FTA Outlook 2015 sample by Annette

FINANCE AND TREASURY ASSOCIATION

OUTLOOK

2014 2015

LO O K I NG OVER THE HOR I ZON

FINANCE AND TREASURY ASSOCIATION

OUTLOOK

2015

FTA Outlook is published by CommStrat

CONTENTS 3 4

President’s Message CEO Report

on behalf of the Finance and Treasury Association

ECONOMIC OUTLOOK

MANAGING EDITOR Chris Atkin e: chris.atkin@commstrat.com.au EDITOR David Michell e: david.michell@fta.asn.au Tel: +61 3 8534 5003 NATIONAL SALES MANAGER Yuri Mamistvalov e: yuri@commstrat.com.au Tel: +61 3 8534 5008

By Stephen Boyd, Head of Corporate Debt Markets Origination, National Australia

Andrew Roberts, Head of European Macro

CAREER FEATURE

Research, RBS

RATINGS OUTLOOK

www.commstrat.com.au All material in FTA Outlook is copyright. Reproduction in whole or in part is not allowed without written permission from the Publisher.

A global fintech career in the front lines of gender diversity by Kimberley Cole, Head of Sales

Australian Non-Financial Corporates: Outlook Stable, but Weakness in Some Sectors

Specialists, Asia, Thomson Reuters

Maurice O’Connell, Vice President and

Elevating Australia’s Finance Learning Standards In Higher

Senior Credit Officer at Moody’s Investors

Education

TAX OUTLOOK Globalisation and Profit Allocation – The Tax Noose Tightens

Andrew Brown CFTP, Head Australia &

TECHNOLOGY OUTLOOK Understanding a True SaaS: What You Don’t Know Can Cost You Philip Pettinato, Chief Technology Officer, Reval

FINANCE EDUCATION FEATURE

Monash University

Valuing Derivatives Under AASB 13 Fair Value Measurement

New Zealand, Chatham Financial

Chris Kinsella, Partner and Stephen Jones, Special Counsel, Minter Ellison Lawyers

The Evolving Role of Cash and Liquidity Management Michael Leighton and Nels Mortensen CFTP, First Treasury

REGULATORY OUTLOOK

China’s renminbi: it’s high time for decisive action

Regulatory Reform: 2015 and Beyond

David Olsson, China Practice Consultant,

CASH MANAGEMENT OUTLOOK

CHINA OUTLOOK

King & Wood Mallesons

by Associate Professor Kevin Tant FFTP,

RISK OUTLOOK

Accounting Advisory Services and

Level 8, 574 St Kilda Rd. Melbourne Vic 3004 PO Box 6137, St Kilda Rd Central 8008 Phone: +61 3 8534 5000

Bank

Steve Castleton, Global Co-Head

ABN 31 008 434 802

Debt Markets in 2015 – Timing Will Be Everything

2015 – Accelerating Global Disinflation Drives Currency Wars

Service

ART DIRECTOR Annette Epifanidis e: annette@commstrat.com.au Tel: +61 3 8534 5030

DEBT MARKETS OUTLOOK

Pieter Bierkens, Executive Director, Rates Regulatory Strategy, CBA

Bringing cash back from China

TREASURY OUTLOOK

Matthew Clarke CFTP, Group Treasurer,

Aligning the Treasury Value Add from Back Office to Board

Intertek Group

Supply Chain Finance – Opportunities & Challenges for Treasurers – an Interview with ANZ

by Alistair McLean FFTP, Group Treasurer, Metcash Limited

2015 FTA Partner Directory 54

By Stephen Barnes FFTP, Director, Byronvale Advisors

FTA Outlook 2015 | 1

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WORKING CAPITAL OUTLOOK

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PRESIDENT’S

MESSAGE

ROSS MCKEAN CFTP (SNR) PRESIDENT THE FINANCE AND TREASURY ASSOCIATION

elcome to the FTA Outlook 2015 magazine. This is the second year of this magazine and I am sure that you will find it a useful reference point for current and new issues that we treasury and finance professionals will face in the coming year. The Finance and Treasury Association is committed to continuing to build on the 30 year foundations of this organisation and to provide a relevant, enjoyable and productive membership offering for all of our members. In 2015, we will continue to provide forums for face to face learning and discussion across a number of issues. We will also build on the 2014 launch of the FTA Academy which is another membership offering for those who due to time pressures do not always have the opportunity to get out of the office to attend specific events. The FTA Academy also contains articles on topics of relevance for researching or looking for different perspectives of Treasury.

The key networking and Professional Development offering of the FTA is our annual Congress. This year it will be in Melbourne, and we again look forward to a successful and well attended event. I encourage all members to attend the Congress. It is the one forum where you can touch base with your peers, meet with new people and also have the opportunity to listen and interact with professionals who share their thoughts and experiences across many different topics in a condensed period of your time. If you walk away with just one new idea or solution to a potential conundrum you face within your work environment, it should be regarded as successful. Similarly, I encourage attendance at all of the events that the FTA puts together for its members across Australia; you will see a range of differing events throughout the year. Participation by way of presentation or attendance to FTA events by our members helps make us a stronger more relevant and better offering for everyone. Lastly, I would like to thank all of the contributors to this magazine. I also thank all of you that continue to sign up as FTA members. Personally I am looking forward to what I hope is a challenging and ultimately successful 2015.

