with shorter payoff horizons resumes. n Not all competing projects are gone. While it is true that competition for resources has eased, it is far from true that banks have only transaction banking to think about. And before transaction banking services can be improved there is much to sort out from ongoing market events. Several of the largest transaction banking players have been and will be involved in hastily agreed-upon acquisitions of other banks, and the fallout from bank failures is still to be felt. For example, WaMu had correspondent banking requirements around the world that will be affected by its failure. The competing bids for Wachovia by Citi and Wells Fargo will also have a profound impact transforming not only these banks, but the US transaction banking landscape. At the same time, all the big banks continue to face huge required investments in their transaction services businesses to comply with regulatory and legislative initiatives that have not gone away. There is SEPA in Europe and the Payment Services Directive in the UK, which has forced massive investments in payments infrastructure for every bank operating in Europe. Whether they put through 100 transactions a day or 1000, the infrastructure investment is the same. Then on the investment side there is MiFID and Target 2 Securities. All affect the cost of doing business and leave less for other developments. n Not all customers will get access to better services. Recent market events will have a profound impact on corporate-bank relationships. From a corporate perspective, the struggle to manage transaction banks has just gotten more difficult. Ensuring adequate liquidity is a prime consideration right now. At the same time, ensuring liquidity providers will be around for even the short term is an even bigger concern. In other words, credit (funding and credit risk), not transaction services capabilities, still drives relationships. Banks, meanwhile, must be evermore careful about the corporates they provide balance sheet to. Mr. Long at HSBC noted: In the current market you have to look from a risk perspective at who your clients and suppliers are. While banks want more business from both corporate and institutional customers as they rebalance their risk profiles, he added: When looking at cash management customers, we have to look at transaction flows in light of the credit quality of that customer in order to keep flows in balance. And in addition to credit risk concerns, going forward, the earnings contribution of transaction services will be closely scrutinized. Noted one transaction banking head: The ability to allocate capital to my corporate customers is directly related to the stable business growth that we can achieve in transaction banking. Seen another way, as the wallet opportunity of existing relationships begins to play a bigger and bigger role in bank decisions to provide balance sheet, more customers will be asked to pay up for transaction services, if not also the credit directly, or take their business elsewhere. n More corporates are looking to improve their own transaction services. While transaction services from banks are needed, they only go so far. As one global cash manager noted: Our banking partners are proposing several value added services related to cash. . . However, they do not solve the problem of data aggregation in our ERP system where this information is more useful across several business units. For this reason, he said, his company is leaning more toward data-warehousing within their ERP and utilizing database analytics tools to run very similar reports to the bank products. The advantage is that it allows the company to populate all banking data into its ERP system as opposed to utilizing several different proprietary bank systems. This approach should only get easier as more corporates join SWIFT and there is further advancement of standards. In other words, for some new services the investment by banks must complement what corporates are doing on their own. Further, as corporates find alternative ways to gain cash visibility and manage liquidity, the value added elements of transaction services may lose some appeal. Thus, banks should ensure they truly understand their customers needs before investing. As one global cash manager pointed out, the more important thing for banks to get right is the transaction processing itself. Weve looked to our banks to provide consistency in transaction processing in the current market situation, and their ability to maintain this annuity stream is dependent on their timely processing of transactions in good times and bad.
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n

With other banks investing to step up their global transaction banking platforms, will Citi, which has traditionally been able to rely on its global transactions banking footprint, invest to maintain its coverage lead? Senior management is committed to this business as part of the universal bank model, noted Michael Guralnick, global head of sales for Citis Treasury and Trade Solutions Unit. They see Global Transaction Services as an investment destination within the company, and understand that we must continue to innovate even in this challenging time. According to a recent survey by Treasury Strategies (highlighted in the September issue of the UK publication FX&MM), while Citi is among the top three transaction banks used by large corporates in the US, Asia and Europe, it is only number 1 in Asia (and tied; see below). If accurate, this survey would suggest more investment in GTS is a good idea. Rank Asia 1 Citi 1 Standard Chartered 1 Maybank 4 HSBC Europe 1 RBS 2 Deutsche Bank 3 Citi US 1 Bank of America 2 JPMorgan Chase 3 BoNY Mellon 3 Citi 86 62 42 42 29 28 25 28 28 28 22 Provider %*

CaN CITI Hold its Global lead?

* Percentage of large corporates (with turnover greater than USD5bn); 25 percent of the 970 survey respondents. Source: Treasury Strategies

International Treasurer / October 2008 15

Join a Peer Group Today!

n Treasurers Group of Thirty Peer Group n Tech20 Treasurers Peer Group n The Bank Treasurers Peer Group n Latin American Treasury Managers Peer Group n FX Managers Peer Groups 1 and 2 n Global Cash and Banking Group n Treasury Investment Managers Peer Group n Internal Auditors Peer Group

These are challenging times so dont look for solutions alone

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or contact Joseph Neu (914) 232-4069 n jneu@neugroup.com