The Treasurer October 2004
SOX – THE SHAPE OF THINGS TO COME?
How dearly some of us end up paying for the crimes of others. This is the viewpoint shared by many treasurers of US listed companies who have taken the brunt of the recent corporate financial scandals by being forced to comply with the corporate governance requirements of Sarbanes-Oxley (SOX) (see No shelter from the storm, p16).
Section 404, governing internal controls for financial reporting, is proving a bitter pill to swallow. Not only is it inundating treasurers of US listed companies with a range of extra activities, such as the documentation of internal controls, but it has burdened them with an even greater task in the testing and ‘evidencing’ of those controls.
But US companies may not be alone when it comes to tightening the reigns on corporate governance. SOX’s strict rules-based approach suggests similar legislation in other countries may be warranted to create a level playing field for corporates and investors worldwide.
While the EU argues that a “one-size-fits-all approach” to corporate governance would be counter-productive across Europe, it too has taken steps to improve Europe’s regime. Take the European Commission’s proposed directive for an effective system of public oversight for auditors across Europe. This not only draws on the US model to ensure greater convergence with SOX’s audit rule, but was developed in close co-operation with the US Public Company Accounting Oversight Board (PCAOB). Is this the start of things to come?
The UK has also taken measures to protect itself more forcefully against the likes of an Enron, Parmalat or a WorldCom. There are plans to review the Combined Code on Corporate Governance on an ongoing basis, and to revisit Nigel Turnbull’s internal control guidelines for directors. At present, the Companies Bill – a new piece of legislation that places more onus on directors to be accountable for financial reporting – is also making its way through Parliament.
While many of us may continue to question the correctness of the tough and punishing new measures SOX introduces, it is becoming equally apparent that there will be no lightening up anywhere in the world – not when it comes to corporate governance.
On a different note, it is probably with mixed feelings that we anticipate the potential carving-out of the Fair Value Option from IAS 39.While debating the whys and wherefores of this change in direction, it is equally important to question why it took until just four months before the timetabled implementation of the new International Financial Reporting Standards (IFRS) – for this to happen.
This news, so close to adoption deadlines, will be a blow to many corporates who have prepared for fair value accounting in the hope of convergence with US Generally Accepted Accounting Principles. In this month’s edition of The Treasurer, we take a special look at the changes proposed for IAS 39 with an in-depth explanation of the carved-out version on page 46 and the views of leading treasurers on how this will impact their adoption of the standard on page 7.
LIZ SALECKA
Editor
marketwatch NEWS (TT Oct04 p6-8)
Bill showing shades of Sarbanes-Oxley
The Companies Bill, which aims to restore investor confidence in companies and the financial markets, has completed its second reading and Committee stage in the House of Commons, putting it on schedule to receive Royal Asset later this year.
marketwatch NEWS (TT Oct04 p8)
Currency risk tops the agenda
Managing foreign currency risks, the bank products that can help, and accounting for currency hedges were among the key topics discussed at the recent Managing Risk: Currency and Interest Rates conference, held in association with Fortis Bank.
International Bonds (TT Oct04 p9-10)
These are a selection of bonds announced recently. The details, updated to the middle of last month, were supplied by Thomson Financial
Securities Data and other sources.
2005: Slowdown or recession? (TT Oct04 p11-12)
A significant slowdown in growth in the second quarter of 2004 was marked in US and Asian countries such as Japan and China. An upsurge in oil prices caused by events such as the war in Iraq led to unsettled stock and bond markets but prices should fall by mid- 2005. Despite the rise in oil prices, consumer inflation will only rise slightly next year. The slowdown in the pace of expansion next year is expected to be significant but tolerable. n Oil prices are expected to come down gradually, interest rates will rise moderately and global pressures should ease.
Delicate operations (TT Oct04 p13-15)
The most important risks faced by treasuries are cash and liquidity, funding, interest rate risk and foreign exchange risk, according to a recent survey. Most treasurers are “very cautious” or “cautious” in their approach. The chosen method of measuring risk must suit the level and type of risk. As a minimum treasurers must be aware of the mark to market value of their positions. Only 44% of treasurers currently measure and report on performance against the treasury policy. Most treasurers now rely on a specialist treasury system or the module of an enterprise-wide system. 44% of treasurers believe that IAS 39 will have an impact on their economic treasury policy. The majority expect to shift to more ‘vanilla’ hedging products. IAS 39 will necessitate a detailed review of treasury operations – at the very least.