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FTA is also committed to growing and rejuvenating our membership and providing the relevant levels of membership offerings for existing members and potential new members. The Pathways membership provides a way of introduction for the next generation of members. We are also looking for more seasoned treasury professionals to provide mentoring for up-and-coming treasury professionals. If you can offer some of your time, please consider being a mentor and passing on your knowledge.

“The Finance and Treasury Association is committed to continuing to build on the 30 year foundations of this organisation and to provide a relevant, enjoyable and productive membership offering for all of our members.”

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FTA Outlook

EDITOR'S

OVERVIEW DAVID MICHELL CFTP (SNR) CHIEF EXECUTIVE OFFICER THE FINANCE AND TREASURY ASSOCIATION

he theme of this year’s FTA Outlook magazine is “Looking over the Horizon” where we have asked our authors to extrapolate on current trends and to consider developments barely on the horizon. In our first article Andrew Roberts RBS Economist asserts that the “number one global macro theme remains … global disinflation” which is sourced in part from the erstwhile growth engine in China. Roberts indicates that despite US growth, global wages growth will be minimal and oil prices will fall further. Falling inflation will affect corporate pricing power in most markets except the US. With rates zero bound in Europe and Japan, “currency wars” will hot up. NAB’s Steve Boyd notes on debt markets “a common view that the sustained rally in credit spreads globally over the past 18 months is overdue for a correction and … that the correction could be major”. While liquidity is expected to remain mostly plentiful it will be more prone to dry up in periods of uncertainty. Timing of deal execution will be critical given heightened volatility. Meanwhile, Maurice O’Connell of Moody’s Investors Service highlights that in aggregate corporate Australia is currently buffered from a return of financial market volatility by “strong balance sheets and liquidity, while leverage and refinancing needs are low”. The article highlights sector-specific challenges and canvasses “possible downside risk for credit profiles next year [and] the potential for M&A and shareholder-friendly activity”. 4 | FTA Outlook 2015

“While liquidity is expected to remain mostly plentiful it will be more prone to dry up in periods of uncertainty. Timing of deal execution will be critical given heightened volatility.”

The article on Financial Regulation by Pieter Bierkens of CBA is an important read to get an overview of the next stage of regulation of derivatives notably the impact of Basel-IOSCO margin requirements for noncentrally cleared derivatives. While Australia appears to have learnt some of the lessons from Europe’s experience here, FTA considers that the capital penalty to banks for transacting with corporates on non-centrally cleared derivatives is excessive and will further raise the cost of corporate risk management. Bierkens and Boyd both highlight how overall financial system liquidity risk has been heightened by a combination of regulations notably, the Volcker rule which limits dealer inventory. Andrew Brown CFTP of Chatham Financial highlights the benefits of a process for qualitative assessment of Credit Value Adjustment (CVA) under AASB13 which helps an entity determine whether to explore a “robust” (system and process-intensive) approach, or a simplified approach. They also note “if an entity is relying on periodic valuation statements from dealer counterparties for fair value measurements in its financial statements, it is very likely that entity is not complying with the requirements in AASB 13”. I am always delighted when practising treasurers take pen to paper even if it is only figuratively these days. In “Aligning the Treasury Value Add from Back Office to Board” Alistair McLean FFTP Group Treasurer at Metcash offers nine tips for treasurers and their staff to add value and get noticed by internal and external stakeholders - for the right reasons.

One new thing more treasurers in Australia will do in 2015 will be to transact in Renminbi (RMB) for the first time. David Olsson of King & Wood Mallesons details Australia’s responses to the internationalisation initiatives of the Chinese government and regulators. He argues that although RMB is still far from being an international currency, Australian companies should be paying closer attention to its evolution. “The use of RMB is fast becoming both an immediate competitive advantage and vital to future strategy for companies with any form of commercial exposure to China”. London-based FTA member Matthew Clarke CFTP is Group Treasurer of Intertek Group plc which operates in over 100 countries including China. Intertek provide an illuminating case study of Cash management in China where they have implemented RMB pooling structures to concentrate cash in China and RMB accounts in offshore RMB centres. Clarke suggests that the recent regulatory changes make now a good time for companies operating in China to review existing cash management processes. Nels Mortensen CFTP of First Treasury argues cash visibility is the “basis of accurate cash flow forecasting” and is enhanced by establishment of “internal bank” structures and payment factories. While Intertek’s Clarke reserves SWIFT “for the accounts we can actually control from treasury”, First Treasury are proponents, in general, of greater SWIFT (and ERP) integration by Australian corporations. Perhaps the key transformative change for treasurers in 2015 will be the Cloud which is revolutionising core technology for treasurers - their treasury system. Reval’s Chief Technology Officer, Philip Pettinato maintains that Software-as-a-Service (SaaS) allows companies to standardise their workflow across the global treasury organisation, across functions, geographies and time zones. With all of the application’s users working on a common technology platform, scope for collaboration is enhanced. With no sign that the pace of globalisation is slowing, former FTA VicePresident Stephen Barnes FFTP interviews Catherine Mallanack and Ryan Fernandes of ANZ about working capital management opportunities for treasurers from cross-border supply-chain financing (SCF). While traditional export and import trade in goods and services continues to grow, the SCF is opening up new growth opportunities by facilitating cross-border business-to-business collaboration.

