FTA Outlook 2014 by CommStrat

FINANCE AND TREASURY ASSOCIATION

OUTLOOK

2014

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FINANCE AND TREASURY ASSOCIATION

OUTLOOK

2014

FTA Outlook is published by CommStrat on behalf of the Finance and Treasury Association

MANAGING EDITOR Chris Atkin e: chris.atkin@commstrat.com.au

CONTENTS 3 4 7

President’s Message CEO Report About FTA Membership

SPECIAL FEATURE

CASH MANAGEMENT OUTLOOK Cash Management: Connecting Corporates to the Global Payments System Infrastructure Kees Middendorp, Commercial Director,

Oceania, SWIFT

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

ABN 31 008 434 802

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

www.commstrat.com.au All material in FTA Outlook is copyright. Reproduction in whole or in part is

Review: FTA Annual Congress 2013

ECONOMIC OUTLOOK

Recent Trends in US Cash Management: Lessons for Australian Corporations Rebecca Dawson, Director Treasury & Capital Markets, Deloitte

Central Banks Fighting Disinflation and an Emerging Markets Crisis

TRADE OUTLOOK

Andrew Roberts, Head of European Rates Research, RBS

Differences Matter Gordon Sparrow, Executive Director of Trade and Supply Chain Finance / FI Sales,

RISK MANAGEMENT OUTLOOK

Westpac Institutional Bank

Using Risk as an Opportunity to Enhance Business Performance

TAX OUTLOOK

Kevin Smout, Partner – Risk Consulting, KPMG

A Reflection On Risk And Corporate Performance Dr Reg Hinkley

Tax Storm Clouds for the Finance Industry Chris Kinsella, partner and Stephen Jones, special counsel, tax controversy group of

Maddocks

not allowed without written permission from the Publisher.

TECHNOLOGY OUTLOOK

DEBT MARKETS OUTLOOK

Aligning Company Growth and Treasury Evolution at Seek

Corporates Reach Funding Nirvana as 2014 Debt Market Competition Heats Up

Eddie Collis, Group Finance Director, Seek Limited

Brad Scott, Head of Corporate Bond Origination, NAB

Treasury Systems: The Past and Future: Piercing the Cloud of Uncertainty

2014 FTA Partner Directory 54

Tim Hart, Director, INFACT Consulting 30

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RATINGS OUTLOOK Asia-Pacific Corporates Tap Capital Markets But Bank Loans Remain Dominant Craig Parker, Director of Corporate & Government Ratings, Standard & Poor’s Rating Services

34 FTA Outlook 2014 | 1

27th Annual Congress Premier Annual Conference for the Australian Finance and Treasury Sector Audience: Finance and Treasury professionals at all stages of their career

Corporate Funding Outlook Update on Overseas and Debt Domestic Funding Debt Markets Update refreshed Audience:

FTA

Professional Development Series

• Corporate Treasurers • CFOs, Corporate finance managers

Covering Key Attributes of the Modern Treasurer A low cost, fast paced format ideal for networking Audience: • Corporate Treasurers • Assistant Treasurers

• Financial Controllers • Assistant Treasurers

The Essential Treasurer

THE FOUR PILLARS

• Head of Investor Relations

• Board Risk Committee Members and CFOs • All FTA members

Fundamentals of Treasury Operations Targeted Event for Treasury Operations Professionals Audience: • Head of Treasury Operations • Treasury Operations Manager • Compliance Manager • Treasury Systems Manager and Business Analyst • Administration roles supporting Treasury

P: 03 8534 5000

www.finance-treasury.com

E: ftapd@fta.asn.au

PRESIDENT’S

MESSAGE PAUL TRAVERS FFTP PRESIDENT FINANCE AND TREASURY ASSOCIATION

t gives me great pleasure to serve as FTA President and I look forward to a year of exciting developments within the Association. A highlight is to present the FTA Outlook - addressing the year ahead with industry specialists offering their perspectives on a range of core issues facing the finance and treasury industry. The core professional development platform for the FTA year is the delivery of the ‘Four Pillars’. In 2014, these events consist of: Corporate Funding Outlook which will refresh our traditional Debt Markets Update; the Essential Treasurer Series and Fundamentals of Treasury Operations both picking up from last year’s successful launches; and the centrepiece of our offering – the 27th FTA Annual Congress to be held in Sydney and likely to be the biggest event we have held in a number of years. I look forward to seeing you at some of those events (more details on page 7).

Our recent review of membership has led us to create a new membership category specially designed to attract younger members starting

To highlight this focus on emerging members of our industry, we are introducing the Young Treasury Professional Award - to recognise the achievements and success stories of our industry up-and-comers. Our treasury dealers, analysts and operations assistants are the fundamental backbone of our middle and back office departments and this is a great initiative to showcase their success stories. As well as these host of new initiatives in 2014, the Finance and Treasury Association will continue to advocate for members and the broader profession to a range of stakeholders including government and regulatory bodies. Finally, I would like to take this opportunity to thank all of our authors who have helped to make this magazine possible and also those who have supported the partner directory - which I encourage you to use. This will certainly be an annual feature for the Association for years to come. Thank you for your support and on behalf of the FTA Board and Secretariat I do hope you enjoy this read. FTA Outlook 2014 | 3

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We recognise the time and geography challenges in physically attending events so we are working on the development of a ‘virtual’ FTA Academy to be launched in the first half of 2014. This Academy will enable members and guests to have access to regularly updated on-demand professional development content as well as be able to interact with industry suppliers. We intend for it to work in tandem with our physical events to provide greater depth and reach than ever before.

We recognise the time and geography challenges in physically attending events so we are working on the development of a ‘Virtual Academy’ to be launched in the first half of 2014.”

out on their finance or treasury careers. We are pleased to introduce a new membership category – Pathways. This category will be an introduction to the Association, providing younger members access to our professional development programs, the on-line FTA Academy and a new mentoring program which we hope will also re-engage our retired members with a vehicle to stay connected with and to put back in to the profession. You might know someone who fits the bill and I would ask you to share details with them (see page 9).

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FTA Outlook

CEO

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

Chris Kinsella and Stephen Jones of Maddocks Lawyers consider corporate tax challenges in 2014 through the prism of debt-challenged governments seeking to claw back revenue via the global “base erosion and profit shifting” (BEPS) process and transfer pricing provisions.

ike our President, I too am excited by the launch of this new magazine. With FTA Outlook, we again have a publication dedicated to the breadth of finance and treasury activity in Australia, and a physical reminder to all readers of FTA’s contribution to our important profession.

Craig Parker of Standard & Poor’s Ratings Services suggests that the funding needs of Asia-Pacific corporates will drive global financial markets and that as the region’s capital markets are still maturing, bank loans syndication and secondary loan trading will grow to meet demand.

