IN PURSUIT OF THE IDEAL BANKING RELATIONSHIP
Ensuring effective banking relationships is often cited as the key goal for corporate treasurers. But do such relationships always prove fruitful... or can they end in tears? Increasingly, we are being advised that a good banker can assist in an array of corporate arenas and prove an invaluable asset by exploring and growing the relationship and developing bespoke products.
The banks themselves are adamant that they are now hotly pursuing a Customer Relationship Management approach, with ‘Know Your Customer’, and the provision of a seamless, total service at the heart of their corporate philosophies.
But does a one-stop solution really represent the corporate ideal? For treasurers, ‘making sure your eggs are not all in one basket,’ has always been very much order of the day, a strategy that is well reflected in ongoing objectives to diversify funding across a variety of sources. Indeed, recent research suggests that about 11% of relationship credit volumes will switch to alternative finance before the end of the year (see Corporates targeting liquidity, page 6). In much the same way that treasurers seek to mitigate the risks they face – so too do the banks – and this is clearly illustrated in their growing movement towards purchasing protection against potential default by corporate borrowers.
Consider for one moment the changed dynamics of the borrower: lender relationship when things go wrong. In the past, for a company heading into financial distress, a priority would be to sit around the table with its bankers and agree covenant waivers, the extension of maturities, or even a rescue package. The banks would have a vested interest in seeing the company get back on its feet and into profit as soon as possible.
But the emergence of credit default swaps (CDS) puts a whole new spin on things. Embraced by corporates as a means of protecting themselves against default by trade and financial creditors (see A credit to your business, page 26), these instruments have their roots with banks, who are using them to hedge corporate credit risks on their balance sheets.
If a bank has purchased such cover for all exposures to a creditor company in financial distress, it may not take such an active interest in helping that company resolve its problems.Worse still, it may have a vested interest in seeing that company is pushed over the edge – and declared insolvent – in the knowledge that a greater gain will be made from claiming under a CDS contract than facilitating a rescue package. This brings a whole new perspective to the corporate:bank relationship and is clearly one that will stay at the top of corporate treasurers’ agendas for the years to come.
Should they adopt the one-stop, seamless service model being promoted by banks for all the efficiencies that it promises? Or is there still so much to be said for the traditional risk mitigating strategies that have characterised corporate treasury for so long?
LIZ SALECKA
Editor
EU opts for carved-out IAS 39
The European Union has gone ahead with adoption of the carved-out version of IAS 39 (See News, page 7, The Treasurer, October) in a move which could raise serious issues for UK and European companies in the process of adopting the new International Financial Reporting Standards (IFRS).
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.
China and India, for so long the domain for western companies looking to manufacture their goods at a low cost, are set to offer new competition to western companies. The recent move up-market by Asian firms means they will be able to develop their own brands and distribution networks. The cost of developing brands in the west is high. Instead, Asian firms are likely to buy into western markets or enter joint ventures with them.
Treasury consultants and analysts believe that SOX compliance in most treasury departments is almost impossible to achieve without the support of a contemporary TMS. Companies are either purchasing a solution for the first time or upgrading their current technology solutions to make sure they are SOX compliant. Core SOX compliance necessitates that companies’ treasury processes are structured, transparent and supported by a full audit process. The company-specific elements of SOX compliance mean a solution has to be analysed, designed, configured, tested and delivered as a distinct project. Pressure is on the technology industry to provide solutions that offer the levels of compliance that suit each company’s specifications. Aided by vendors, senior managers have the final say on compliance in their organisation. They authorise procedures, sign the financial reports and face prosecution if SOX is breached.
If cost of capital is poorly managed, this can lead to a company overpaying for acquisitions, incorrect statement of asset values on balance sheets and the inability to assess which balance sheets can be stretched to maximise the impact of financial leverage. Cost of capital was considered the domain of the finance department and CFO, but treasurers have an important role in its analysis. Judging capital markets behaviour, how debt is priced and what equity returns shareholders can expect are just a few of the main roles that treasurers can play. Cost of capital theory and analysis can be used to assess optimal capital structure. Calculating optimal capital structure requires estimating the cost of debt and cost of equity capital at different levels of gearing.
