Regulatory watch

What Comes After Dodd-Frank Regarding Rulemaking and Derivative Exemptions?

By Joseph Neu With Dodd-Frank now law, treasurers will continue to help regulators with rulemaking. With Dodd-Frank now the law of the land, the real fun begins as treasurers watch what the regulators do, and perhaps try to coax them into not making any adverse decisions. Take for instance the rulemaking on derivatives, which are still the major focus for corporates. Certainly what treasurers dont want is the unintended result that is putting a chill on the assetbacked securities market. There, ratings agencies have stopped allowing ABS issuers to use their ratings for fear of legal action if they are wrong. Treasurers will get the chance at some influencing, as the SECone of several rulemakers plans to expand its normal process, by seeking public comment on rules required by the Act. It plans to do this before the agency actually proposes any rules, rather than seek comment only after it publishes its proposals. ENd-USer eXeMpTioN coNSideraTioNS Of top priority for corporate end-users is the status of their exemption from derivative clearing requirements when mitigating commercial risk, usually due to foreign exchange or interest rate exposures, and the carve-out for foreign exchange swaps and futures. Hedge exemption. According to a comprehensive summary by the law firm Davis Polk: The bill provides an optional exemption from clearing to any swap counterparty that (1) is not a financial entity, (2) is using the swap to hedge or mitigate commercial risk and (3) notifies the CFTC or SEC how it generally meets its financial obligations associated with entering into uncleared swaps. There is no specific mention of a hedge definition, but there is reference to the fact that both the CFTC and SEC have the right to adopt a rule defining commercial risk or any other term included in an amendment to the Commodity Exchange Act. They can also modify definitions or further define swap, swap dealer, major swap participant, and eligible contract participant, if they see transactions and entities that have been structured to evade [the rules]. Also, not to forget: The bill requires any issuer of securities registered under the Securities Act or reporting under the Exchange Act to obtain approval to enter into swaps that are subject to an exemption from the clearing requirement from an appropriate committee of its board of directors.

Featured Meeting Summary: The Treasurers Group of Thirty

AUGUST 2010 What Comes After Dodd-Frank Re: Rulemaking and Derivative Exemptions?
By Joseph Neu

With Dodd-Frank now law, treasurers will continue to help regulators with rulemaking page 1

Helping Chinese Banks Play for Real

By Joseph Neu

Its in every treasurers interest to interact with Chinese banks in ways that help make the case for reform. page 2

Anticipated Exposures
FX Dealers Need the Flow Volume; ISDA Releases New Version of FpML; and more. page 4-5

JUriSdicTioN aNd RUleMaKiNG

Is Securities Lending In or Out?

By Bryan Richardson

n Mixed swaps n Swaps, including credit default n Security-based swaps, including swaps on non-securities or a credit default swaps on a single n CFTC-exempted agreements, broad-based index of securities security or a narrow-based index contracts and transactions of securities n Major swap participants n SEC-exempted accounts, agreements and n Major security-based swap transactions involving a put, call or other n Swap dealers participants option on one or more securities n Swap data repositories n Security-based swap dealers n Consistent and comparable regulations n S  wap execution facilities n Security-based swap data n Similar treatment for functionally for swaps repositories or economically similar n Derivatives clearing n Swap execution facilities for products or entities organizations with regard security-based swaps to swaps n Clearing agencies with regard to security-based swaps

SEC

SEC / CFTC

CFTC

Determining the state of securities lending for US MNCs depends on whom you ask. page 6

Understanding FASBs Proposed Changes to Hedge Accounting

By Helen Kane

The ED on hedge accounting would represent a game-changer for many corporate hedgers. page 12-13

Source: Davis Polk

continued on page 3

EDITORs NOTEs
Founding Editor & Publisher Joseph Neu Contributing Editors Anne Friberg, CTP Ted Howard Bryan Richardson, CTP Advisory Board Andy Nash SVP, Treasurer Ahold Finance Group James Haddad Corporate Vice President Cadence Design Systems Chris Growney Principal, Director of Sales & Marketing Clearwater Analytics Susan Stalnecker VP & Treasurer E. I. DuPont Co. Peter Marshall Partner Ernst & Young LLP Adam Frieman Partner Etico Capital LLC David Rusate Deputy Treasurer General Electric Company Martin Trueb Senior VP & Treasurer Hasbro, Inc. David Wagstaff Managing Director, Head of US Tech, Media & Telecom HSBC Securities (USA) Inc. Michael Irgang Senior Director, Financial Risk Management McDonalds Corporation Arto Sirvio Director, Treasury Center Americas Nokia Peter Connors Partner Orrick, Herrington & Sutcliffe LLP Robert Vettoretti Director, Treasury and Financial Management Services PricewaterhouseCoopers LLP Doug Gerstle Assistant Treasurer Procter & Gamble Susan A. Hillman Partner Treasury Alliance Group LLC Michael Collins Managing Director, Head of Corporate Equity Derivatives Wells Fargo Securities, LLC 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. 17, No. 6 2010 The NeuGroup, Inc. 135 Katonah Avenue Katonah, NY 10536 (914) 232-4068 Fax (914) 992-8809 subscriberservices@itreasurer.com www.iTreasurer.com SUBSCRIPTION INFORMATION Published Monthly. Annual subscription rates are $295. International Treasurer is a publication of The NeuGroup, Inc.

Treasury management By Joseph Neu

Helping Chinese Banks Play for Real

he difference between banks in China and banks in the US is that when the government asks banks to lend to stimulate growth, the Chinese banks ask how much and to whom. In the US, banks simply refuse and hold their cash in reserve. This oft-cited anecdote gets to the heart of concerns that treasurers havealong with China observers, generallyregarding Chinese banks: they are too intertwined with the Chinese government and its policy priorities, which may not be aligned with MNC interests or their standing as reliable counterparties. Its possible this situation is so bad that it will eventually drag down the Chinese economy. This also would not be good news for treasurers. Neither would an ongoing trend of unreformed Chinese banks continuing to rise atop global bank tables, thanks to ongoing Chinese expansion. Thus, it is in every treasurers interest to interact with Chinese banks in ways that help make the case for reform.

state-owned asset management companies, as the banks special purpose vehicle of choice. These AMCs essentially buy up bad bank assets in exchange for bonds. The banks classify these AMC bonds as quality assets, because the Chinese government backs them (sound familiar?). As the Wharton article makes clear, this sort of government-supported shell game is nothing new. However, now that Chinese banks are listing, their minority shareholders, including multinational banks, are also in on the financing. Since such shell games are at odds with global financial reform, at some point, Chinese banks must stop them if they want to continue to grow and win the international presence their size should dictate.

WhaT caN TreaSUrerS do?

Aside from avoiding exposure to toxic Chinese bank assets, what can treasurers active in China do to encourage Chinese banking reform and banks that lead the way? One area of focus is working to change the culture within banks. This will not be easy. The Knowledge@Wharton article cited Marshall Meyer, a Wharton management professor, who recalled a recent visit to China where a bank manager lamented that he had to choose between being a responsible banker and keeping my job. This suggests that, thanks to joint ventures, education and training efforts to enhance technical knowledge, Chinese bankers do know what best practice is. The problem is that some members of bank boards dont care as much. Patrick Chovanec, a professor at Tsinghua Universitys School of Economics and Management in Beijing, also has noted on his blog the problems with Chinese bank culture. For example, what look like best practice approaches to employee performance reviews actually function as simple rotational sharing of best performer and merit awards to everyone on the team. Treasurers can counter this by making their own assessments of Chinese bank employees and make these assessments known to local bank partners. Insisting on working only with high performers can help to foster change. Better this than to eventually face Chinese banks, and their current practices, not just in China but on the global stage.