Tertiary education in business and finance is now one of Australia’s major sources of service sector export income. The number of courses and providers has grown rapidly adding variety and competition. But the quality is variable which has implications for how finance is practiced in this country, and also the reputation offshore of an

Treasurer Hockey will hand down the Government’s response to the Murray Financial System Report after a consultation period ending late March. However, the main game after that for the Commonwealth Government in 2015 is likely to be the Tax White Paper where lifting tax revenue will be the over-riding objective.

“Perhaps the key transformative change for treasurers in 2015 will be the Cloud which is revolutionising core technology for treasurers their treasury system.” Chris Kinsella and Stephen Green of Minter Ellison highlight how Governments around the world are addressing erosion of their tax base, and the ramifications for Australia's corporates of the G20/OECD action on Base Erosion and Profit Shifting (BEPS). Kinsella and Green highlight three key action areas for finance and treasury professionals – hybrid mismatches, interest deductions and the digital economy. They note the Australian Tax office is currently investigating 86 multinational companies over their tax planning arrangements, including concerns over intangibles; offshore marketing and procurement hubs; hybrid entities and transfer pricing outcomes. On the last point, the focus of future ATO enforcement activity related to BEPS may well depend on the outcome of a Federal Court case heard in October 2014 on which the judge has to date reserved his decision. ATO is pursuing US oil company Chevron for $258m in unpaid tax plus penalties for claiming tax-free interest on inter-company loans which the ATO asserts were not at arms-length. My brief summary does not do justice to the great analysis in the 2015 FTA Outlook. I hope you like it! As technical and professional issues emerge throughout the year, you will benefit from being part of the FTA network. Join FTA for discounts on professional development and password-protected information. Subscribe at www.finance-treasury.com to our fortnightly FTA Update for my own CEO Comment on emerging developments and FTA advocacy for the profession. FTA Outlook 2015 | 5

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Hong Kong-based former Melbournian Kimberley Cole argues that having “a global mindset” and embracing gender diversity helps foster collaboration and is a way the individual finance professional can continue to evolve along with their operating environment. Concerned by the perennial issue of low female representation and senior executive roles, Cole who runs an Asia-Pacific wide business for Thomson Reuters candidly shares her experience with introducing more flexible work practices to retain own staff.

Australian education. In his article Associate Professor Kevin Tant FFTP of Monash University highlights the response of Australia’s peak universities by developing minimum competency standards that tertiary-educated finance students must exhibit before they may be permitted to graduate. FTA and other finance professional bodies assisted by providing a practical focus.

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Cash Management Outlook

THE EVOLVING ROLE OF CASH AND LIQUIDITY MANAGEMENT BY MICHAEL LEIGHTON AND NELS MORTENSEN CFTP, FIRST TREASURY

Following the GFC of 2008, the business environment for corporate treasurers was characterised by liquidity shortage, high volatility in exchange and interest rates and a widespread credit crunch. Suddenly no financial institutions, outside Australia at least, were “too-big-to-fail”. The regulatory follow-ons (Basel III, Dodd-Franck etc.) have affected the way banks operate, further impacting corporates. Today, 6 years on, this has led to an increased importance in - and increased responsibilities for - Treasury in regards to the disciplines of cash and liquidity risk management. At the same time, Treasury faces increased pressure from their banks, regulatory authorities, rating agencies, management and board.

The main pillar of Treasury, the Finance Policy, is no longer a policy just for Treasury, but for the whole company.” 44 | FTA Outlook 2015

In this article we will look at the changing role of Treasury focusing on the disciplines of cash and liquidity management, as well as some bestpractise approaches, and by taking a more global look we will give a prediction of what may be coming next for Australian corporates. Cash management was previously primarily viewed as a secondary task to Treasury, and the main purpose was “to know how much cash is in our bank accounts today” (or more likely “yesterday” or “last week”). Today, it is one the most important disciplines and has an impact on nearly all areas of the treasury. Cash management today entails the following areas:

• • • • • • • •

Choosing house banks Managing bank accounts Achieving cash visibility Cash pooling Cash forecasting Internal banking Payment factories Working capital management

Especially the last item, working capital management (WCM), may be unexplored territory for most treasuries, but as more and more treasuries have optimised their other areas of cash management, the focus has shifted to WCM, which traditionally has been the responsibility of the financial controllers. Due to the increasing responsibilities of Treasury throughout the company, treasury departments are at the same time becoming more centralised. The main pillar of Treasury, the Finance Policy, is no longer a policy just for Treasury, but for the whole company. Key performance indicators (KPIs) are set up to ensure the entities and subsidiaries satisfy the demands of Treasury, so they can make the best use of cash and liquidity. At the same time, centralisation of standard systems ensures automation, with incorruptible reporting and solid audit trails. Historically cash management functions were decentralised in the company. The positive side of this is that local people could deal with local

issues and relationships were with local banks. It could be said that with the move by many companies to do business with the developing countries that these positives are still there. However, the requirements of Treasury today require centralisation. Cash visibility is at the heart of cash management. Having control over the company’s cash gives a number of quantitative and qualitative benefits and often provides its own business case: • Fewer bank accounts reduce bank fees, reduce risk in their maintenance, and leave less idle cash • Control of the present cash in bank is a necessary starting point for cash flow forecasting • Control of the cash balance means less likelihood to need to draw on overdraft facilities • Control of the currency balances helps in the FX management • Control of cash can help to attain better ratings (and therefore cheaper funding) Companies should therefore keep banks and bank accounts to a minimum and keep account balances continuously updated in their systems. Even a small improvement can facilitate huge savings for the company, and the business cases in this area are often compelling.