The inaugural edition of the FTA Outlook addresses key challenges that corporate finance and treasury practitioners are expected to face over the course of the year. My own article provides a roadmap of the Association’s plans for 2014, tying them into how I and our expert authors view the operating environment. A synopsis of key messages from our 2014 FTA Outlook authors follows. Providing an Economic Outlook for 2014, Andrew Roberts, Head of European Rate Strategy for RBS suggests that global monetary conditions will remain easy due to the debt overhang, and that the risk to the real economy is actually disinflation. Concluding that “differences matter”, Gordon Sparrow of Westpac looks at the role of the corporate treasurer in view of opportunities and challenges posed by globalisation. He provides an alternative framework in which to consider decisions about preferred capital structure, regulatory and legal jurisdictions, and labour arrangements. 4 | FTA Outlook 2014

With FTA Outlook, we again have a publication dedicated to the breadth of finance and treasury activity in Australia, and physical reminder to all readers of FTA’s contribution to our important profession.”

2013 was ‘‘funding nirvana’’ for Australian corporates according to Brad Scott of National Australia Bank. He suggests that in 2014, they will again seek to diversify funding sources, and to borrow more and for longer to “bullet-proof balance sheets” while interest rates remain low. Kevin Smout FFTP of KPMG suggests that a weak global growth environment and more financial regulation impacting on corporates requires greater C-level attention to decision-making tools used for risk management by professionals such as corporate treasurers. Former Treasurer of BP Australia, and former Head of Audit at BP plc, now of the Lloyds Insurance Council (the global re-insurance market), Dr Reg Hinkley presents his unique risk management insights. He considers the importance of corporate culture in BP’s Gulf of Mexico oil spill, and the UK LIBOR-rigging scandal, and provides his thoughts on the importance of incentives and performance management in design of finance and risk functions.

The welcome cash management challenges of a company growing globally and the opportunities for using technology to address them are considered in the case study provided by Eddie Collis, Group Finance Director at Seek Ltd. Tim Hart CFTP of Infact Consulting notes that in 2014, treasurers have increasingly pressing systems decisions to make, including the key security versus functionality question of degree to which it is prudent to migrate business critical functions and high value transactions to “the Cloud”. He notes also the need to ensure that systems are ready for multiple changes flowing from new derivative and financial reporting rules. Kees Middendorp CFTP encourages corporates to connect to the global payments system infrastructure via SWIFT in order to meet new cash management challenges such as doing business in Chinese renminbi. These messages are reinforced by Rebecca Dawson of Deloitte who considers recent trends in US cash management as a partial template for Australian corporations. Key regulatory and treasury best practice highlights from the 2013 FTA Congress have been distilled by journalist Rex Pannell, Editor of the FTA Update. Rex interviewed speakers from the Brisbane event including FTA Technical Committee Chairman Steven Cunico CFTP, and Committee members Marion Johnstone CFTP, Group Treasurer of CSR Ltd and Joanna Wakefield CFTP, Group Treasurer of Asciano Ltd. The article concludes with the Australian economic outlook from Saul Eslake, Chief Economist for Australia and New Zealand, Bank of America Merrill Lynch. Some of the themes not picked up directly by our authors are matters which I have been pushing on behalf of FTA in the weekly FTA Update, the annual Congress programme and my external advocacy activities. So how does the Finance and Treasury Association propose to support its members in this challenging environment in 2014?

Financial reporting rules - particularly accounting and valuation standards as they pertain to financial instruments. In 2013/14, FTA has already written to the IASB, AASB and IVSC (International Valuation Standards Council), about matters related to the principles and application of the IFRS 9 / AASB 9

Members and other treasury professionals will again be able to look forward to FTA Congress, Australia’s premier annual conference for the Australian wholesale finance and corporate treasury sector. ”

Key benefits of FTA membership in 2014 • Discount to the annual FTA Congress • Access to members’ only FTA Online Treasury Resource Centre

The Financial System Inquiry chaired by David Murray AO – which in its early stages has already provided an opportunity to FTA to highlight the unique perspectives of non-financial corporation end-users of the financial products and services. Global regulation of the Over-the-Counter derivatives market - At the time of writing, FTA and the industry’s discussions with Commonwealth Treasury, the Reserve Bank and the ASIC are at a delicate stage. FTA considers that there is the potential for unintended consequences from the application of rules intended to curb excessive risk-taking in banking to the whole community of end users including corporations and superannuation funds. Should FTA be unsuccessful in its advocacy then by 2015, Australian corporations may be required to report all of their derivative transactions to external “trade repositories”. Moreover, corporate treasuries may also be required to centrally clear their derivatives transactions, or pay extra to banks to use derivatives which due to their relatively bespoke nature are unable to be cleared. Banks are being required by the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) via APRA to set aside additional capital against so-called exotic derivatives. Since 2011, in submissions to the Council of Financial Regulators, of which Treasury, RBA, APRA, and ASIC are members, the Association has made the following points: •

“FTA recognises Australia is obliged to act quickly to ensure Australian businesses and investors are able to demonstrate that they are subject to an equivalent regulatory regime and so be able to continue to participate in the major derivatives markets of the world while still being primarily regulated in Australia.

•

“FTA reiterates that non-financial corporations (“corporates”) are large users of financial derivatives and that these transactions are primarily used to manage financial risk positions created through ongoing business operations or funding activities. FTA is particularly concerned to ensure its Australian corporate treasurer members will continue to be able to use flexible OTC instruments such as forward foreign exchange contracts and cross currency swaps and these vital tools not be made prohibitively expensive nor administratively unworkable.

• Weekly FTA e-news industry updates • Complimentary invitations and member discounts to a number of professional development forums throughout the year • The opportunity to participate in the newly launched ‘virtual’ FTA Academy • Access to the FTA Member Directory • Being part of a body to develop letters and submissions to influence regulatory developments in treasury and risk management areas

FTA Outlook 2014 | 5

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During 2014, FTA will continue to represent a corporate treasury perspective to Government, and to domestic and international regulators on the following matters:

Financial Instruments Standard, and IFRS13 / AASB 13 Fair Value Measurement.

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FTA Outlook

‘FTA sees these financial regulations having a significant impact on the risk and liquidity management activities of corporate treasuries, and potentially the willingness of corporations to takes risks and to invest for growth.” FTA considers that deals done by nonfinancials are a tiny part of the derivatives markets here and abroad, and are not material in their impact on systemic risk and hence should be exempted from the proposed rules.”

that is valued by the membership. Many FTA Professional Development events are also open to all comers but FTA members will, as always, be able to attend face-to-face events at a deep discount. •

We also noted that there may be a negative real economy impact on the corporate sector from the direct application of these OTC derivative regulations, coupled with changes to the Basel capital and liquidity rules. FTA sees these financial regulations having a significant impact on the risk and liquidity management activities of corporate treasuries, and potentially the willingness of corporations to takes risks and to invest for growth. •

“A common experience with regulation is that any extra costs and complications end up being borne by the end user, and so dampen economic activity; policy-makers and regulators need to be careful what they impose.” (Source: http://financetreasury.com/category/knowledge-portal/ submissions/)

At the time of writing FTA is working with the other associations and regulators on creating workable thresholds below which direct reporting and clearing by corporations engaged in the act of hedging may not be required. We are also connecting with our peer treasury associations via the International Group of Treasury Associations (IGTA) to ensure that FTA has a voice internationally.