ChiNeSe baNK GrowTh riSK

Already, China boasts the worlds two largest banks by market capitalizationICBC and China Construction Bankand its banking dominance may not end there. According to Oliver Wymans most recent annual State of the Financial Services Industry report, Chinas banking sector is expected to grow some 10 percent per annum between 2009 and 2014, besting almost every other G20 country. Unfortunately, as noted in a Knowledge@ Wharton post sparked by the recent IPO of Agricultural Bank of China (the last of the four largest Chinese banks to list), the growth prospects for the sector have been marred by the decision to use Chinese bank lending as the official conduit for economic stimulus. This decision has reversed progress on reform efforts begun in 2000 to transform the sector away from the policy bank template established in the 1980s to fund state-owned enterprises solely at government discretion. The result has been highly suspect bank balance sheets across China. Plus, questionable securitization practices, highlighted in a July report by Fitch, serve to keep banks most aggressive lending off-balance sheet. Many of these toxic securities end up with

ACCOUNTING & DIsCLOsURE

Exemption, continued from page 1

FX carve-out. Per the Davis Polk summary: The bill provides that foreign exchange swaps and forwards will be considered to be swaps, and subject to CFTC jurisdiction, unless Treasury makes a written determination that either or both types of transactions (1) should not be regulated as swaps and (2) are not structured to evade the bill. As the Davis Polk summary also notes, the House and Senate could not agree on whether to scope foreign exchange contracts in or out, so they left it up to the US Treasury. Margining scope-in. There is also disagreement as to where the controversy surrounding margining requirements stands. According to the Davis Polk summary, the bill does not expressly exempt from the margining requirements those swaps counterparties that are exempt from the clearing requirement. However, a June 30, 2010 letter from Sen. Dodd (D-CT) and Sen. Lincoln (D-AR) to Rep. Frank (D-MA) and Rep. Peterson (D-MN) has stated that it is not the intent that such non-financial swaps counterparties be subject to the margin requirements. For some market participants, the letter settles the issue, but

for others it leaves a sense of uncertainty. Grandfathering of existing swaps? Unfortunately, Davis Polk also notes that the bill does not expressly provide for grandfathering of existing swaps with respect to capital or margin requirements. This has been a point of great sensitivity for a number of market participants, and regulators will have to weigh in. The bill requires the CFTC and SEC to issue interim final rules providing for the reporting of uncleared swaps entered into before the date of enactment within 90 days of the date of enactment. Meanwhile, market participants have 90 days (for those entered postenactment, but pre-effective date) or 180 days (for swaps entered into prior to enactment) to report swaps that they want to exempt from the bills clearing requirements. Recordkeeping and documentation. As a study by the US Chamber of Commerce points out, both the CFTC and SEC will adopt rules to require the maintenance of records of all activities in relation to transactions in swaps and securitiesbased swaps, including those that are uncleared. And these are just the highlights from the derivatives

section. Over the coming weeks, there will more to discover about what regulators will be determining over the next 12-18 months (see sidebar right). LooKiNG ahead The rulemaking will not only have to deal with the known issues outlined in the legislation, but also the unanticipated. Rating agencies expert liability. For example, the SEC has already had to issue a no action letter to exempt ABS issuers from requirements to include ratings in registration statements. No one fully anticipated that rating agencies would withhold consent to use their ratings in official documentation immediately following enactment. This came in response to Dodd-Franks revocation of their prior exemption from expert liability considerations. Thus, the SEC has given them, and markets, six months (and likely more) to sort the matter out. With so much uncertainty remaining for all aspects of the bill, it will continue to cloud financial markets and relationships with financial institutions until all the new rulemaking and studies are done.

The number of new rulemakings under Dodd-Frank is mammoth, likely more than 243. Here is the estimated breakdown according to Davis Polk & Wardwell:  Bureau of Consumer Financial Protection . . . 24  CFTC . . . . . . . . . . . . . . . . . 61  Financial Stability Oversight Council . . . . . 56  FDIC . . . . . . . . . . . . . . . . . . 31  Federal Reserve . . . . . . . 54  FTC . . . . . . . . . . . . . . . . . . . . 2  OCC . . . . . . . . . . . . . . . . . . 17  Office of Financial Research . . . . . . . . . . . . . . . 4  SEC . . . . . . . . . . . . . . . . . . . 95 Treasury . . . . . . . . . . . . . . . 9 Davis Polk said that these estimates could be under the actual totals as it only includes rulemakings explicitly mentioned in the bill. A similar study by the US Chamber of Commerce puts the number at 533 regulatory determinations, 60 studies and 94 reports. It is hoped that regulators charged with writing the rules find the right balance between properly implementing the legislation and building in enough flexibility to address changes in market conditions.

HUNdredS of rUleS

International Treasurer Trusted Intelligence for World-Class Treasurers

135 Katonah Avenue Katonah NY 10536 USA Phone (914) 232-4068 Fax (914) 992-8809

Subscription Form
To Order:

Subscriptions include 12 print issues of International Treasurer, and full online access to iTreasurer.com, including daily intelligence, eBrief and Peer Group Highlights. Online: www.iTreasurer.com Phone: (800) 535-2884 or (914) 232-4068 Fax: (914) 992-8809 Send an invoice. Charge my credit card: Check enclosed. Amex Mastercard Visa

Yes, please begin my annual subscription at $295 

(Group subscriptions available)
Name: Title: Company: Address: City: E-mail: Country: State: Phone: Zip/Postal:

Card number Expiration date _______ / _______

Your satisfaction is guaranteed. If you are not satisfied, we will promptly refund the balance of your subscription.

X___________________________________________________
Signature (required on all orders)

ANTICIPATED EXPOsUREs
Capital markets

FX Dealers Need the Flow Volume

hroughout the financial crisis, FX trading volume dropped off markedly, although spreads more than made up for the flow declines. This in turn allowed major FX banks to still profit from FX trading. So with FX trading volumes coming back to pre-crisis levels, is currency trading going to again become a mostly flow business? BUT will iT weiGh oN SpreadS? Data released from the Bank of England [date] show that currency trading flows in the UK grew by 15 percent in the six months to April, taking the daily average to $1.747 trillion. Spot trading was a significant part of that, as the most basic spot products surged by one-quarter to $642 billion a day In the US, meanwhile, according to the New York Fed, daily currency flows grew at 11.8 percent to $754 billion in the six months to Apriljust short of the record $762 billion hit in October 2008. While continued global economic uncertainty has sparked much of the trading (along with central bank intervention) and implied vols for major currencies are still in the teens, the good news is that the trading is taking place. The next question is will spreads stay healthy enough to keep FX trading as a profit engine for dealers? The hope for these banks is that the volume increase does not fully erode their spreads. Looking beyond spot, they also must factor in the impact of OTC derivatives reform. This impact will be enormous if the US Treasury decides not to exempt FX forwards and swaps from central clearing. But it will also be significant with the exemptions. charGeS reMaiN Whereas trades subject to margining will have credit charges stripped out of bid-offer spreads, non-margined trades for exempt instruments or end-users will maintain these charges, along with new capital and liquidity requirements for derivatives business, and sundry add-on
4 International Treasurer / August 2010
n