Reporting is an essential element of the process, so the cash manager can compare version to version to see where changes have come from and also to compare actual balances against previous forecasts to find out where data was unreliable and take the necessary course to rectify data quality in the future.

Finally, the forecast can also be useful to the CFO, strategy department, tax department and is also an integral part of a public rating process. Rating agencies do not look at P&L or balance sheet items, their focus is liquidity. Good cash visibility is an essential foundation to a good cash flow forecast. An often heard excuse for not having a reliable forecast is that the data providers, mainly the operational subsidiaries of the group, do not deliver data of a sufficient quality. Here it is important to set the right incentives and be able to measure accuracy.

An often heard excuse for not having a reliable forecast is that the data providers, mainly the operational subsidiaries of the group, do not deliver data of a sufficient quality. Here it is important to set the right incentives and be able to measure accuracy.”

As an example, the treasury department of a large electricity producer was unhappy with the efficiency of its cash processes. A large float had to be kept on the bank accounts in case of unexpected payments and a large amount of guesswork was used in judging how far forward to hedge FX exposures. Short-term investments of excess cash had to be rolled forward, or cut short increasing costs and operational risk.

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Cash flow forecasting can offer many benefits to Treasury and to the company as a whole. In general, cash flow forecasts should be dynamic with a rolling horizon and include the ability to drill down to currency and entity. Manual inputs to cash flow forecasts, or budgeted figures, can be unreliable, both in size and timing. Optimisation is therefore dependent on automation, taking as much data as possible from the companies ERP (A/R, A/P etc.) and from the treasury management system (TMS).

Other benefits of accurate and reliable cash forecast include: • Reduction of idle cash in bank accounts (reduced need for a ‘float’) • Visibility of present cash balances and forecasted balances in the future • Funding manager can use cash flow forecast in his own funding management • Cash manager can use cash flow forecast to optimise short-term loans/ investments, reducing number of deals and operational risk • FX manager can use currency cash flow forecasts to optimise FX management, reducing number of deals and operational risk (provided the forecast is at sufficient level of detail) • Subsidiaries can use drill-down cash flow forecast to entity, optimising internal loan/ deposit requirements

Unfortunately, this is not an uncommon scenario. A cash flow forecasting solution was set up with the ERP system providing the system support. Bank balances and short term business flows FTA Outlook 2015 | 45

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Cash Management Outlook

came from the ERP and known and forecasted treasury flows were imported from the TMS. Longer term flows came from manual forecasts from 15 business units. The cash float was immediately reduced by 2/3, and as the forecast could be drilled-down to currency, individual currency forecasts were used to find optimal terms for FX forward hedging. Short-term investments and loans were optimised and the forecasts could also be drilled-down to entity level, the subsidiaries could use the individual forecasts for their own purposes. Initially manual forecasts were not optimal, but version-to-version and version-to-actual reporting was used to set up a “league table” of forecasting accuracy. This league table was 46 | FTA Outlook 2015

sent to the business units each month and within 6 months manual forecasting accuracy had improved enormously. Liquidity management takes cash flow forecasting a step further. Liquidity not only includes cash, but also short-term investments, which can be easily converted to cash, and unutilised bank facilities. The main goal in managing liquidity is to avoid financial stress (the inability to fund the daily business). The risk of financial stress is usually managed by means of the calculation of a liquidity ratio, i.e. the ratio of available liquidity to the company’s outgoings over a particular horizon. The ratio used and the horizon of the outgoings is dependent on the business and the company’s risk appetite.

Another benefit of proper liquidity management is that it can be used as a driver to improve the company’s ratings and therefore funding costs. Good cash flow forecasting is an essential foundation of good liquidity management. Other tools that can improve cash management, which we won’t go into too much detail on, are Internal Banks and Payment Factories. These are rarely seen at a larger scale among Australian companies, but are widely used in Europe and the US.

and the systematic management around the sending of invoices, collections of payments due and in the management of disputed payments. Much can be automated in order to reduce operational risk as well as optimise straightthrough-processing and reduce outstanding debtors. Good processes around collections and dispute management will reduce Days Sales Outstanding (DSO), the Cash Conversion Cycle (CCC) and help optimise both working capital and cash management.

WHERE DO WE GO FROM HERE? When done right, setting up an Internal Bank can help optimise cash synergies across the business. An internal bank should be thought of as a real bank – it just happens to be internal and managed within the Group by Treasury. It should involve the design of new business structures, processes, organisational setup as well as a system to support the transactions being handled and executed via the internal bank. Payment factories allow a company to optimise straight-through processing of their payment solutions via centralisation and automation of the payment process. It is most commonly channelled through a system in order to optimise automation. Payment factories might be in the perimeter of a traditional treasury area of responsibility, but it is imperative that Treasury is involved in the project of setting up the factory, and their skills can be extremely useful in the process.