•

In 2014, FTA will be seeking industry support, and running information sessions for members on these critical regulatory and advocacy issues.

•

A strategic objective of the FTA Board is to continue to deliver training and development

•

6 | FTA Outlook 2014

In 2014, FTA members and other treasury professionals will again be able to look forward to FTA Congress, Australia’s premier annual conference for the Australian wholesale finance and corporate treasury sector. Delegates will enjoy the Congress Gala Dinner, the pre-eminent networking event of the Australian treasury calendar. Returning to Sydney in October, the memberdeveloped event will again provide thought-leading keynote speakers, three streams of peer case studies and expert insight and invaluable networking opportunities across two days and nights. In 2014, FTA’s Professional Development program will step up a gear with the return of practical hands-on workshops in Developing a Treasury Policy in April and Treasury Policy Performance Measurement and Benchmarking in the second half of the year. The Corporate Funding Outlook will provide an update on critical funding sources for corporate treasurers, notably various offshore public and private debt markets and the local corporate bond and syndicated lending markets. And FTA will be building on 2013’s great innovations, the Fundamentals of Treasury Operations conference, and the Essential Treasurer Series. In 2014, the Fundamentals Conference will extend on its key elements –

reinforcement of basic principles, treasurer and treasury operations case studies, and implementation sessions tracking practical use of the latest in treasury technology. This event is a key occasion for treasury middle and back office staff to network with peers, and for anyone looking to understand the first principles and key drivers of the overall treasury function. •

Members should pay special attention to the Essential Treasurer series which is being revamped to prepare treasurers ahead of a more difficult funding, liquidity, risk and regulatory environment in prospect by mid-year. The low cost Essential Treasurer update in each State is structured to complement Congress and provide more networking opportunities.

Elsewhere in this publication you will read about FTA’s new member offerings in 2014 – Pathways membership, Mentoring for younger members, and the exciting Virtual Academy. (You will receive updates through the course of the year.) In 2014, FTA members can also look forward to more free webinars, to complimentary attendance at the annual Financial Reporting Updates throughout Australia, and to more Chapter-based networking functions. To stay up-to-date with FTA and industry trends, members and other professionals are encouraged to keep an eye out for my CEO Comment in the FTA Update most weeks, and on FTA’s website www.finance-treasury.com. Dear finance and treasury professional, you have a critical role to play in the success of your organisation. I look forward to assisting you do that, and to meeting you in person in 2014!

ABOUT FTA MEMBERSHIP As an association we provide an expert voice on policy issues for the industry as well as delivering quality training, skills development and technical knowledge to both members and non-members. This has been our goal throughout more than 30 years of existence and why the CFTP (Certified Finance & Treasury Professional) recognition is still the preeminent accreditation within treasury. Finance and Treasury Association membership is open to professionals working in treasury or finance role and the key benefits of full membership are: • Professional Development Series • Advocacy • Networking

PROFESSIONAL DEVELOPMENT SERIES The ‘Four Pillars’ are the centrepiece of the professional development program of physical events held around the country. Entry to these events, whilst open to non-members, is significantly discounted for FTA members. FTA Congress is the premier conference for the Australian finance and treasury sector and features many practical, in-depth forums and discussion panels sharing current thinking and best practice. Each year it is attended by over 250 people and this year’s event will be held in Sydney from 29-31 October.

The Essential Treasurer Series covers all the attributes of the ‘modern’ treasurer in just half a day. It will incorporate a balance of technical content,

Fundamentals in Treasury Operations spotlights the fundamental elements of treasury operations in the context of current best practice, regulatory and technological developments. The content is technically-based and addresses treasury management framework, the role and core responsibilities of the treasury operations function.

ADVOCACY Your experienced and highly qualified board is drawn from senior finance and treasury professionals around the country. They are supported by David Michell, our CEO, to provide expert advice to the broad finance industry. They are consistently working with government, regulators and academia to shape the future of our industry and in doing so represent the interests of members of the FTA and the broader finance and treasury profession.

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Corporate Funding Outlook will provide a debt markets update that considers funding both domestically and overseas whilst featuring an issuer/investor panel discussion.

best practice update and critical personal skills whilst keeping attendees up-to-date on the everchanging legal and regulatory environment.

The ‘Four Pillars’ are the centrepiece of the professional development program of physical events held around the country. Entry to these events, whilst open to non-members, is significantly discounted for FTA members.”

FTA Outlook 2014 | 7

Take a step in the

right direction

FINANCE & TREASURY ASSOCIATION

PATHWAYS MEMBERSHIP First Year Subscription $199

p 03 8534 5003 | e membership@ @fta.asn.au

www.finance-treasury.com

NETWORKING

Pathways Membership

The FTA has active state chapters that work to create strong local networks within the association as well as representing the interests of those members at board level. In addition to the professional development events that occur in that state, each chapter organises its own networking events where members can meet their peers in a relaxed and informal environment.

We are delighted to announce a new membership path for those commencing their career in finance and treasury. This category is designed to provide the individuals that will be the future of our industry, the tools to develop their careers into front office treasury roles and will replace the current student category. FTA Pathways Membership will provide valuable insight and career advice from senior FTA members - via a newly created Mentor Program. It will also offer further learning through access to the FTA Academy and significantly discounted attendance at the annual Fundamentals in Treasury Operations conference. This category is available to non-members aged under the age of 30 at joining with a first year subscription of $199 (incl GST) that is payable by direct debit. An individual’s membership within this category is limited to 3 years after which it would be envisaged they join as full members.

NEW IN 2014...

More than ever before, we believe the FTA offers a value proposition to members that is critical for someone working in finance and treasury functions, whatever their level.”

Launch of FTA Academy This year we are excited to be launching a multimedia knowledge portal that offers new ways to access presentations, case studies, articles, and webinars – the FTA Academy. This emerging technology will be available to members from April (accessed through financetreasury.com) and will allow members to view webinars and participate in live Q & A sessions. It will also allow members 24/7 access to a library of content relevant to the finance and treasury profession all year round.

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More than ever before, we believe the FTA offers a value proposition to members that is critical for someone working in finance and treasury functions, whatever their level. For more details about becoming a member of the Finance and Treasury Association please visit our website – www.finance-treasury.com.