costs. This will tend to keep upward pressure on spreads and perhaps introduce separate fees to offset the higher costs of doing business in FX instruments generally. Downward pressure on dealer spreads is going to be felt, too, however. Corporates do have the opportunity to trade FX on electronic platforms, and access twoway streaming pricing, so this will make it difficult for any one dealer to seek to subsidize other parts of their FX business with spot spreads. As a result, we may see further impetus for FX forwards, swaps and options trading to migrate to e-trading platforms, too, or traditional exchanges, to keep spreads tighteven if this migration eventually comes with some central clearing and margin component. Remember, exempt corporates still have the option of going to exchanges if they want, and they may well choose to do so if the lines between e-trading platforms (like FXall) and exchanges blur and the economics are right. Plus, as recent market commentary from Citi has noted: Although banks are sure to pass on added costs to their corporate clients, it is also likely that banks will compete more than ever for available flow business in order to earn bid-offer spreads. Thus, it looks like we are indeed returning to an era where FX is a flow business and competition for volume between banks, e-trading platforms, exchanges and other non-banks will help reinforce this turn and take it beyond spot trading.
Software and systems

update since 2004; and, with additional post-trade processing schemas, it is well-timed to aid development of the next-generation of OTC clearing and settlement systems to cope with postreform derivatives markets. Hopefully, all market participants will be on the same page when it comes to standards to handle the evolving mix of standardized, CCP-cleared, and custom, non-CCP cleared instruments in an integrated and automated fashion. Version 5.0 covers mainly interest-rate, credit, equity and commodity derivatives. Version 5.1, expected to be out at the end the year, will cover FX and syndicates loans, as well as incorporate recommendations of the collateral working group. CoveraGe For the instruments covered, version 5.0 provides mark-up to help automate, for example, the following post-trade processes: E  xecution notification (for platforms to report order fills) E  xecution advice (to report executions and settlement info to service providers) Allocation (expanded for version 5) Confirmation r Consent negotiation Clearing (new for Version 5) Status reporting
As treasurers consider systems and service provider alternatives to support derivatives use, post-market reform, they should inquire about the status of vendor offerings with regard to FpML.
Treasury management

ISDA Releases New Version of FpML

ML standardization may eventually automate and integrate financial information exchange across all markets front-to-back. Moving the OTC derivatives markets in this direction is the International Swaps and Derivatives Association (ISDA) with its release of Version 5.0 of its Financial products Markup Language (FpML). This represents FpMLs first major

Collateral Mgmt Systems Academy

hen it comes to navigating the emerging landscape of collateral management for derivatives post Dodd-Frank, corporate treasurers will be following to some extent in the buy-side footsteps of asset managers. Looking to them for whats ahead in implementing collateral management systems can help

For additional information visit iTreasurer.com

ANTICIPATED EXPOsUREs
guide technology decisionsincluding those of third-party providers who may support post-trade processing. A recent IntegriData survey of operations managers and C-level executives at financial buy-side firms has the following key findings: Non-standard data is a problem As with every business process, data capture and standardization is a critically important prerequisite for process effectiveness. Non-standard file and data formats, as well as lack of robust delivery methods, hamper the ability to achieve a high level of process automation. Adoption of specialized software While larger firms utilize specialized applications software, small-to-medium sized firms use Excel to varying degrees; still, end-to-end automation is rare for all firms. People-intensiveMost buy-side firms were found to need highly-skilled staff to achieve acceptable control levels. Given the process complexity and the potential financial consequences associated with errors, according to IntegriData, highly-skilled knowledgeable workers tend to be used to overcome the inherent data and systems limitations. The cUrreNT STaTe of Tech Given that specialized applications and systems offer limited opportunities for automation at this stage, the current state of technology is utilized most for creating a centralized collateral management database. The survey revealed that 76 percent of respondents have some type of a central repository that holds some or all of their collateral and margin data. Of those that have a repository, 44 percent utilize 3rd party software; 38 percent have a propriety database, and the remaining 18 percent use Excel. It should come as no surprise, then, that a central repository for all collateral and margin related data was the functionality ranked as the most vital (by 80 percent) when choosing a system. This functionality was followed by position holdings matching and margin reconciliation (75 percent) and file collection and data transformation/normalization (61 percent). This functionality also is in line with the daily execution of operational risk management tasks considered to be best practice: reconcile collateral (63 percent); verify broker margin (63 percent) and match/reconcile holdings (60 percent). While ultimately the state of play will improve rapidly as more derivatives trading migrates to regulated exchanges with their own systems and standards, as IntegriData notes, this will not happen overnight, nor will it occur for all activity. Perhaps to a lesser degree than asset managers, corporate treasurers will confront the same challenge IntergriData highlighted: to work with counterparties and systems vendors to encourage standardization and appropriate technology development to facilitate processing efficiency and control automation.
Accounting and regulation

Basel Softens, US Toughens

he Basel Committees Board of Governors recently agreed to changes in bank capital and liquidity requirements to be introduced in November under Basel III. At the time of the agreement, Germany opposed them as not easing up enough. It appears the US isnt liking it either for opposite reasons. One big takeaway from the Basel changes is that they respond to concerns about introducing tough new rules in the early phases of economic recovery. This is not sitting well with Senator Chris Dodd and Representative Barney Frank, since Dodd-Frank included preordained adherence to presumed stricter Basel rules. They thus plan to hold hearings. The concern, expressed by Senator Ted Kaufman, is that it will result in weak and perhaps even nonbinding provisions that provide credit to banks for holding forms of capital that have little or no value in absorbing losses.

ADDING RISK ONE TOE AT A TIME

RISK TYPE PLANNED SPRING 2009 SPRING 2010

The appetite for risk is returning.

But there will be plenty of analysis and approval to go with it: n 70% will perform research and credit analysis n 45% will perform scenario analysis n 85% will go to the CFO or board committee for approval

Duration Risk Credit Risk Asset Class

35% 35% 70%

55% 70% 25%

Note:  The question in 2009 was actually about diversifying asset classes while 2010 was about adding risky assets.

usiness media outlets have repeatedly pointed out that corporate America is stockpiling cash in response to the ongoing concern over the economy and to Washingtons anti-business posturing. In further support of this fact, the AFP recently released its fth annual liquidity survey highlighting that companies are placing this cash into ultra-conservative investment vehicles; valuing safety of principal over both liquidity and yield.

The AFP liquidity survey respondents included 337 companies, of which only 12 percent had annual revenues of $5 billion or greater. By contrast, in a March survey of The NeuGroups Treasury Investment Managers Peer Group (TIMPG) where 69 percent of participants had revenues of $5 billion or greater, and well over a billion in their portfolios, a slightly different story emerges. While this group has been taking a more

conservative duration posture with 62 percent stating their current portfolio duration is shorter than their target, they are generally planning to add more risk to the portfolio. Indeed, 55 percent of TIMPG members indicated they plan to increase duration risk in 2010 and 70 percent indicated they plan to increase credit risk. This may lead to a conclusion that the more dollars you have to play with, the more comfortable you will be with a riskier investment strategy.

Source: NeuGroup Peer Research, Spring 2010

For additional information visit iTreasurer.com

International Treasurer / August 2010 5

TVA
Capital markets

Is Securities Lending In or Out?