Treasury policies should be approved at board level and give personnel the guidelines on their roles, what their boundaries are and how their performance will be measured. Treasury policies should not skim the key risks faced by a company’s treasury and should set out exactly what instruments are to be used and the exact purpose of transactions. A policy which focuses mainly on financial or accounting risk management could mean that other key risks are being overlooked. Treasurers should review their existing policies at least annually and make necessary changes when their companies undergo changes such as acquisition. Unless a treasury policy is regularly updated, clear, specific and comprehensive, it is only slightly more useful than no policy at all.
Many companies have warehoused large amounts of unwarranted credit risk. There are many forms of credit risk and it is essential for companies to set up systems that measure and quantify each operation’s inherent credit risk. A centralised risk management system will aggregate risks across different business lines for each counterparty. Credit derivatives are becoming more popular and provide users with more transparent, tradable, liquid and standardised contracts. They can also pay out and settle without the buyer having to prove financial loss. Credit default swaps – the underlying contracts in most credit derivatives – pay out if the reference entity suffers a ‘credit event’ such as bankruptcy. Companies with a good understanding of the credit risks that affect their businesses, and who manage them with credit derivatives, can make considerable long-term cash savings.
Lack of up-to-date technology and complexity are the main reasons why securitisation has been considered the domain of large corporates. Recent reports indicate that securitisation is past the ‘pioneer’ stage and is growing rapidly, with nearly 20% of top European companies stating that they have securitised assets within their companies. The five types of securitisation used by corporate treasurers are trade receivables, whole company, vendor finance, future flows and property. Invoice securitisation is expected to emerge as a frontrunner over the next few years, especially for post-LBO/MBO companies.
Cash pooling and internally-generated funding are attractive because they eliminate the banker’s spread and the risk of interest rate fluctuations. The regulatory environment has a major impact on corporates’ cash management practices. The latter will be impacted, for example, by the various regional and countryspecific interpretations of Basel II. If externally-generated liquidity is required at some points in the working capital cycle, it is better to rely on a range of providers. Corporates should always retain responsibility for their ‘risk appetite’ and not let their service providers decide on suitable investments.
Emap’s treasury function is responsible for ensuring funds for its aggressive growth strategy, which has been characterised by both acquisitions and organic growth. Strong cashflows have facilitated the organic growth. Having relied predominantly on bank facilities in the past, the company turned to the debt capital markets in 2003. It published credit ratings for the first time, confirming its status as an investment grade company. The company is focused on ensuring a good return on capital and the group’s weighted average cost of capital (WACC) is monitored closely. IAS 39 represents a major issue for the media company and it is looking to invest in a new TMS solution to meet the standard’s effectiveness testing and accounting requirements.
EU emphasis on governance
Corporate governance has been the flavour of the month for several years in the UK and the US, and the European Union (EU) is now working hard to catch up with certain practices. A flood of new initiatives has come out of the EU in the past month. These are aimed at improving governance across member states and achieving consistency from country to country.
An issue of size
2003-04 was a slow year for the investment-grade bond market, witnessing the typical decline experienced in new corporate bond supply across markets and currencies.
Loans enter a new term
Limited M&A activity during 2003- 04 reduced corporate lending significantly, bringing favourable pricing, longer tenors, reduced fees and relaxed covenants.
The strongest link
Activity in equity-linked issuance was underpinned at relatively healthy levels during 2003-04, following on from the flood of transactions witnessed in 2002-03, despite suggestions that this market would level off.
Moving into the mainstream
Securitisation and structured finance continued to see growing acceptance as financing techniques in 2003-04, providing many corporates with the opportunity they wanted to diversify their sources of funding.
IPOs take their slice of the cake
Limited M&A activity again dampened issuance in the equity markets during 2003-04, although the markets were tapped by companies looking to refinance their balance sheets or raise money for company restructurings or growth and development. The IPO market also witnessed further steady issuance and demand, with many deals several times oversubscribed.
Reaching new heights
2003-04 continued to see good activity in the high-yield bond sector, boosted by the benign credit backdrop and relaxed perceptions of the general economic outlook.