FTA Outlook 2014 | 9

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Special feature

Review: FTA Annual Congress 2013 FACTORS IMPACTING ON THE POST GFC WORLD INCLUDING INCREASINGLY COMPLEX FINANCIAL REGULATIONS; RAPID CHANGE IN FINANCIAL AND BANKING SYSTEMS AND PRODUCTS; FINANCIAL DELEVERAGING; CONTINUING MARKET VOLATILITY; AND HEIGHTENED SOVEREIGN GOVERNMENT DEBT LEVELS WERE KEY ISSUES THAT LEADERS FROM AUSTRALIA’S NONFINANCIAL CORPORATIONS GATHERED TO DISCUSS IN BRISBANE AT THE 2013 FTA CONGRESS . BY REX PANNELL, EDITOR, FTA UPDATE WITH DAVID MICHELL CFTP (SNR), CEO – FINANCE AND TREASURY ASSOCIATION

Approximately 300 finance and treasury professionals attended the 26th Annual FTA Congress when it returned to Brisbane in 2013. Attendees gained valuable knowledge about current treasury issues and hot topics while also enjoying a vibrant social program, commencing with the welcome reception overlooking the picturesque Brisbane River. With the theme Strategic Treasury in a Transforming World, a key message in the program was how financial markets are being transformed every day, by regulation and by the ongoing easy money supplied by central banks globally. Yet while liquidity has been plentiful for some years, this was not expected to be the case for much longer hence the strategic Treasurer must plan ahead. 10 | FTA Outlook 2014

The Congress began strongly with a full plenary room at the Sofitel Brisbane. As if on cue, FTA President Paul Travers FFTP was able to announce the long-awaited IFRS 9 Financial Instruments Standard for Hedge Accounting which had just been released overnight. Corporate treasurer concerns about the cost and degree of regulation were highlighted during a panel discussion centred on the Impact of Financial Regulation on Risk Management by NonFinancial Corporations. Group Treasurer of CSR Limited, Marion Johnstone CFTP, expressed strong reservations about the scope of regulations, citing a pressing need to review regulations which were potentially too onerous for non-financial corporations.

Commenting on the level of consultation by regulators, Ms Johnstone said one instance that particularly triggered her concern was the OTC derivative reporting consultation paper put out by the Australian Securities and Investments Commission early in 2013. “The only reason I became aware of that paper was due to the FTA Newsletter. The paper didn’t reach our company secretary through ASIC mailing lists. We were very surprised to find out there was a major change coming in without consultation. “Regulators need to clearly understand that the impacts on the non-financial sectors are very different to those of the financial sector. The way that the non-financial sector uses derivatives and other financial tools is very different. Derivatives “are really to assist us doing our job as opposed to taking risks for our business in its own sake.” Joanna Wakefield CFTP, Group Treasurer Asciano Ltd, said the Global Financial Crisis had focused the spotlight on the need to rigorously follow processes. Ms Wakefield was a key speaker in the Panel Discussion – The Corporate Treasurer’s Experience.

“My concerns about the regulations are two-fold. One is the cost. When costs are imposed directly on banks they affect the way banks have to allocate their capital. It’s inevitable those costs are going to be passed onto borrowers.

Above: FTA Board Members and delegates viewing a presentation at the Thursday morning plenary including Tony Weder FFTP, Treasurer QIC and FTA Board member Don Burtt FFTP.

“We, like other corporate borrowers, have experienced an increase in our margin due solely to that element where it’s clear that banks have to ration capital.

“We’re seeing more onerous reporting obligations in the form of accounting standards and in relation to double-sided reporting of OTC derivatives. I’m also concerned about – in terms of the cost of capital – the cost of the margining and possible clearing of OTC derivatives, and the requirement that’s going to pose to corporates to carry more liquidity.”

[Derivatives] are really to assist us doing our job as opposed to taking risks for our business in its own sake.”

“What the GFC has done is really highlight how important those processes are and why we should have always been doing them. No matter whether you’ve got good times or bad times, you need that stability.” Ms Wakefield went on to note that part of Treasury’s role was to educate; to reassure Boards that the company was in a sound position. “That’s why you need very regular reporting [to the Board]. You need to be showing the robustness of your policies and adherence to your policies. The Treasurer’s role is now viewed more as a role – as a function – rather than an adjunct to something that was done within a finance role, be it the CFO often did it ‘on the side’. FTA Outlook 2014 | 11

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“The other part of the cost of regulation,” Ms Johnstone said “is the cost of reporting.”

She noted Treasurers are “doing the right thing” if they maintain “a nicely spread maturity profile, long dated so you don’t have cliffs, and have hedging in place”.

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Special feature

And “with the high level of uncertainty, accountants are looking to Treasurers to obtain guidance/knowledge on how to deal with changes. We’re having to work really closely with the finance and accounting teams to make sure we get the right outcomes.” The changing role of Treasury and how Treasury could drive or influence that change was also focus of an address by Steven Cunico CFTP, Partner Treasury and Capital Markets, Deloitte Australia, and Chairman of FTA’s National Technical Committee. Mr Cunico said it was Treasury’s responsibility to assess how its role fitted within the organisation. “You don’t want to go it alone; you want to have conversations with other stakeholders like the CFO and Board members, and try to win their hearts and minds.” “The more effective organisations are the ones that engage all parts of the business, including Treasury, and benefit from its experience and knowledge.” “If processes around payments or receipts or working capital aren’t working, then the best Treasurer in the world can’t fix those sorts of problems. It’s about moving from being a central group function that is a specialist in a central role to actually getting integrated in the business and taking more of an active role.” Mr Cunico said Treasury executives had to widen their expertise to place more importance on people management if Treasury is to become more integrated in the business.

“We’ve still got a currency that in the words of the Reserve Bank is ‘uncomfortably high’ and I don’t see that changing through to at least the end of 2014.” Mr Eslake conceded that housing demand was picking up in response to low interest rates yet “since investors disproportionately buy established dwellings as opposed to new ones, this housing recovery is doing more to put upward pressure on prices and less to induce new dwelling construction than the RBA wants or the country needs.” In conclusion, “I think we are, in this country, due for a period of under-performance relative to our peers – the opposite of what’s been the experience of the past five years.” FTA Congress is the pre-eminent annual event for treasury professionals, providing delegates with specialist information, peer guidance, and valuable networking opportunities. Similarly, the Gala Dinner is the pre-eminent networking event of the Australian treasury calendar. 250 delegates packed in to the Sofitel Ballroom for the FTA NAB Gala Dinner where delegates heard from the highly entertaining man of the moment, the Australian cricket coach Darren Lehmann. On the night before the first ball of the return Ashes Test Cricket Series between Australia and England, Lehmann assured all that there was confidence in the Australian dressing room and that Australia had plans in place for their English opponents. His words proved to be most prophetic!

Above: FTA Congress delegates socialising at the Welcome Drinks at Jade Buddha overlooking the Brisbane River.

The 2014 FTA Congress will be held in Sydney October 29th to 31st. Diarise it now.