By Bryan Richardson Determining the state of securities lending for US MNCs depends on whom you ask. The securities lending practice of most custodian banks certainly took its lumps during the financial crisis. Unfortunately it continues to plague certain institutions. Witness State Street Banks recent Q2 financial results. The company missed expectations due primarily to a $251 million after-tax charge emanating from its securities lending business; this on top of its need last year to curb redemptions from the program, which will be eased this month. The overall product category has seen a dramatic drop-off in activity since the crisis. According to a recent report from Bernstein Research, lending volumes at the three large US custodian banks in late 2009 were down by 40-60 percent compared with the previous three years. The reason for the business run-off comes down to the risks involved. Like so many other securities or practices that were assumed to be safe, the financial crisis exposed weaknesses that many knew were there but never imagined would materialize. The two big risks in securities lending are borrower default and collateral investment risk. If the borrower of your securities fails to return your securities by the agreed upon time, you may liquidate their collateral to make yourself whole. Collateral is commonly in the form of cash, which gets invested for the benefit of the lender. However, if the collateral was invested in something that has lost value or become illiquid you now have a problem. It is these risks that have been an obstacle for many institutional investors to utilize this service and sent many others to the exits. whaT The TiMpG SayS In recent discussion among The NeuGroups Treasury Investment Managers Peer Group (TIMPG), representing highly cash-rich firms, one member asked the group, Who is doing securities lending and what types of investments
6 International Treasurer / August 2010
n

do you permit for the collateral? Out of 13 responses, only one was participating in a securities lending program. Two had participated formerly but discontinued sometime in the past two years due to risk concerns. Two others had researched the option and concluded the risk was not worth the return. Initiating a securities lending program is like picking up pennies in front of a steamroller? Scott J. Whalen, an executive vice president and senior consultant with Wurts & Associates Inc. in Los Angeles, supports this view, noting that many of his clients who participate in securities lending may well decide to withdraw, concluding that they were picking up pennies in front of a steam roller. provider reSpoNSe The environment has impacted the service providers, too. These entities, also known as agents, have tightened up their risk tolerances for their collateral pools where customer collateral is often co-mingled. After moving into those safe assets, such as MBS, to enhance returns on the collateral pools, agents have been dialing down the risk. In a BlackRock marketing brochure for Securities Lending dated January 2010, the following frequently asked question and answer is included: Question: How has BlackRocks cash management changed as a result of the credit crisis? Answer: During the credit crisis, our strategy has been to reduce risk in the cash collateral portfolios by reducing exposures to sectors most impacted by the dislocation, shortening the maturity profile and maintaining increased levels of liquidity. So agents, with the help of regulators and investors, have been reviewing how to best restructure their programs in order to reignite the product. Among the

options reported as being considered are replacing commingled collateral funds with separate accounts, establishing a greater reliance on non-cash collateral which would eliminate the need for reinvestment, separating the functions of matching lenders and borrowers, and investing collateral by assigning them to different specialized providers and simply implementing more conservative investment policies. There is also talk of establishing a central clearinghouse regulated by the SEC. All of this will no doubt have a negative impact on returns from the product and revenue for agents. Goldman Sachs, in its recent Q2 results reported, Securities Services net revenues were $397 million, 35 percent lower than the second quarter of 2009. The decrease in net revenues primarily reflected tighter securities lending spreads, principally due to the impact of changes in the composition of securities lending customer balances, partially offset by the impact of higher average customer balances. The opTiMiSTS In spite of the blight on securities lending, many firms are seeing clients regaining confidence in the product. Northern Trust recently recruited two senior managers from JPMorgan to support renewed interest for securities lending among its clients, according to Andy Clayton, global head of securities lending at Northern Trust. Eight executives and senior managers at State Street have enough confidence in the product and market that they left State Street in June to join a securities lending startup. The same Bernstein Research report cited earlier predictions of 6 percent volume growth for US securities lending in 2010, followed by 18 percent growth. However, this increase is driven mostly by growth in M&A activity and hedge fund assets. But for now, those with any doubts are perhaps best suited for the sidelines.

For additional information visit iTreasurer.com

THE TREAsURERs GROUP Of THIRTY

Spring 2010 meeting briefing

Better Access to Capital Continues

More time for cash forecasting, reporting
Sponsored by:

When members of the Treasurers Group of Thirty met in March 2010, credit had begun to flow again and members were able to start thinking of other aspects of running treasury. Key areas of discussion included: 1) Funding markets. Meeting sponsor HSBC led a discussion of funding markets, touching on how capital and bank credit markets continued to improve. Key Takeaway: Capital markets are back to as-good-as-it-can-get status, but bank credit markets could still improve for those who can wait. 2) Counterparty Risk Management. Sustained, greater attention to counterparty risk remains a reality for T30 members. Key Takeaway: Treasurers should consider the need for credit support on derivatives transactions

and inevitabilityits a when, not an if to implement solutions for collateral and margining management. 3) Cash Forecasting and Working Capital. Improvements are still to be had, though each round of efficiency becomes more difficult. Key Takeaway: Most companies will soon have exhausted the gains to be made without investments in new systems and the processes they enable. 4) Board-Level Reporting. Board-level reporting on treasury metrics continues to be a priority for most members. Key Takeaway: Even a modicum standardization or accepted practice on what and how much information boards should receive would be beneficial.

Funding Markets Update

The meetings first session was a spirited discussion, led by HSBC, on how the capital and bank credit markets have continued to improve. There was also debate about the decision whether to refinance now or wait, and how Basel II and presumed Basel III regulations will affect pricing and availability in the bank credit market and how both banks and corporates have become more discerning about whom they do business with. As of publication, the Basel Committee came to an agreement on capital and liquidity requirements. Many consider the new rules, which will take effect seven years from implementation in November 2010, to be less onerous than earlier proposals and give banks much more leeway in defining what counts as high-quality, or Tier 1, capital. Key TaKeawayS 1) Bank Group Rationalization Accelerates. HSBCs Richard Jackson noted that many corporates are shrinking their number of liquidity providers, but want more liquidity nonetheless:  Corporates pre-crisis established more revolvers because they were nearly free options (pricing was in the single-digit basis-point range), but with the cost of those now much higher, counterparty risk issues top of mind and the desire to work more exclusively with banks that have proved their mettle in the crisis, more corporates are scaling back.  The desire to more efficiently manage bank relationships favors having fewer institutions that are willing to provide bigger percentages of financings rather than more banks that are only willing to step up for, say, 10 percent of a deal. As one member noted: Thats why you dont want to take just a little from a bank, because youre still going to have to take calls from them just to say thanks but no thanks later on.  Another member added that banks interest in developing core relationships was one factor driving the uptick in reverse inquiries. 2) ...But its a Two-Way Street. HSBC, for example, described the workings of its Deal Prioritization Committee, which is essentially a capital allocation decision body that looks at each transactions return in the context of the relationship.  Getting a transaction through the DPC can be harder than getting it approved by the credit committee.  Jeremy Bollington, HSBCs head of corporate banking for the Americas, who sits on the committee, said it reflects a fundamental shift in the banks strategy toward a focus on a smaller group of clients. Most banks are having this sort of conversation about what client makes senseit depends on footprint, geographic focus, etc., he says.

Most banks are having [a]

conversation about what client makes senseit depends on footprint, HSBC

geographic focus, etc.