No shelter from the storm (TT Oct04 p16-18)
Section 404 of SOX places stringent requirements on the internal controls used for financial reporting. UK companies with a US listing must be compliant for financial year-ends as of July 2005. In the US, the cost of s404 compliance has soared well beyond expectations. Although the average cost per company was estimated at US
3.14m. There is no escape for treasurers of UK companies with a US listing. They must play a key role in ensuring the effectiveness of internal controls, and be prepared to take the blame should things go wrong. To ensure compliance, treasurers must start early, focus on key controls and collate adequate evidence over a sufficient period of time. Testing of internal controls is one of the biggest hurdles, accounting for about 40% of a s404 project – and it is not going to go away in the future either. An independent audit of controls must also be conducted annually. New IT systems that provide s404 compliance may be the answer to treasurers’ prayers. Although the technology is still in its infancy, solutions that allow greater transparency of processes are being developed.
Weighing up FX hedging (TT Oct04 p19-21)
Companies want to reduce the effects that adverse currency trends have on their bottom lines and limit FX-induced volatility. One-year rolling exchange contracts are inadequate if adverse trends continue for years and to combat this, companies must re-evaluate their hedging strategies. Using advanced averaging methodologies and layering hedges over a period of years allow companies to factor in cashflow and earning forecast uncertainties. Corporate management can take control of a hedging programme by establishing criteria, which when triggered, execute a specific hedging strategy. A Purchasing Power Parity (PPP)-based hedging program, can also improve performance. PPP can also determine the best hedging instruments that are required at a certain point in time. It is the turn for European corporates to deal with the effects of a strong performance of the euro on foreign subsidaries, particularly those generating revenue in US dollars.
Lending corporates a hand with pricing (TT Oct04 p22-24)
Limited M&A activity has reduced corporate lending significantly, bringing favourable pricing, longer tenors, reduced fees and relaxed covenants. Loan volumes in the UK have fallen by 8% on last year, and transaction numbers are at an eight-year low. Cyclical data indicates that the loans market will see low prices for at least another year, benefiting corporates looking for refinancings and M&A facilities. Banks lending decisions are based on overall returns and credit quality with the capital adequacy provisions of Basel II – due to be fully implemented by 2007 – also making an impact. A corporate’s credit rating will be imperative to those banks compliant with Basel II at a basic level. Although figures for the UK, French and German syndicated loan markets indicate convergence in pricing, loan volumes increased by 41% in France and 71% in Germany during the first half of this year. The trend on the continent is towards syndicated facilities with smaller bank commitments to individual borrowers.
Building bridges overseas (TT Oct04 p25-26)
Britannia’s treasury team is responsible for £5.5bn of liquid assets, £7bn of wholesale funding and the balance sheet management of £22bn in assets and liabilities. Britannia’s credit status ensures attractive pricing in overseas markets such as the US, Canada, France and Australia. Its money markets team enters up to £500m of transactions per day. Cash from Britannia’s branches is pooled in and out of the main bank account and is managed by the treasury team. The treasury team focuses heavily on asset and liability management (ALM), managing exposures to adverse movements in interest rates. The balance sheet is divided into four books to reflect underlying interest rate exposures. Britannia Treasury Services, a separate company in the group, has raised more than £2.5bn through securitisation since 1997.
A brighter future for forecasting (TT Oct04 p28-31)
A formalised cash forecasting process can bring huge benefits to your cash management, potentially adding 30bps of added return to a portfolio. Survey results indicate that many treasurers are frustrated with their cashflow forecasting – 40% identified it as a leading cause of excess cash balances. The most common pitfalls in forecasting are limited resources; inaccurate/insufficient cashflow data; and process design flaws. Successful forecasting calls for solid data collection; consistent methodologies; a process to analyse variances; and effective reporting mechanisms. The three most commonly used forecasting methodologies – balance sheet forecasts; statistical models and receipts and disbursement forecasts – have their own strengths and weaknesses that lend them to specific situations. A cash forecasting process must validate projections against results; understand current variances; and determine how the forecast can be improved.