“That sort of skill is critical for anyone wanting to implement change or take on a leadership role.” The closing keynote speaker at Congress was Saul Eslake, Australian Chief Economist, Bank of America Merrill Lynch, who provided a cautious view of the nation’s economic outlook. “The mining investment boom is now winding down so the burden on the rest of the economy is to grow more quickly.” 12 | FTA Outlook 2014

“The more effective organisations are the ones that engage all parts of the business, including Treasury, and benefit from its experience and knowledge.”

I think we are, in this country, due for a period of underperformance relative to our peers – the opposite of what’s been the experience of the past five years.”

27th Annual Finance & Treasury Association Congress

FTA Outlook 2014 | 13

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03 8534 5003 | ftacongress@fta.asn.au | www.ftacongress.com.au

29th – 31st October 2014 Sheraton on the Park | Sydney

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Economic Outlook

CENTRAL BANKS FIGHTING DISINFLATION AND EMERGING MARKETS CRISIS HOW DOES THE WORLD LOOK THROUGH 2014? GLOBAL CENTRAL BANKS STAY SUPER EASY WHILE FIGHTING DISINFLATION AND AN EMERGING MARKETS CRISIS. BY ANDREW ROBERTS, HEAD OF EUROPEAN RATES RESEARCH, RBS

My number one mantra as a strategist for a very long time now has been ‘call liquidity right and everything else falls into place’.” 14 | FTA Outlook 2014

My evolving view through 2013 was of a gradualist US recovery, such that by end-year we could even be (for the first time in 8 years for me) optimistic over growth in 2014.

balance sheet expansion in turn gives economic operators confidence, and the beneficial snowball from there of equity expansion and positive wealth effect that central banks desire.

There have been building signs that much of the caustic deleveraging process was coming to an end (e.g., household debt/income dropping back to trend, and debt service cost ratios at a record low).

See my favourite chart for global liquidity (Figure 1).

Meanwhile, China is moving to a slower growth path, one demand factor (on top of an unprecedented orgy of investment in China, Australia, etc which is the supply factor on the other side) behind the negative commodity view we have held through most of 2013, and still do. Lower commodity prices aiding lower inflation pressures globally, and thus aiding easier central bank policy, is a good equity cocktail. Hence why we have been so bullish of mid cap stock indices (avoiding the commodity heavy mainline indices), particularly in the US. The US midcap index returned +33.5% last year. The key is what happens to central bank policy, whether they will continue to show an equity put that has been in play for some years, in clear evidence via balance sheet expansion. This

As equities dipped in summer 2010, and H1 2011, central banks (I have taken the main 6 central banks active with their balance sheets: US, UK, EMU, Japan, Switzerland, China) launched unprecedented liquidity injection. This was also a presence through 2013. My number one mantra as a strategist for a very long time now has been ‘call liquidity right and everything else falls into place’. The main negative liquidity shock was the payback by European banks of the ECB 3yr cash funding (Long-Term Refinancing Operations, or ‘LTROs’) that many were forced to take during the crisis. This funding had an escape clause after one year and much of it has been paid (we estimate 70-80% of outstandings are now from Spanish/Italian banks), such that the ECB balance sheet has shrunk from a peak E3trn at start 2013 to a current E2.2trn.

We expect this drain on liquidity to reverse and turn positive. The speculation in the Wall Street Journal that Germany has agreed to the end the sterilisation of the ECB’s bond buying programme, is tantamount to a E170bn liquidity injection, and is part of this. But this has not happened (yet). So, we are stuck in an irony that I remain a believer that this chart governs everything the only problem is that it is acting in opposite fashion to that which I expected i.e., shrinking, as tapering is not replaced by the ECB, or by more Bank of Japan aggression.

FIGURE 1. GLOBAL CENTRAL BANK LIQUIDITY HAS BEEN THE ONGOING SUPPORT FOR GLOBAL EQUITIES 3 month cumulative expansion of central bank balance sheets (LHS) 3mth rolling cumulative expansion of central bank balance sheets (LHS)

10 10

% change,

65000 65000

%balance change, balance sheet size sheet size weighted

8 8

weighted

60000 60000

Assuming USA tapering $0bn Assumingto USA

6 6

tapering to $0bn

4 4

50000 50000

2 2 45000 45000

0 0 40000 40000

-2 -2

On top of this, the entire complex of Emerging Market (EM) countries are de facto suffering tightening liquidity conditions as some of the $370-470bn of excess capital (source: IMF) tries to flee. They were the beneficiary of easy money, and the most exposed region to fear of liquidity withdrawal. Yes, there are issues in Ukraine, Turkey, South Africa, but it is the tapering trigger that has kick-started capital flight across the product. The Figure 2 shows EM fixed-income capital flow. 2009 was the last ‘run’ in EM. Flows turned negative in March 2009 and did not move positive until September 2009.

35000 35000

-4 -4

30000 30000

-6 -6 BoJ BoJ

-8 -8 Jan-09

Jul-09

BoE BoE

Jan-10

Jan 09 Jul 09 Jan 10

ECB ECB

Jul-10

Jan-11

Jul 10

Jan 11

Fed Fed Jul-11

Jul 11

SNB SNB Jan-12

PBOC WorldWorld equity (rhs) PBOC equity (rhs)

Jul-12

Jan 12

Jul 12

Jan-13

Jan 13

Jul-13

Jul 13

•

In May 2013 – now (we are still seeing consistent net outflows), 17% of capital has been removed

This is a rough guide. But it seems valid to say we are 57% through the process i.e., a long way to go.

30 30

ST External Debt, GDP ST External Debt, % GDP

C/A Deficit, % GDP 25 25 C/A % GDP FIGURE 2. Deficit, WE THINK

WE ARE 57% OF THE WAY THROUGH THIS EM ST External financing needs - ST External debt + C/A Balance, % GDP 20 20 ST External financing needs - ST CRISIS, I.E., STILL A LONG WAY TO GO 15

External debt + C/A Blaance, % GDP

10 10 6.00 55

DM FI. 4wk sum

EM FI. 4wk sum

00 4.00 -5 -5 -10 -10

None of this is positive for risk assets, which we remain of the steadfast belief is what is being targeted by some central banks.

-2.00

Core EMU CPI ex taxes, dangerously low

-4.00

2.50 2.50 -6.00

1.50 1.50

-10.00

1.00 1.00

-12.00

Core EMU CPI ex taxes, dangerously low

2.00 2.00

-8.00

Mar 07

So rather than just see more of the same, we should expect some CB fightback.

0.00

0.50 0.50 0.00 0.00 Dec 04 07

Sep 08 05 06 05 06

Jun 09 08 Mar09 10 07 07 08 09

Dec 10 11

10 10

Sep 11 13

12 12

Jun 12

Mar 13

Dec 13

Source: RBS; EPFR FTA Outlook 2014 | 15

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Figure 3 shows who we should be watching as most exposed to capital flight.