Facilitated by

For more information: www.NeuGroup.com

2010 The NeuGroup. This information is sourced from the Treasurers Group of Thirty Peer Group.

PEER INsIGHT: T30

iN-hoUSe ToolS  he committees yes decisions come easier T when they involve clients representing a substantial base of business over a long historical period. When someones wallet is lumpier and day-to-day transactions are smallsay for metals and mining firms thats a harder sell. 3) Capital Markets Refis. At the time of the meeting, there was little consensus yet on whether it was time to term out loans in the bond market.  HSBC noted that the highest-quality corporates that never lost their access to the CP market during the crisis feel there will always be demand and so are staying short.  Still, other companies see they can get 30-year money at 6 percent, according to HSBC, which is a great dealplus you dont need to talk to banks every day.  One member noted he had been in the market prior to the meeting with several hundred million in 30-year notes and was quite happy with the pricing: 6.379 percent yield, 170bps over Treasuries. 4) Bank Revolver Refis: Waiting on the Feds. While the group acknowledged that conditions in the bank credit market were improving, and four-year tenors were starting to pop up, at the time of the meeting there was no benchmark five-year deal. 5) But Liquidity Insurance Has Its Value. One group member raised the question of

DEAL IS EVOLVING / RESULT IS UNCERTAIN

One of the most enduring takeaways on funding was that the financing structures which kept the one members company going were almost exclusively developed in-house. This fact points to the importance of having good capital market and structuring skills on staff, particularly for a lesser credit, and keeping in-depth knowledge at hand about the structures already in place, as well as the idiosyncrasies of legal entity and tax frameworks. Bank teams cannot have this knowledge on their own, and making a financing structure work within the existing frameworks, including the covenants of prior arrangements, is often critical. While bankers can add value, they cannot always be relied upon to come up with the structure you need for meeting funding needs in times of potential distress.

whether it makes sense for a self-funded company with plenty of cashand one whose banks were not particularly supportive when the company hit a rough patch in the pastto allow its revolver to expire when it comes due and just tap the capital markets as needed. 6) The importance of execution strategy in acquisition financing. M&A structures continue to emphasize fee/margin arrangements that compensate banks and provide incentives for the acquiring company to repay/ cancel the bridge rapidly. This implies a clearly defined and wellcommunicated takeout plan, according to HSBC. Part of the execution strategy too will be creating the proper degree of competitive tension amongst banks in order to minimize cost while still ensuring financing success. (see table below) oUTlooK: The funding markets discussion at this meeting marked another step in the direction of normalcy, especially on the capital markets side. The hope clearly was that good news for funding would continue; however, continued interest in liquidity, viewing funding transactions through the lens of fortunate windows of opportunity and concerns about use of proceeds pointed out that member treasurers had not fully regained their risk appetites.

EXecUTioN STraTeGieS
TIMING BANKS INVOLVED

COMMENTS

Phase I Structuring and Commitment Phase II Sub-Underwriting / Limited Syndication

Before the official offer announcement

2 to 3 trusted banks

Full underwriting of the acquisition-bridge Require exclusivity

After posting offer documents

Initial underwriters + 4 to 5 key relationship banks Large number of relationship banks and financial institutions Initial underwriters and sub-underwriters

First round of syndication Share bond take-out economics for participation in the acquisition bridge Require exclusivity

AGREED DEAL / RESULT IS CERTAIN

Phase III General Syndication

Shortly after Phase II Upon certainty of the acquisition but ideally before closing

Optimize distribution across the market

Phase IV Permanent Financing

Optimize permanent capital structure Minimize overall cost of financing

Source: HSBC

8 International Treasurer / August 2010

For additional information visit iTreasurer.com

PEER INsIGHT: T30

Managing Counterpary Risk
The general trend revealed by the pre-meeting survey was that the beefed-up monitoring of counterparty risk as a result of the financial crisis was being continued for the majority of firms. The members discussed the use of internal counterparty risk analysis and how they applied it to their financial counterparties, including now to their insurance counterparties, and considered what more they can do to get involved on the business counterparty side. Having assured their own survival through the crisis, more member firms were turning to look to the health of smaller, yet critical components of their value chain (customers and suppliers). The discussion also touched on CSAs: one member explained how he implemented CSAs with his counterparties, which he said also gave him more credibility when engaging legislators amid regulatory reform efforts in Washington. Key TaKeawayS 1) Dont forget insurers. Several members now apply internal counterparty credit measures to their insurance counterparties. One member, for example, asks its insurers for their portfolios, not just to assess credit risk but to evaluate their liquidity risk as well. 2) Adding value on the business counterparty side. Though treasury generally plays less of a role here than with financial counterparties, the value of greater treasury involvement is seen and the role of treasury will likely grow at more companies. For instance, most members agreed that the D&B self-assessment approach is flawed and business credit profiling can be improved with treasury involvement, even using D&Bs data rather than its scores. 3) CSA benefits. The principal reason to pursue CSAs and collateral management processes is that they are probably inevitable outcomes, regardless of how new regs end up. In terms of the regulatory reform debate, including OTC derivatives, one member explained that as an early adopter its extensive use of CSAs gives him and his company a lot of credibility with policy-makers. We have two dozen and people say that if everyone did what you do, there wouldnt be a problem. Pricing benefits are harder to see for the company, which already benchmarks the midpoints, but this member admitted there is a likelihood that his treasury will be able to avoid or postpone erosion from those benchmarks thanks to its CSAs. While most companies may not need CSAs immediately, David Wagstaff from HSBC urged beginning the process of putting ISDAs and CSAs into place when theyre not needed. You dont want to go to CSA negotiations when theres a problem around your credit. And if you are thinking about it, realize it will take 3-6 months to work through your counterparties. 4) Dont get too stuck on a single CSA template. One member attempted to use the same template across all counterparties, but that didnt work. The company ended up with three versions. It argued with counterparties to get all existing trades under the CSAs, and there was a lot of push-back; his trading partners said he was changing the rules of the game. 5) Chose your triggers carefully. Given the hassles of posting margin and collateral management, treasury will do well to consider a well-thought-out mix of CDS-based triggers or ratings-based triggers on the CSAs. HSBCs Mr. Wagstaff worries that there might be huge swings in CDS spreads and the possibility of market manipulation. 6) Get help from third parties. JPMorgan manages the collateral and related valuation processing for one member firm. This member is not entirely comfortable with the bank having his book and calculating the mark-tomarket every day, but theres not a better alternative. He also uses a third-party firm for marks to help avoid pricing disputes. oUTlooK: The continuing member emphasis on counterparty-risk mitigation will eventually prompt more T30 companies to move toward more comprehensive credit support for financial transactions such as derivative trades, regardless of new OTC derivatives reform legislation. It is really a question of what the appropriate timetable is for your firmand most treasurers would rather follow their own timetable than one set by government. However, should firms be allowed to move according to their own timeframe they should not use this as an excuse to refrain from starting down the path to support financial trades with collateral and margining positioning.
For additional information visit iTreasurer.com
n

Members compared notes on their reports to senior management and boards, and also discussed how much information really is enough. Key TaKeaway 1) Approaches vary but less-is-more approach prevails. For example, one member provides a two-page quarterly report to senior management with metrics such as interest rates; shareholder repurchases; dividends; counterparty information; liquidity targets; credit rating; total cash; FCF; shares out; credit facilities; maturities; and banks. It also provides macro indicators used by planners and business leaders. Another member provides even less one side of one page but more frequently: in this case each week. It reports CP outstanding; dealers; longerterm debt and pricing; debt to ebitda; some market data; cash position by country; currencies and commodities. This gets modified from time to time with anything else that management is interested in and goes to the CEO, CFO and general managers of the business units. Treasury reports to the board on an ad hoc basis, or more regularly during the crisis.