Optimisation of collections and dispute management is the improvement of processes

The pressure for change can seem a little incomprehensible with today's strained budgets, ever changing regulatory and market environments, all the while trying to manage your day jobs at the same time. Overall it is important that a coherent approach is deployed. It is often seen that companies focus on one problem at a time, potentially “burning bridges” in the process. As the potential benefits can be huge from optimising your processes, a good starting point is that Treasury formulates a Treasury Roadmap which should be based on a clear understanding of the overall financial objectives of the company as a whole. As part of this, Treasury should be prioritising which initiatives (i.e. improve cash management and forecasting, bank account management, payment factory etc.) should be the focus for the coming years. Technology is becoming a more integral part of all aspects of the business, and this is ever true for treasury. It should be included as an integral part of the roadmap vision. This could include streamlining bank connectivity (i.e. SWIFT), closely integrating data sources (ERP integration), and implementing treasury, cash and working capital management solutions.

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Working capital management is another area which traditionally may not lie within Treasury. However, as described above, the evolving role of Treasury has made it even more important that Treasury is engaged in this process in order to optimise cash usability. One of the first areas to look at is around collections and dispute management. The reason for this is that it is an internal process and it is not needed to involve suppliers, customers, banks, or other third parties.

The increased focus on cash and liquidity management has been high on the agenda in Europe and the US for the past few years and the trends are gaining ground in Australia as well.

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Regulatory Outlook

REGULATORY REFORM: 2015 AND BEYOND BY PIETER BIERKENS, EXECUTIVE DIRECTOR, RATES REGULATORY STRATEGY, CBA

Since the start of the GFC, each year brought further developments in the global regulatory environment. The new year will be no exception.

dealer trades in products for which clearing is available, are being cleared already.

NON-DEALERS AND CENTRAL CLEARING TREASURY ANNOUNCES A CLEARING MANDATE AND EXEMPTS END-USERS

The immediate impact of the clearing mandate will be limited, as most inter-dealer trades in products for which clearing is available, are being cleared already.” 48 | FTA Outlook 2015

As 2014 drew to a close, Australia’s Department of the Treasury announced a central clearing mandate for interest rate derivatives transactions denominated in A$ or ‘G4’ (Euro, Yen, British Pound, and US$) currencies, to apply to transactions between ‘the major domestic and foreign banks’. Treasury also provided relief from trade reporting for financial services organisations that undertake small amounts of OTC derivatives activity, by allowing ‘single sided reporting’ to such ‘Phase 3B’ entities. End-users such as non-financial corporations will be permanently excluded from the regulatory framework applying to OTC derivatives, given that ‘research indicates they don’t play a systemically significant role in the Australian OTC derivatives market’, where the eight largest dealers traditionally account for approximately 90 percent of the A$ interest rate derivatives market (AFMA). The immediate impact of the clearing mandate will be limited, as most inter-

Illustrating the concentration of derivatives activity among dealers, is a ‘non-dealer’ survey published last year by the Council of Financial Regulators (APRA, ASIC, RBA). Although larger non-dealers were over-represented in the sample, the respondents’ median outstanding notional of around A$10bn is a small fraction of the A$1.2tr average outstanding for a dealer in the Australian market (see Figure 1). The survey further showed that a small number of non-dealers currently have client clearing arrangements in place. In addition, a significant number of respondents reported they were at least considering central clearing, even in the absence of an actual clearing mandate. In so doing, they may seek access to optimal pricing and liquidity, even if this may not yet be reflected in current market conditions. Similarly, price differentials between collateralised and uncollateralised transactions have prompted a number of financial institutions to start posting variation margin.

As for any clearing requirement applying to nondealers in the future, regulators will ‘continue to monitor the availability of client clearing for OTC interest rate derivatives and the incentives-led migration to central clearing, particularly by nondealers with access to sufficient liquidity’. They do acknowledge, however, that ‘for some non-dealers it is unclear if [the benefits of clearing] will ever be sufficient to offset the costs’ (Report on the Australian OTC Derivatives Market, 2014). Barring a non-dealer clearing mandate taking effect, any end-user decision to clear, or post collateral when trading bilaterally, involves a careful weighing of among other things, liquidity costs, operational costs, and capital costs charged by the bank counter party. Generally speaking, only standardised and liquid derivatives transactions are clearable. Costs, risks, and operational aspects of setting up a clearing account will be weighed against any pricing and liquidity advantages to end-users that trade actively in those clearable derivatives. The posting of collateral affects pricing on bilateral derivatives transactions. This dynamic changes as bank capital requirements, and approaches for measuring counter party credit risk change. Bank capital requirements may be impacted by recommendations of the Murray Financial System Inquiry. Managing collateral presents its own operational challenges and risks, but some end-users will have the collateral decision made for them, by the Basel framework for margining of uncleared swaps.

THE MARGINING OF UNCLEARED SWAPS

Notional principal outstanding, September 2013

$b Average

Median

0 All nondealers

Government Investment agencies managers

Smaller ADIs

Insurance Noncompanies financial corporations and super funds

Source: Regulators’ survey

Importantly for Australia, fx forwards, and the fixed physically settled fx transactions associated with the exchange of principal of crosscurrency swaps are exempt from initial margin requirements. How the framework will take shape in Australia is not exactly known as yet, but any implementation is to be consistent with overseas regulations. Suggested collateral requirements may require some modifications to Australia’s legal framework, providing a challenge to the intended implementation date. Besides the timing, the framework presents a number of other challenges to the covered entities. These include the daily posting of collateral, CSA agreements, limits on the reuse of collateral, the posting of initial margin on a gross basis, the modelling of initial margin requirements, and cross-border harmonization of rules, to name a few. ISDA has requested a delay in the global implementation schedule.