25000 25000

Jul-14

Jul 14

PPhh ilipilli pipe ne n s es C C hi h na i na R SoS usRu utou siass h t Ko K ia re o a re BrB a ar C C zial z ol o omlu in bm ia b M M ia ex e InIn icoxic dod neon o si e as i C C a hi R R lehi omo le am ni a an ia In I di n ad ia PoP lao ndla nd Is I ra s M M elra e al a S Soo ay la l utut siays hh Af A ia ric f H H aric unu a gang r Ta T y ary iwa ainw C C an ze z ThT chec aiha h la i ndla Tu T nd rku eyrk e

In March – September 2009, 30% of all capital exposed to EM FI was removed

Jan-14

Jan 14

Source: RBS

-15 -15 2.00

•

55000 55000

sheet size sheet size weighted

6 6

8 8

2 -2

4 -4

60000

6 6

6 -6

8 -8 Jan-09

50000 50000

45000 45000

0 0 40000 40000

-2 -2

35000 35000

-4 -4

30000 30000

-6 -6 BoJ BoJ

BoE BoE

ECB ECB

Fed Fed

SNB SNB

PBOC PBOC

40000 40000

35000 35000

30000 30000

equity (rhs) WorldWorld equity (rhs)

BoJ BoE ECB Fed MOST SNB PBOC equity (rhs) 25000 distorted) data weakens further, -8 BoJ 25000 -8 BoE ECBCOUNTRIES Fed SNB PBOC WorldWorld equity (rhs) FIGURE 3. IDENTIFYING THE RELIANT ON CONTINUED If the (weather Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 25000 25000 CAPITAL INFLOW tapering by the USA. But Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Jul 13 Jan 14 Jul 14it will call into question Jul-09

Jan-10

Jul-10

Jan-11

Jul 10

Jan 11

30 30

ST External Debt, GDP ST External Debt, % GDP

25 25

C/A Deficit, % GDP

Jul-11

Jul 11

Jan-12

Jul-12

Jan 12

Jul 12

Jan-13

Jan 13

Jul-13

Jan-14

USA to make dovish noises for a very long time, certainly throughout 2014, and especially with the excellent Ms Yellen in charge. While everyone is anticipating ‘when is the first rate hike’, our economists are more focused on how forward guidance is hardened. Watch for any debate on ‘optimal control’, a November 2013 paper by the Fed’s William English suggesting no hikes until 2017 lit up market interest in this subject, and remains a must read.

ST External financing needs - ST External debt + C/A Balance, % GDP

C/A Deficit, % GDP

20 20

ST External financing needs - ST 55 External debt + C/A Blaance, % GDP 00

External debt + C/A Blaance, % GDP 15 Deficit, C/A % GDP 10 External financing needs - ST External debt + C/A Balance, % GDP ST 10

10 10

-5 -5

-10 -10

PPh

GLOBAL DISINFLATION IS HERE. NEXT, CENTRAL BANKS REACT

hi il lip lip pi e ne n s es C C hi h na i na R SoS usRu s utou iass h t Ko K ia re o a re BrB a r a C C zial z ol o omlu in bm ia b M M ia ex e i c InIn oxic dod neon o si e as i C C a hi l R R ehi omo le am ni a an ia In I di n ad ia PoP laol nda n Is I d ra s M M elra e a SSoo laay la l utut siays hh Af A ia ric f H H aric unu a gang ry a Ta T ry iwa ainw C C an ze z ThT chec aiha h la i ndla Tu T nd rku eyrk e

-15 -15

Phh ilipilli pipe ne n s es C C hi h na i R R na u So S s u utou siass h t Ko K ia re o a re BrB a ar C C zial z ol o omlu in bm ia b M M ia ex e InIn icoxic dod neon o si e as i C C a hi R R lehi omo le am ni a an ia In I di n ad ia PoP laol nda n Is I d ra s M M elra e a SSoo laay la l utut siays hh Af A ia ric f H H aric unu a gang ry a Ta T ry iwa ainw C C an ze z ThT chec aiha h la i ndla Tu T nd rku eyrk e

-15 -15

Source: RBS

Core EMU CPI ex taxes, dangerously low

FIGURE 4. EMU CPI IS A POSTER CHILD FOR THE GLOBAL DISINFLATION 2.50 THEME, BUT2.50 BY NO MEANS ON ITS OWN Core EMU CPI ex taxes, dangerously low 2.00 2.00 1.50 1.50EMU CPI ex taxes, dangerously low Core

Yes, central banks are targeting equities and will not stand back through any sustained fall (I am not getting bearish risk products anyway, midcap US equities are only -1% YTD total return). But they have a much bigger headache to contend with: global disinflation. This has been my favourite subject since last summer when we argued that EMU CPI should fall sub 1% and settle there, as tax hikes dropped out of indices. That in itself has major policy implications, (we expect a cut to 0.10% and possibly a move to negative deposit rates, in March). See Figure 4.

1.00 1.00

2.50 2.50

Core EMU CPI ex taxes, dangerously low

US INFLATION IS ALSO DANGEROUSLY LOW

0.50 0.50

2.00 2.00

0.00 0.00

1.50 1.50

04 04

05 05

06 06

07 07

08 08

09 09

10 10

11 11

12 12

Low CPI is not just a European theme. US productivity is running at 3.2% in Q4 after 3.6% in Q3 - the best run rate since H2 2009. The flipside is that unit labour costs fell -1.6% in Q4, a symptom of just how weak are underlying inflation pressures.

13 13

1.00 1.00

Five years into expansion, with unprecedented fiscal and monetary shock and awe, even in the USA, which is gradually moving onto a more solid footing, inflation pressures are still flagging.

0.50 0.50 0.00 0.00

Jul-14

it does not, we should fully expect the Jan 14even Julif 14

Jul 13

C/A Deficit, % GDP

25 25

-10 -10

55000 55000

45000 45000

20 External 20 ST External GDP needs - ST ST Debt, % financing GDP STDebt, External

-5 -5

tapering to $0bn

2 2

30 30

55000 55000

50000 50000

Jan 09 Jul 09 Jan 10

tapering $0bn Assumingto USA

4 4

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0 0

tapering to $0bn60000

Assuming USA

Economic Outlook

4 4

2 2

tapering $0bn Assumingto USA

weighted

04 04

05 05

Source: RBS 16 | FTA Outlook 2014

06 06

07 07

08 08

09 09

10 10

11 11

12 12

13 13

Within Q4 GDP, the market-based PCE inflation measure is running at 0.5% qoq annualised. The core number is not much higher, at 0.9% qoq annualised.

This is unacceptably low, and I am amazed at how little focus this dangerously low inflation gets and that there are still many views out there calling for early tightening in various countries (less so in EMU, but there are certainly many rate hawks in USA and UK). For us, this is a world where the focus should not be on central banks tightening policy due to higher growth. This is a world where the consensus should be focused on inflation, and trying to explain why inflation is so much weaker than almost anyone has expected even though growth has been fine.