Board-Level ReporTiNG

(continued on p. 10)

International Treasurer / August 2010 9

PEER INsIGHT: T30

Cash Forecasting and Working Capital Initiatives
Other members offer more detailed, longer reports that have more internal metrics and market benchmarks or have capital markets, investment and FX dashboards, all with various data and targets, for management to review.
(continued from p. 9)

This session addressed whether cash forecasting, visibility and working capital initiatives realistically could be improved beyond efforts already made or being implemented. Members noted that the crisis had taught them that forecasting is vital and that there are always ways to win improvements, starting with incentivizing the business units to provide as accurate a forecast as they can and ensure their data is spot on. However, these gains were hard won and CONCLUSION further gains in refining cash and working Sustained higher levels capital initiatives will be harder still. We see of board interaction the ability to further pursue wins for the next with treasury and treasury metrics reporting two-three years, one member noted, but there is a concern about how to continue to have not yet led to improve performance after that. standardization. However, increasing Members dont have a sense of how much calls for financial and improvement is enough, but now is not yet risk management elethe time to signal that enough has been done.
ments as part of corporate governance best practices should eventually encourage greater standardization when it comes to what should be included in treasury reporting and in what format. Directors participating across multiple company boards will help to cross-fertilize reporting innovations. To stay ahead of the curve, members should periodically share advances in their board-level reporting and encourage standardization in a direction that makes the most sense from a treasury perspective.

cash generation targets, can help a company move toward having a more consolidated process. IBM, which was one of the member companies that expressed greater satisfaction with its cash forecasting capabilities, makes use of Cognos to consolidate data collection and perform high-order analysis. After a few years of success in working capital, there is a concern about how to continue to improve performance after that. T30 member 4) The curse of the spreadsheet. Several members discussed DSO metrics, which need to be adjusted for the fact that you can get discounts for early payments. oUTlooK: The unspoken conclusion of this session is that no treasurer wants to tell their CFO that further efforts to make gains in cash flow forecasting and working capital are going to yield ever-dwindling returns. At some point, the relative value of efforts to generate cash and working capital through business growth will be higher, but its not really treasurys job to determine when that is. Regardless, however, the next generation of efficiencies will not be won unless CFOs are willing to make the investment in the new systemsand the processes they enable that will be required bring them about. Helping CFOs to see this need is something treasurers can help to do; for example, as owners of order-to-cash cycles they can formulate the business case for new systems.

Key TaKeawayS 1) Two different needs. You need two different things: a cash balance versus a cash flow forecast. A cash balance is no challenge. But a cash-flow forecast is a really difficult number for a lot of reasons. 2) Getting company-wide focus on cash. Basing part of annual compensation on free cash flow, rather than earnings alone, helps focus employees on it. 3) The curse of the spreadsheet. The holy grail of integrating cash processes into a strategic planning process remains held up by continued reliance on spreadsheets. Some members say that checking discrepancies with cash flow forecasts, and having specific

CONCLUSION & NEXT STEPS

Although financial reform has passed and some of its impacts known, and with a debt and banking crisis in Europe abatingon the surface, anywaymembers preliminary topics for the next meeting still include updates on regulation, the impact of FinReg on rating agencies and insurers as well as banks, and the state of the global economic recovery. A continued focus on cash is also likely to be on the agenda, including staples like determining optimal cash levels for the balance sheet, on the one hand, and share repurchase economics on the other. Given the continued volatility in
n

To LearN More

Contact: Joseph Neu 914-232-4069 jneu@neugroup.com or Anne Friberg 212-233-2628 afriberg@neugroup.com

foreign exchange markets, currency management is also on the list for consideration, along with the ramifications of updated guidance on hedging accounting that has been exposed since the last meeting. The next meeting will take place in New York City on October 13-14, 2010. Other topics suggested for that meeting include:  xample of counterparty credit reports E  New FASB guidelines re derivatives accounting  X hedging strategy F  conomics of share repurchase E

10 International Treasurer / August 2010

For additional information visit iTreasurer.com

Join a Peer Group Today!

The Treasurers Group of Thirty n Tech20 Treasurers Peer Group n The Bank Treasurers Peer Group n Internal Auditors Peer Group n The Corporate ERM Group
n

These are challenging times so dont look for solutions alone

FX Managers Peer Groups 1 and 2 n Global Cash and Banking Group n Treasury Investment Managers Peer Group n Latin American Treasury Managers Peer Group n European Treasurers Peer Group n Engineering & Construction Treasurers Peer Group
n

HELP US FORM NEW GROUPS: Sr. Exec. Sector Peer Groups: Insurance, Energy, Healthcare Regional Peer Groups: Asia Pacific, India, China Functional Peer Groups: Payments, Supply Chain Finance

To learn more, go to www.neugroup.com/peergroups

or contact Joseph Neu (914) 232-4069
n

jneu@neugroup.com

ACCOUNTING & DIsCLOsURE

Hedge accounting

Understanding FASBs Proposed Changes to Hedge Accounting

By Helen Kane, HedgeTrackers The ED on hedge accounting would represent a game-changer for many corporate hedgers.

Proposed changes to the Financial Accounting Standards Boards derivative accounting carry good news and bad news for corporate hedge programs. For those companies that have been protecting their hedge programs by preparing statistical analysis to support their use of derivatives that are obviously highly effective there is great news buried in the May 26 exposure draft. For those that have stubbornly clung to short-cut or matched-term accounting and tossed de minimis tests out to placate the auditors, the news in the exposure draft is devastating. For corporates that rely on hedging intercompany transactions as a proxy for 3rd party currency risk, the jury will remain out until the redline version is issued (now expected as late as September 1). And for hedge programs that tried to squeeze highly effective results out of overall hedge relationships there is great news coupled with new opportunities to hedge. The draft shifts away from a focus on the potential of a relationship to be ineffective to a focus on precisely how ineffective is this relationship. QUalificaTioN To MeaSUreMeNT Under the proposal, hedge relationships can be established by qualitatively evaluating the likelihood that the derivative will be reasonably effective in offsetting changes in cash flows or fair value of the hedged item, for the risk hedged. This qualitative discussion will in most cases replace the statistical analysis of historical or scenario relationships between the hedged item and derivative currently known as prospective and retrospective tests. Although obvious relationships (e.g., a yen forward sale contract hedging anticipated yen revenues) will be able to circumvent quantitative assessments altogether, relationships that are less obvious (e.g., euro forward sales hedging USD oil revenues) would continue to
12 International Treasurer / August 2010
n

require a quantitative analysis suggesting that the relationship would be valid over the hedge period. This will directly impact audits of hedge programs replacing the rigor currently focused on R squares, beta slopes, T-tests, and sundry other quantitative exercises to a new rigor around the probability and the critical terms of the hedged item. HedGed ITeMS BecoMe FocUS Under the proposal corporates can no longer assume that a derivative is a perfect match for changes in the hedged item. Wiped out are the simplest measurement strategies: short-cut and matched terms, where the underlyings change in value was presumed equal to the derivatives change in value. This change will lead to a greater focus on the measurement of the change in value of forecasted transactions, as the debit/credit approach for cash flow hedging is fundamentally changed. Current guidance approaches cash flow hedge accounting by recording the derivative as an asset/liability and then preserving the effective component of the derivative in OCI, until the hedged item is recognized in earnings. When this happens, that element of the derivative is reclassified to earnings, limiting period-

to-period ineffectiveness to overperformance of the derivative. The new debit/credit approach will record the derivative as an asset/liability, record the change in the hedged item as an OCI value until the underlying is recognized in earnings and capture any difference between the two in income. This is a nuanced variation on current fair value hedge accounting in that fair value accounting anticipated the recording of changes in the derivative and underlying in both the balance sheet (asset/liability) and in earnings, whereas the proposed cash flow accounting records changes in the derivative and underlying to the balance (asset/liability/ equity) and then the net to earnings. For those that have stubbornly clung to short-cut or matched term, the ED is devastating. With the hedged item driving earnings, there will be a new focus during audit on the precision with which the change in value of anticipated transactions are calculated. In the spirit of simplification the guidance specifically allows the use of a single date for measurement of a group of forward transactions when the forward price