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In September of 2013, BCBS-IOSCO published its ‘Margin Requirements for Non-Centrally Cleared Derivatives’. They are to take effect from December of this year, for transactions between ‘financial firms and systemically important nonfinancial entities’: so-called ‘covered entities’. Such transactions are subject to variation margin from December, and depending on the size of the entity’s derivatives book, initial margin as well. Initial margin requirements are to be implemented incrementally, according to the nearby schedule.

FIGURE 1. AUSTRALIAN NON-DEALER RESPONDENTS’ OTC DERIVATIVES

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Regulatory Outlook

FIGURE 2.

Dec 2015

Any covered entity with a derivatives portfolio of over 3 trillion Euro

Dec 2016

Any covered entity with a derivatives portfolio of over 2.25 trillion Euro

Dec 2017

Dec 2018

Any covered entity with a derivatives portfolio of over 1.5 trillion Euro

Initial margin requirements are to be implemented as above, subject to a ¤50 m Euro threshold. Importantly, the calculation of ‘outstanding OTC derivatives’ does include fx forwards and crosscurrency swaps, although these transactions are exempt from actual initial margin requirements.

One of the key planks of the global regulatory agenda, is addressing the issue of banks being ‘too big to fail’. An important ingredient of this is an effective resolution regime, which should prevent a run by the firm’s creditors and counter parties.” 50 | FTA Outlook 2015

As much as derivatives reform is a key aspect of regulatory change, other changes are afoot as well, including measures to address ‘too big to fail’, and measures to strengthen banks’ prudential standards.

LIQUIDITY COVERAGE RATIO, AN ISDA PROTOCOL On January 1, the Liquidity Coverage Ratio took effect in Australia, requiring Australian deposit taking institutions to hold high quality liquid assets in excess of the expected cash outflow over the next 30 days. This impacts the market for deposits of any kind, especially those of corporates and financial institutions. Given the requirement, longer dated deposits will become commensurately more attractive to banks, and therefore relatively higher yielding, while atcall money will be less attractive with pricing reflecting this. One of the key planks of the global regulatory agenda, is addressing the issue of banks being

Any covered entity with a derivatives portfolio of over 750 billion Euro

Dec 2019

Any covered entity with a derivatives portfolio of over 8 billion Euro

‘too big to fail’. An important ingredient of this is an effective resolution regime, which should prevent a run by the firm’s creditors and counter parties. In the absence of a cross-border regulatory framework of resolution of systemically important financial institutions, the Financial Stability Board (FSB) coordinated with ISDA the development of a Resolution Stay Protocol, signed late last year by eighteen major international banks. The signatories agree on a stay of resolution in the close-out of derivatives contracts, deemed critical for the orderly resolution of the signatory banks. The FSB expects any adoption of the protocol, or more broadly, of the necessary contractual language on stays in resolution, to become more widespread, through marketbased regulation or market conduct regulation, in the near future.

MARKET LIQUIDITY AND THE AVAILABILITY OF COLLATERAL The increased collateral demand resulting from regulatory reform, combined with the fact that Central Banks are now buying highly rated securities in their pursuit of unconventional monetary policies, has raised concern about a dearth of highly rated assets.

Estimates suggest, however, that incremental collateral demand resulting from global regulatory reform is around $4tr (BIS), arguably a manageable number in light of the more than $50tr in outstanding high quality assets, or the annual $1tr net available issuance of AA and AAA rated government securities (IMF). In Australia itself, the supply of high quality assets ‘would appear sufficient to support current demand for collateral’ (RBA). Notwithstanding a sanguine outlook for global collateral availability, market participants increasingly prioritize the optimal use of collateral. ISDA data suggest that one-third of market participants now see this as a front office function. Increased regulatory scrutiny is also being directed to the global allocation to higher yielding, less liquid asset classes, by investors searching for yield in today’s low rate environment. An example is US mutual funds’ appetite for bank loans, an asset class whose net inflows in 2013 exceeded those of the entire decade prior. This asset allocation coincides with a substantial drop in market making activity across many asset classes, including markets for corporate bonds. This raises concern for market pricing and liquidity, in the event of a sudden reversal of this investor demand. ‘The exits can get jammed unexpectedly and rapidly’, as RBA’s Guy Debelle put it late last year.

As a result of this legislation, as well as developing regulations on capital, margining, and liquidity, dealers’ inventories have declined by an estimated thirty to eighty percent since the GFC, depending on the asset class. Some dealers have significantly curtailed their overseas presence:

ACTIVE IN AUSTRALIAN MARKETS

Per cent

AUD bn

-10

0 2006

2008

2010

2012

Lhs: Foreign bank share of net trading securities2 Rhs: Central government securities3 Corporate securities3 2

four-quarter rolling averages

Australian banks’ net holdings

To some extent, the decline in dealer liquidity is a consequence of regulatory change. The upcoming Volcker rule curtails banks’ ability to take proprietary risk, limiting dealer inventory to what is needed to service ‘reasonably expected near-term customer demand’.”