“We should remember that sub 1% inflation is not tolerable for any period of time for any central bank. Why? Because any growth hiccup downwards, and you are in potentially corrosive deflation.”

When the Bank of England introduced forward guidance in August 2013, it anticipated inflation would be 2.8% by end-year. Yet the actual outcome was 2.0%, a 0.8% miss for a forecast just four months in the future, and best indicator of how wrong footed the world is on this theme. Everywhere I look (outside of Japan and, strangely enough, Australia and New Zealand), this theme is intact. The Bank of Canada is grappling with trying to work out why CPI is so low (as I write this, the BoC Deputy Governor has just said ‘we need to do our best to determine why inflation is below target, but no matter how hard we try, there will be uncertainty about our diagnosis’). Latest Singapore CPI data showed a miss to consensus by 0.5%mom, enormous in inflation forecasting terms. We should remember that sub 1% inflation is not tolerable for any period of time for any central bank. Why? Because any growth hiccup downwards, and you are in potentially corrosive deflation. This is why every central bank has a central target a fair amount above zero, which gives a breathing space.

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So, our best guess as the year unfolds is that interest rates will stay lower, for longer, in general across the developed economies region, and that short-dated (e.g., 2-5y) bonds hold value. Problems in Emerging Markets will be an ongoing theme for 2014. And we have not given up on the liquidity story, and remain buyers of non-EM, noncommodity equities, especially – boringly, in the same vein as 2013 – the US. FTA Outlook 2014 | 17

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Risk Management Outlook

USING RISK AS AN OPPORTUNITY TO ENHANCE BUSINESS PERFORMANCE BY KEVIN SMOUT FFTP, PARTNER – RISK CONSULTING, KPMG

Risk management plays an important role in strategic planning, but only 66 percent surveyed said it was factored into these decisions.” 18 | FTA Outlook 2014

Risk management is most often seen as the management of a wide range of potentially negative impacts on business. This view is justifiable when the massive amount of regulatory oversight and compliance that is required in the world we operate in is considered. However, success lies in being able to use risk to one’s advantage, to understand the opportunities risk creates and to position business strategically so as to be able to benefit from the changing and volatile market.

as a tool for collaborative decision making. This can be done by embedding it into management routines (such as strategic planning, risk committee meetings, budgeting and corporate policy-making) and by engaging all C-level executives in debate and discussion about enterprise risk. Individual members will gain the perspective of their peers and be able to share ideas about emerging risks and how best to manage them and identify the opportunities provided.

The Economist Intelligence Unit conducted a global survey, sponsored by KPMG International, to explore how more than 1,000 C-suite executives are effectively integrating a holistic governance, risk and compliance (GRC) framework throughout their businesses. The principal findings of the survey create the basis of this article. In the sections that follow, we will describe in more detail the problems exposed by the survey and offer some potential solutions.

Faced with growing legal and business responsibilities, board members are becoming fully engaged in understanding the risk management and strategy link. They expect regular updates from management and are engaging in dialogue with designated risk owners and not relying solely on discussions with the CEO and CFO. Open communication between the Board and senior management, enables companies to use risk management as a tool that ties long-term strategy with short-term implementation.

1. STRATEGIC IMPORTANCE OF RISK MANAGEMENT 2. ASSESSING RISK EXPOSURES Risk management plays an important role in strategic planning, but only 66 percent surveyed said it was factored into these decisions. A risk program can only become fully operational when all C-level executives are using risk management

The largest proportion of executives (47 percent) cite in their top three challenges the difficulty of understanding the entire risk exposure on a global enterprise basis, and 44 percent see the same

HOW IS THE RISK PROFILE OF YOUR ORGANISATION DEVELOPED AND AGGREGATED? SELECT ALL THAT APPLY. The business has a risk and control self assessment process in place

48%

There is no process in place to aggregate risks

20%

38% 34%

The risk management function performs a bottom-up risk assessment process at least annually

The risk assessments of all the risk and control functions are aligned to ensure a complete risk profile

Note: Percentages may not add up to 100% as respondents were instructed to select all that apply

relationships of risk and clearly understand the velocity at which risks may occur. It is clear that, say, a downgrade of a company’s credit rating will affect other aspects of its business. Its cost of borrowing is likely to rise and market perceptions might deteriorate. Executives need to think carefully about the way risks relate to each other. The management risk committee, comprised of cross-functional members, can evaluate the risks from multiple vantage points in the company to see how risks link. The committee can also often connect the dots when aggregating risks and common themes will begin to appear. What may seem like random threats may collectively amount to significant strategic risks.

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problem at the business unit level. Twenty percent of executives said there was no process at their company to aggregate risks, an essential part of any strategic plan. When assessing a company’s risk exposure, executives should start with a ‘topdown’ assessment of the most important strategic risks tied to overall strategy. Then, the company should undertake a ‘middle-up’ risk assessment focused on business and functional units. If the company starts with a bottom-up assessment (potentially only process-level risks), there is a danger of it becoming mired in excessive detail, which may make it difficult to aggregate the risk assessment into an enterprise-wide view.

The largest proportion of executives (47 percent) cite in their top three challenges the difficulty of understanding the entire risk exposure on a global enterprise basis, and 44 percent see the same problem at the business unit level.”

Self-assessments are an effective way to corroborate prioritisation of the risk profile. When aggregating risks, it’s important to identify interFTA Outlook 2014 | 19

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Risk Management Outlook

CHART 1: HOW DO YOU MEASURE THE RETURN ON INVESTMENT (ROI) IN YOUR RISK MANAGEMENT PROGRAM?

We use quantifiable measures to value the risk management program (e.g., capital costs, hedging or

20%

28%

We have no mechanism to measure ROI of the risk management program

insurance costs, etc.)

17%

30%

Stress testing of core business processes against specific scenarios

We review past results or risk events to assess the effectiveness of risk management response

3. RETURN ON INVESTMENT Risk management is viewed as making a key contribution to the business, however, organisations need to improve how they measure risk management’s return on investment (ROI), and how they communicate its processes, value and effectiveness to key stakeholders. Almost half (47 percent) of C-suite executives indicated that risk management is essential for adding value to the overall business, with another 34 percent citing occasional improvements to the business resulting from risk management. However, varying methods of measuring return on investment from risk management are deployed, with 28 percent of organisations having no measure. There appears to be an opportunity for organisations to capture greater shareholder value from their risk management efforts through more effective measurement and communication. Many companies struggle to estimate ROI for risk management, primarily due to limitations in defining the ‘return’ component of the equation as well as determining the scope of risk management activities across the three lines of defence. We therefore do not suggest over-engineering the actual calculation. Rather, start by understanding the linkage between risk management and corporate strategy. 20 | FTA Outlook 2014

We rely on the racing agency to review our risk management program

By understanding how identified risks threaten the achievement of strategic business objectives (e.g., business transformation), executives can move risk management from a theoretical exercise to a business tool. Depending on the culture of your organisation, this will automatically allow risk management to move into the same ROI measurement mechanism as deployed by the rest of the organisation. As an organisation’s risk management capabilities are enhanced, certain trends should become more apparent – effective use of hedges, insurance instruments and offloading risks to third parties; improved cost of capital and debt rating; increased resiliency regarding emerging risks; successful acquisition decision making (both deals executed and terminated); clear examples of risk/loss avoidance; and more alignment between risk appetite and desired returns (deploying effective stress testing and scenario planning for strategic growth assumptions) reducing the volatility in estimated earnings.