PROPOSED GUIDANCE CASH FLOW HEDGE

aSSeT / liabiliTy Change in Derivative Fair Value EQUITY OCI Change in Hedged Item P&L Under & Over Performance of Derivative
Source: HedgeTrackers

FAIR VALUE HEDGE

SAME AS CURRENT GUIDANCE

For additional information visit iTreasurer.com

ACCOUNTING & DIsCLOsURE

difference between that date and the perfect date(s) are minimal. This may require increased analysis of the expected dates within the month or quarter that the transaction(s) will be recorded. Given the focus on measuring amounts of ineffectiveness and not assuming perfect effectiveness, HedgeTrackers recommends those treasuries hedging groups of transactions happening over time be prepared to select and support a maturity date that differs from the derivative. HedGed iTeM valUe fUN One interesting measurement question that has not received much attention concerns the malleability of the hedged items inception rate or value. Take a case where a perfectly effective hypothetical derivative is established at the outset and assigned a rate or value (e.g., a 3.5 percent fixed rate on an interest-rate swap calculated to achieve zero fair value at inception). If during the life of the transaction the actual cash flows on the underlying debt change from quarterly to monthly, should ineffectiveness be calculated based on the 3.5 percent originally established for the relationship? Or should one return to the inception model and recalculate an inception value (perhaps 3.45 percent) that recognizes the instrument as quarterly for the first few years and monthly thereafter? In other words, does the originally established hypothetical derivative change in response to the underlying or must the hypothetically perfect derivative set at inception be the benchmark against which the P&L impact is measured? It is rare, but possible, to encounter auditors with the view that the inception model should be refreshed; however, as firms refocus on measurement, this operationally difficult approach may grow in popularity. INcepTioN Doc ChaNGeS? Speaking of inception model changes, the ED proposes ongoing amendments to hedge designation documentation. The ED makes clear that the FASB continues to be concerned about companies designating, dedesignating and redesignating hedge relationships. However, far and away the greatest application of dedesignations and redesignations are related to adjusting hedge relationships or documentation to avoid failures. In the current environment announcements of restatements (positive or negative) attributed to hedge accounting failures are met with yawns or even annoyance by investors, and frustration and resentment by issuers. The FASB has learned from these experiences that when companies fail hedge accounting and restate financials or record one-time adjustments, the usability of the financial statements is reduced. As a result one of the key objectives of the proposed draft is to provide consistent accounting for instruments in the financials over time. Inserting the ability to update and modify hedge relationship documentation over time is necessary given the FASB proposal to disallow dedesignation of relationships and their objective to maintain hedge accounting for consistency in reporting. The good news in general seems to outweigh the bad in this latest ED, unless the interco edit finds its way into the redline draft. The proposal to eliminate dedesignation and the ability to update documentation will need to be further explored, especially for companies with de/redesignation programs currently employed to modify the proportion of an underlying hedged, generally in net investment and fair value relationships.Will companies simply change their hedge documentation to reflect proportion changes daily, or quarterly? The ability to modify documentation is mentioned in the draft but not elaborated on, so it remains to be seen how substantial an improvement this represents. A STicKy EdiT Still unsettled is the 2008 ED edit that precluded intercompany hedge accounting that does not survive consolidation (oxymoron?). The FASB has indicated that this edit would not be considered a change in hedgeable transactions but rather a clarification of the existing standard. If reinserted the first we will learn of it will be in the redline version of ASC 815, now due out in late August. With a September 30 commentperiod deadline, this wont leave much time for digesting the impact and reaching out to the FASB. The good news in general seems to outweigh the bad in this latest ED, unless the intercompany edit finds its way into the redline draft. We encourage corporates to explore the vagaries with their audit firms, push the FASB for clarification and tool up for the new rigors around measuring changes in hedged items.
For additional information visit iTreasurer.com
n

As the FASB approaches convergence, one substantial difference has been, and might remain, accounting for the time value in options. US GAAP has allowed the effective changes in premiums to be recorded in income together with the hedged items earnings effect. International GAAP captures all changes in time value as either ineffective or excluded depending on designation an anathema of volatility for US reporting companies. In the Exposure Draft the FASB is offering a compromise: allow effective changes in the time value to amortize to income in a reasonable fashion over the life of the derivative. A palatable compromise? This makes for a confusing but palatable result for US constituents who will likely be willing to lose the match of recording the option premium and the hedged item together, for another predictable method. Under this method, HedgeTrackers believes an entity would model a perfectly effective hypothetical option, capture changes in the hypothetical in OCI and separately calculate a (straightline?) amortization of the hypothetical premium that would be recorded in income over the life of the option. For interest-rate or other cap/floor strategies this would require each caplet to be amortized over the caplet life because amortizing the entire premium would result in amounts associated with the very first caplet being recognized in periods after the exercise date. Again this will be operationally messy.
Helen Kane is the Founder and President of HedgeTrackers. She can be reached at (408) 350-8580 or hkane@hedgetrackers.com 13

OpTioNS STill SoMe TroUble

International Treasurer / August 2010

PEER GROUP UPDATE

GoiNG deep Risk management

FX group members have also expressed concerns about what is being hedged and the value of hedging. This is influencing a push among members to take a deeper dive on cash-flow hedging strategies. Other questions surrounding cashflow hedges include:  How are companies tweaking their cash-flow hedge programs due to changes in their business or management attitude?  How is FX volatility impacting dynamic hedge strategies, including systematic or formulabased approaches?  What impact is being seen on instrument selection, starting with the cost/ benefit of options?

NeuGroup FX Groups Set Agendas

By Anne Friberg and Joseph Neu FX Managers set top priorities for September meeting agendas Members of The NeuGroups FX Managers Peer Groups 1 & 2 set agendas in recent weeks for their meetings in September. The resulting agendas overlap on topics of high importance, starting with the implications of financial reform and necessary action items for corporates. iMMediaTe coNcerNS of reforM The principle concern for FX managers is the impact of OTC derivatives reform to be ushered in by the Dodd-Frank legislation. Members of the FX groups give priority to the immediate practical concerns, such as: Will ISDAs need to be renegotiated if banks have to push out certain activities to a separate legal entity, and what happens to bilateral CSAs? Naturally, they want to know what steps their bank counterparties are required to take and how it will impact them from a process, credit risk, and cost point of view. There are already reports circulating of dealers changing the processing entity for derivative trades, which has got FX managers antennae up to see if master agreements need to be amended to avert settlement issues. Treasuries that have CSAs in place also are asking about changes required for these, including regulatory margining requirements vs. the negotiated terms of their CSA. How to navigate potential OTC market shifts offshore? There has long been the expectation that derivatives dealers would look to figure out how to move OTC trades offshore to circumvent at least some of the reform regulation. If this shift happens, it will be starting soon, so FX managers want to know how to manage attempts at jurisdictional arbitrage from their perspective. Understanding the various mechanisms available to clear exempt and non-exempt derivative trades, including connectivity to exchange CCPs and alternatives. Standardized contracts will be migrating to exchange clearinghouses as well as electronic multilateral clearing platforms. The latter may also accommodate some forms of remaining OTC derivatives. As corporate end-users, FX managers will want to know how current clearing will work and evolve over time to capture new efficiency opportunities (e.g., STP) and mitigate operating
n