A central collection (TT Oct04 p32-34)
Centralisation of the cash management function offers cost savings and control benefits. By forming strategic relationships with global banks, corporates can eliminate the need for bank accounts in every country in which they are active, and reduce fees. Payment factories and in-house banks allow the consolidation of financial payments and payables and receivables. An in-house bank can convert expensive cross-border transactions into cheaper, domestic ones. While maintaining visibility over all treasury activity, a centralised treasury can also allocate levels of control to subsidiaries. It can also deliver clean, dependable data, enabling treasurers to analyse reports and drill down for information. This audit trail is a big step towards higher standards of corporate governance.
Cashing in on outsourcing (TT Oct04 p35-36)
The decision to outsource should be made as part of your company’s long-term strategy, not purely to reduce immediate costs. Treasurers are interested in outsourcing liquidity management, particularly cash pooling and management of inter-company loans. Outsourcing liquidity management was considered ‘hot’ five years ago, but is now common practice for both corporates and their banks. Choice of service provider is vital as reversing the outsourcing process is difficult if things go wrong. Questions to consider include: will outsourcing reduce staffing requirements and eliminate the need for support services such as IT, and will it eliminate high levels of spending on infrastructure? The levels of automation offered by your service provider are crucial.
Why cash is king (TT Oct04 p38)
Corporate financial scandals such as Enron and WorldCom have caused banks to cut back the availability of short-term credit. According to a recent online poll, 64% of banks and 47% of corporates believe this will be the case for the foreseeable future. A company’s cashflow is now considered a significant lending criterion, with 81% of banks and 85% of corporates believing it outranks historic P&L. Cash forecasts must go beyond two-week timeframes and just treasury cash.
Overhauling sterling overnight (TT Oct04 p39-41)
The Bank of England is changing its official operations in the sterling money markets to reduce overnight interest rate volatility. This will bring higher overnight rates, which is good for funds with a heavy weighting in these deposits. It may also increase liquidity in the overnight market to much later in the trading day, allowing such funds to offer a later cut-off time. MMFs will be less prone to arbitage-driven redemptions when overnight rates move. The Bank’s new system involves allowing banks to average out the sums they hold with it over a maintenance period. If overnight rates fall, banks will be able to switch funds to the Bank, causing the overnight rates to rise again, and vice-versa.
Sizing up liquidity funds (TT Oct04 p42-45)
Credit rating downgrades have placed more pressure on treasurers to diversify their investments and spread counterparty risk. Liquidity funds can satisfy many requirements – providing security, liquidity and the potential to enhance yields. A number of factors must be considered when selecting a liquidity fund provider such as credit quality, the size of the fund and the solution’s position along the yield curve. Enhanced yield funds diversify outside of traditional instruments and offer durations of 90 to 365 days, providing a home for cash balances with a 6-12 month horizon. Liquidity funds also offer a variety of services and options such as sameday settlement and late dealing deadlines. Other benefits include instant liquidity without penalty and automatic sweeping of uninvested cash. Some providers also offer online services.
Technical Update (TT Oct04 p46-48)
EC proposals for cut-down IAS 39
Extensive lobbying from European banks over the International Financial Reporting Standard – IAS 39 – has led the European Commission (EC) to propose its own cut-down version of the standard (see Editorial, page 1, The Treasurer, September).
technical Update Extra (TT Oct04 p49-50)
Existing beliefs relating to ISDA documentation should be questioned. It is not necessarily “standard form” and banks do not always provide “accurate contracts” suitable for non-bank users. Beliefs regarding the documentation’s logic, and the stability of derivatives law/documentation should also be questioned. A professional legal review is essential in most cases. A “holistic” approach that takes account of existing relationship/finance documentation between corporates and their banks as well as the swap documentation is recommended. Structural issues such as the form the documentation takes as well as the extent and scope of collateral arrangements must be considered. Default sensitivity should also be examined on both sides – that of the corporate and that of the bank. Corporates should consider their relationships with their banks in terms of borrowings and deposits when drafting the ISDA documentation they enter.
Toughen up soft skills (TT Oct04 p54)
The rules for recruiting the perfect treasury specialist are constantly evolving. Whilst there will always be focus on talented, knowledgeable people, the argument exists for placing more importance on how the professional will handle themselves in a work environment and how they will relate with their clients and peers. These are known as ‘soft skills’ and are not found in a candidate’s CV.