Source: BIS, 2014

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FIGURE 3. AUSTRALIAN AND FOREIGN BANKS

Whether it is OTC derivatives reform, the strengthening of banks’ prudential standards, managing ‘too big to fail’ or monitoring market liquidity: regulatory reform will continue to impact markets and market participants in the new year, and beyond. FTA Outlook 2015 | 51

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Treasury Outlook

ALIGNING THE TREASURY VALUE ADD FROM BACK OFFICE TO BOARD BY ALISTAIR MCLEAN FFTP, GROUP TREASURER, METCASH LIMITED

I had the privilege of addressing the FTAâ&#x20AC;&#x2122;s Treasury Operations conference in August 2014, a group with the potential to become the Treasurers of the future. I wanted to explore the idea that an operations team can go beyond operational excellence. I therefore chose to discuss how a Treasury can add value to an organisation from Back Office through to Board.

Errors happen in Treasury, it is part of the job. Treasury disasters often begin with someone hiding simple errors which later become major problems.â&#x20AC;? 52 | FTA Outlook 2015

The philosophy for my Treasury team is quite simple: a well-functioning Treasury should never be noticed. At first this might seem a strange statement to make. However where all the risks within a Treasury have been managed appropriately, funding for the future is in place then Treasury is enabling the organisation to focus on what it does best which usually is to make money. Throughout my career I have noticed the same thing about the best Treasury teams: they are generally highly regarded and visible (even if they are not noticed), they empower their people to manage risks and there is a real collective integrity to that team. A good treasury team will make risk management easily understood by the business without making things too technical. So what can a Treasury team do to never be noticed? From my experience of working in Treasury teams over the last 15 years, I would give the following advice:

Add intellectual capital to everything which crosses your desk. Whether in person or by e-mail, I encourage everyone to question every interaction they have with others and try to ensure that they add something to the process. Ask yourself whether that task is important: if yes always contribute something to further the process, if not ensure that the process does not need to be repeated. Always put your hand up if a mistake is made. Errors happen in Treasury, it is part of the job. Treasury disasters often begin with someone hiding simple errors which later become major problems. Let someone more senior know immediately about any error and then together take the necessary steps to fix the problem. Finally put a control in place to ensure the same error never happens again. Make sure people understand what is important to you. Everyone you work with has something different which motivates them. Integrity is an important value to me, but many people in Treasury share this same value. In my dealings with others I try to ensure that they understand the importance of this value. I have always found it useful to be mentored by someone else whether that is done formally or informally. When I find myself in a tricky situation I ask myself two questions: what would my Mentor do in this situation and how do I differentiate my

solution from that of my Mentor to ensure that solution I propose aligns with my values? Never be frightened to put forward an idea. Great ideas always come up in conversation and the key is to pick these ideas up and take them forward. Simply talking to both internal and external parties will often give you those ideas. However, particularly when dealing with banks, if someone comes up with a truly proprietary idea then make sure that they are rewarded for this, rather than shopping that idea around. Always speak up if you are not comfortable. In any work environment it is important to understand what you are doing and why. If you don’t feel comfortable, try and establish the reasons and motivations behind that request. Treasury disasters often arise where one person is able to manipulate another. I try to create an environment where my team feel that they can speak up, but at the same time know that there is someone else outside Treasury who they can talk to if they still feel something is wrong. People are the key to long term sustainable relationships. One party cannot lay off risk without another party being willing to take it on. I believe that you need strong personal relationships with those in the market so that you can create a win-win situation for both parties. To this end it is important to know all the people who you deal with and to have regular face to face contact with them. Whatever you do, don’t hide behind long e-mail trails.

Don’t bypass controls. The older and wiser me knows that controls are there for a good reason. Almost every mistake in a Treasury can be traced back to a failure in control. By all means challenge them and then improve them or remove them if necessary, but whatever you do always follow controls. So where is the value from the Operations team to the Board? A treasury department makes the average Board very nervous as it manages some very significant risks. A Board has no choice but to trust its treasury team. I often say that it is easier for a Treasury to deal billion dollar derivatives than order a box of pens, as long as it is done in line with policy. A Board doesn’t want to see a treasury team who has significant control failures in their day to day operations. Every time an internal audit report picks up simple control failures a Board is less inclined to trust that Treasury team when it comes to managing the significant risks within the organisation. By following the advice above a Treasury operations team will gain the trust of their Treasurer, their Organisation and their Board thereby making themselves an invaluable asset to their organisation.

ABOUT THE AUTHOR Alistair McLean, FFTP, is currently Group Treasurer at Metcash Limited and has worked in a variety of different treasury roles in both Australia and the UK over the last 15 years covering front to back office. Alistair is a Fellow of the FTA and a Member of the Association of Corporate Treasurers.

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Become an expert. This is one of the easiest ways to move your treasury career forward. Treasury is an environment which is constantly changing, therefore there is always the opportunity to personally learn and develop (and occasionally the opportunity for advancement and reward). Be consistent. Treasury is about managing risks for the long term sustainability of an organisation. Whilst people may not always agree with your opinion, you will be respected for that clear and consistent message. Often you will find that consistency turns disagreement into agreement. FTA Outlook 2015 | 53

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2015 FTA Partner Directory ANZ Contact | Catherine Manallack, Global Product Manager – Supply Chain Finance Phone | +61 3 86554788 Email | : catherine.manallack@aanz.com Website | www.anz.com ANZ is one of the world’s 25 largest listed banks by market capitalisation, a top 5 listed company on the Australian Securities Exchange and the largest bank in New Zealand; with over 50,000 staff servicing over 9 million customers worldwide. ANZ is among the highest-rated banks globally having retained an ‘AA’ band credit rating with all three major rating agencies. Our geographic location and footprint (33 markets globally, 29 in Asia Pacific) coupled with our enhanced Trade, Clearing and Payments & Cash Management services, position us well to better service customers’ growing activities throughout Asia Pacific.