and counterparty risks. What are the available derivative processing solutions? A related point for discussion involves the specialty applications, new treasury system functionality and services by external providers that are or will be offered to FX managers to help them process derivative trades under the new market rules. This includes a comparison of in-house vs. outsourced solutions offered by dealers and custodial banks. With new derivatives trading rules as a backdrop, FX managers also are eager to digest the FASBs proposed update on hedge accounting guidance currently out for comment. Will the proposed hedge accounting guidance be the net benefit to hedgers that early assessments indicate? While the new guidance would make it easier for hedges to qualify for hedge accounting, the P&L impact requires a shift in focus to measuring the difference in fair value between hedge and hedge item. rEPORTING fX iMPACTS The results of hedge programs are also part of the discussion of FX managers interest in reviewing management and external reporting of FX impacts. The impact of high FX volatility on company earnings has generated increasing focus on being able to explain to management and outside stakeholders both the impact of FX and how the FX teams actions mitigate the swings. The bullet points for this discussion include: n How to calculate FX performance: How do you do it and what is best practice? n What is included in management reporting packages for FX. What do reports look like and how frequently are they produced? n How is the impact of FX and mitigating actions communicated to investors? Concerns about what is being hedged and the value of hedging is also influencing FX managers interest in taking deep dives on cash-flow hedging strategies. Also, how are companies tweaking their cash-flow hedge programs due to changes in their business or management attitude? While subject to change, these topics indicate the current priorities of leading FX managers as they look to the second half of the year.

14 International Treasurer / August 2010

For additional information visit iTreasurer.com

PEER GROUP UPDATE

Getting to World-Class Cash Management

By Bryan Richardson The NeuGroups Global Cash & Banking Group seeks to determine what world-class means. At the March meeting of the Global Cash and Banking Group (GCBG), the peer group decided it would conduct a survey of members to determine the key principles for operating a worldclass cash management organization, regardless of size and budget. The members from 3M, Bechtel, Dell, Kimberly-Clark, Merck, and later Eli Lilly, volunteered to form the Core Team that would perform the heavy lifting of identifying the key areas of interest, such as organization structure, policies and procedures and technology, and developing those critical survey questions that would help determine those worldclass principles. Shortly after the Core Team began its work, Citibank, the sponsor for the September meeting, volunteered to step into the picture with their Treasury Diagnostics tools. Too biG for oNe MeeTiNG During the survey development process, the group determined it would be best to split the project into two phases. The first phase, to be covered at the September meeting, includes the following categories: Member demographics  Treasury and shared service centers Centralization Organization Policies and procedures Talent Technology Bank relationship management The second phase, to be covered at the March, 2011 meeting will include these following categories: Bank account management Accounting Liquidity management Cash-flow forecasting Cash positioning Intercompany transactions After a series of testing and survey iterations, the final survey was launched on July 29. The first phase is focused mostly on structural categories such as geographical locations, responsibilities, and supporting policies and technology. The second phase will be focused primarily on core operations and processes within cash management. The projecTS Goal The survey aims to collect useful benchmarking data that will help GCBG members improve their global cash management efforts by comparing their own metrics to those of their peers and create guiding principles that define what is world-class in this area. It is important to note that the effort is to focus on worldclass principles that can apply to any company. It would be easy to conclude that a world-class treasury operation surely has the latest version of the most robust treasury management system in place, or that they use only three banks globally to get their jobs done. But this is inaccurate. Many smaller companies have very sophisticated and streamlined operations using their banks on-line banking products efficiently. Technology is one of the topics of particular interest as companies seem to always be in pursuit of some technological improvement. One line of questions in the survey is about the realistic endstate vision of the members, including what the end state looks like in terms of system utilization, straight-throughprocessing and the like, as well as how close they are to achieving it. Therefore, is the principle in play here that a worldclass company is constantly pursuing improvement? Or, is it a simple matter of technology advancing faster than companies can keep up? TreaSUryS GoT TaleNT Another interesting category is that of talent. The survey questions address various sub-topics such as rotational programs, succession plans, employee development, recruiting and retention practices. Certainly these are topics a responsible treasury leader would seek to manage well. But how does a world- class organization approach them? Is high employee turnover due to strong development programs a sign of excellence, or is longevity, stability and well-rounded experience in treasury a better indicator of world-class status? CeNTraliZed vS. deceNTraliZed Finally, one area that has garnered extra attention in the project planning is the matter of centralization versus decentralization of treasury activities. This is in line with the general reassessment of optimal centralization taking place across the peer member companies of The NeuGroups. Without it being overtly expressed, judging from recent back and forth with members, it seems there is a legitimate need to dismantle the presumption that centralization is inherently better than decentralization in every case and to view them both as potentially effective structures each with their pros and cons. Thus, as a practical matter when benchmarking key processes, for example, it is not always safe to assume that central treasury executes all aspects of the process. There may be regional or local execution elements and these may not be entirely standardized throughout the world. Where and how processes get done can provide useful insight into how treasurers should think about centralization vs. decentralization going forward. These are the considerations the GCBGs 28 members will be working on at the September meeting to determine amongst themselves, not what systems, turnover ratios or organizational structures are best, but how these areas are approached and managed within the context of industries, company size, geographical coverage and so forth. You can look forward to more reports of this effort in the coming months.
n

Organization

For additional information visit iTreasurer.com

International Treasurer / August 2010

15

Daily Trusted Intelligence for World-Class Treasurers The NEW iTreasurer.com

International Treasurer now has daily online features that bring you intelligence drawn from a world-class network of treasury professionals who share their insights, concerns and solutions on tough treasury issues.

Latest Intelligence

Latest Intelligence
Your daily source of breaking news and intelligence that puts information in the context of whats important to treasury.:

Resources
International Treasurer

Most Popular Articles

Hot topics at-a-glance such as the developments in OTC derivatives legislation and hedge accounting reforms, checklists to help implement treasury best-practices and calculators to help support decisions relevant to current treasury challenges.

This Month in International Treasurer

Recent articles appearing in the agship, monthly newsletter contain in-depth insight into the issues affecting treasury and agendas of treasury practitioners. You can rely on 15 years of nance and treasury editorial experience, as well as the shared knowledge of world-class treasurers, to know whats important to treasury.
This Month in International Treasurer:

Subscribe
Full access to iTreasurer.com is only available to subscribers of International Treasurer. To subscribe go to: www.iTreasurer.com/ITsubscribe or call: 1 800-535-2884.

Sign up for FREE eBrief

Comments Privileges
Only subscribers are allowed to add comments to articles, so you will be able to read, share and interact in a meaningful way with other world-class professionals seeking to advance treasury best practices.

News Briefs
A carefully selected collection of news articles from the nancial press featuring a timely call-to-action on important issues that are likely to affect your treasury and organization.

Visit daily for breaking news ad articles on the following topics:

News Briefs:
Peer Group Highlights:

IT eBrief
A weekly roundup of the weeks latest intelligence and breaking news delivered to your desk via email.

Weekly Datapoints
Unique charts and graphs that highlight a weekly topic and give you the data to make a decision or change in your treasury.

Weekly Datapoints:

Monthly Peer Group Meeting Summaries

Find out whats on the minds of the treasury professionals who are members of The NeuGroup Peer Groups, including The Treasurers Group of Thirty.

Featured Events:

Go to www.ITreasurer.com to log in or to subscribe.