Byronvale Advisors Contact | Stephen Barnes, Managing Director Phone | 0402 034 490 Email | stephen@byronvaleadvisors.com Website | www.byronvaleadvisors.com Byronvale Advisors is a boutique management consulting company that advises clients whose businesses are struggling to understand and manage financial drivers within their business, and assists them improve their cash flow, implement systems and processes, and reduce their risk. Their hands-on approach both teaches and mentors the clients so these skills are both imparted and learned. Byronvale Advisors has specialised knowledge of a range of industries including financial services, construction, manufacturing, software development, property development, energy, horse breeding and not-for-profit, and have worked restructuring and reorganising organisations from multi-nationals to start-ups and not-for-profits.

Moody’s Investors Service Contact | Philip Christie, Vice President & Head of Relationship Management AUS/NZ Email | philip.christie@moodys.com Website | www.moodys.com

Phone | +61 2 9270 8115

Moody's Investors Service is a leading provider of credit ratings, research, and risk analysis. Moody’s covers approximately 130 sovereign nations, 11,000 corporates, 21,000 public finance entities and 76,000 structured finance obligations. Moody’s won Australia’s KangaNews “Rating Agency of the Year” award for 2014. In addition, Moody’s was recognized as “Asia’s Most Influential Credit-Rating Agency” by FinanceAsia in 2013 and 2014; and “Best Credit-Rating Agency” by AsiaMoney and Institutional Investor in 2012, 2013, and 2014. Moody's Investors Service is a subsidiary of Moody's Corporation (NYSE: MCO), which maintains a presence in 33 countries and employs 9,700 people.

Reval Contact | George Chapman, Sales Director Phone | +61 2 9224 5900 Email | george.chapman@reval.com Website | www.reval.com Reval is a leading, global Software-as-a-Service (SaaS) provider of comprehensive and integrated Treasury and Risk Management (TRM) solutions. Our cloud-based software and related offerings enable enterprises to better manage cash, liquidity and financial risk, and includes specialised capabilities to account for and report on complex financial instruments and hedging activities. Using Reval, companies can optimise treasury and risk management activities across the enterprise for greater operational efficiency, security, control and compliance. Founded in 1999, Reval is headquartered in New York with regional centers across North America, EMEA and Asia Pacific.

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SWIFT Contact | Kees Middendorp, Commerical Director – Oceania Phone | +61 2 9225 8104 Email | kees.middendorp@swift.com Website | www.swift.com SWIFT is a member-owned cooperative that provides the communications platform, products and services to connect more than 10,500 banking organisations, securities institutions and corporate customers in 215 countries and territories. SWIFT enables users to exchange automated, standardised financial information securely and reliably, thereby lowering costs, reducing operational risk and eliminating operational inefficiencies. SWIFT brings the financial community together to work collaboratively to shape market practice, define standards and debate issues of mutual interest. SWIFT is delighted to have been selected as the vendor for Australia’s New Payments Platform. With NPP, we will take a new journey with the Australian community.

Thomson Reuters Contact | Sydney – Dave Stewart, Melbourne – Edwars Arias Suarez Phone | +61 2 9373 1500 Email | general.info@thomsonreuters.com Website | www.thomsonreuters.com Thomson Reuters is the world's leading source of intelligent information for businesses and professionals. We combine industry expertise with innovative technology to deliver critical information to leading decision makers in the financial and risk, legal, tax and accounting, intellectual property and science and media markets, powered by the world's most trusted news organization. Thomson Reuters shares are listed on the Toronto and New York Stock Exchanges (symbol: TRI).

Veda Corporate Ratings Contact | Brad Walters, Head of Rating Services Phone | +61 2 9278 7925 Email | brad.walters@veda.com.au Website | www.veda.com.au Veda Corporate Ratings (AFS #341391) is a leading Australasian Credit Rating Agency specialising in the corporate and broader mid-market. With more than 100,000 financial statements and one of the country’s largest databases of comparable private financial statement data, Veda Ratings is uniquely positioned to provide invaluable sector intelligence. Whether you’re looking for an issuer or counterparty rating, and/or a public or private assessment, Veda can provide you with corporate credit ratings that are highly credible, comprehensive and authoritative reports that stand up to public and political scrutiny.

Visual Risk Contact | Richard Hughes, Managing Director Phone | +61 2 9262 6969 Email | richard.hughes@visualrisk.com Website | www.visualrisk.com

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Visual Risk is the most advanced treasury system of its kind for Corporates. At the core of our solution is the ability to process, analyse and display complex data in a unique graphical manner. This assists treasury to better visualise, understand and report complex information to senior management, leading to better decisions. Modular by design, integrated by nature, it delivers the broadest range of functionality available in the market today, covering risk analytics, treasury management, hedge accounting and cash/liquidity management. Whether your requirements are simple or complex, we can deliver a system to perfectly meet your needs.

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