4. ARTICULATING RISK APPETITE An overwhelming majority (86 percent) of respondents said that risk management considerations are to some degree factored into strategic planning decisions.

Yet only one in five (19 percent) respondents say their organisation has fully developed and implemented a risk appetite statement and 19 percent say the organisation has not addressed this issue at all. While some progress has been made, organisations will need to increase their efforts in developing creative tools for decision-making (e.g., building risk appetite measures and statements).

CHART 2: HOW OFTEN ARE RISK MANAGEMENT CONSIDERATIONS FACTORED INTO YOUR ORGANISATION’S STRATEGIC PLANNING DECISIONS?

Constantly, in all strategic planning decisions/sessions Often, in the majority of strategic planning decisions/sessions 3%

At least annually at the strategy planning session

11%

Companies will have difficulty developing a strategic plan without knowing their appetite for risk, and whether they are taking on too much risk for a given level of return or too little. Companies may find they can afford to increase their risk appetite, assuming the business gains are high enough. But they won’t know if they don’t develop a framework of their appetite for risk. Indeed, a key question for executives is how to reach a common understanding of the company’s risk appetite, as part of the strategic planning process. Most executives believe they have an intuitive sense of the organisation’s risk appetite. The challenge is creating a common understanding among the Board and executive team of that appetite. It should be a tool to help executives make decisions about how much risk to take on. It is meant to enable them to determine whether they are comfortable with the company’s position on the risk spectrum, from high tolerance to low. If a company operates without a risk appetite statement, it is hard to know whether it is taking excessive risks or too few — the latter can be as injurious as the former.

20%

Rarely, only in key strategic planning decisions/sessions

27%

Do not know/consideration of risk management in strategic planning varies widely across business units

39%

86%

An overwhelming majority of survey respondents said that risk management considerations are to some degree factored into strategic planning decision

would be jeopardised and (b) the value at which a risk event might jeopardise its credit rating. If there is a sizeable gap between operational values-atrisk versus financial resilience, then there may be opportunities to take on more strategic risk. If the gap is narrow, then the company may be taking on too much strategic risk.

CONCLUSION Managing risk amid stagnating global economies and heightened regulatory pressure has created formidable challenges for the C-suite. Despite the improvements to risk management driven by executives to date, stakeholder expectations continue to rise requiring a greater level of sophistication. To meet this challenge, organisations need to enhance risk management capabilities to address the imperatives discussed. This will require increased involvement and leadership of executives in order to respond to the demands of the market regarding governance, risk, and compliance.

Business managers should calculate key risks in monetary terms so that corporate executives can monitor whether the aggregated risk exposure comes close to (a) the value at which solvency

KPMG’s Director’s Toolkit is a free resource (available for download at kpmg.com/au/ directorstoolkit) that can further help organisations to navigate these demands.

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Risk appetite statements link risk exposures to financial performance in a way that offers insights into risk-taking strategies. There are two parts to the assessment of risk appetite: (1) Companies should stress-test the resilience of their balance sheets by calculating the monetary value at which solvency would be jeopardised. If they don’t do this, then they are taking on risk without a financial framework. (2) At an operational level, companies should calculate the monetary value at which a loss or risk event would jeopardise its credit rating, bank covenants, and other key financial ratios, such as interest rate cover.

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Risk Management Outlook

A REFLECTION ON RISK AND CORPORATE PERFORMANCE BY DR REG HINKLEY, A FORMER MEMBER OF COUNCIL OF THE LLOYDS INSURANCE MARKET, AND CURRENT CHAIRMAN OF THE LLOYDS PENSION SCHEME

In 1999, when Vice President and General Auditor for BP Amoco, I wrote an article for the FTA describing BP’s management framework, with a focus on risk management. Since the article was published, there have been a number of major disasters which call into question the adequacy of present-day corporate risk management. It is therefore timely to reflect on the issues in the light of experience.

I described a number of the key features of the then BP Amoco model aimed at tackling each of these issues. In particular I highlighted the importance for public companies of:

KEY POINTS FROM THE 1999 ARTICLE

ii. Defining the role of the Board as setting direction, specifying boundaries, approving high level performance goals and the incentives for delivery, and monitoring outcomes.

In principle, the challenge facing Boards and Management today is the same as that in 1999, namely how do we design a company to deliver high levels of performance, whilst controlling the risks that are thereby created. I suggested then a reasonable framework for tackling this challenge, based on a Research Report (212-97) of the Conference Board of Canada – ‘A Conceptual Framework for Integrated Risk Management’. In essence it means being clear on: •

The organisation’s objectives and strategy

•

The associated risks and opportunities

•

The processes and systems to deliver performance, and manage critical risks

•

The means of assurance that the organisation is performing as expected

i. Clear separation and differentiation of the roles of the Board and the Executive, and, as a consequence, those of the Chairman and Chief Executive.

iii. Establishing clear delegation to the executive team, together with the means of monitoring delivery. iv. Creating a culture and performance management environment which embraces risk as well as return, and ensures that reward properly reflects the key elements of both. v. Creating the means for challenge by functional experts in critical areas of corporate activity. I would suggest that these principles remain just as important today. Nevertheless, the last 10-15 years have been associated with a number of corporate disasters – some of them on a breath-taking scale. This experience begs questions as to the root causes.

I want to explore these under three headings: •

Environmental influences

•

Weakness in organisational design

•

Culture, incentives and performance management

Because BP’s experience in the Gulf of Mexico is still subject to US litigation, there are limits to what can be said about those events. But some conclusions can be drawn, and can be put alongside developments elsewhere, notably in the financial services sector in Europe and the US. Australian readers will be able to add their own examples.

IS THE WORLD A RISKIER PLACE? Boards inevitably need to evaluate the environment in which they will be operating. In particular they need to ensure that they have the capabilities – organisational, technical and financial – to manage the key risks which they will be facing. Some of those risks will be sector-specific: others may relate to the broader environment. Some may be more susceptible to control, or at least influence, than others. Given the pace of change, Boards need to re-evaluate these factors periodically.

Companies need to consider not only the potential for their own activities to create risk but also the adequacy of their procedures for meeting contingencies e.g. arising from the natural environment or hostile action by third parties. The

a) In the Gulf of Mexico, advanced technologies were involved, notably in drilling. Whilst these had been subject to considerable testing through time, BP attributed the cause of the disaster to a series of failures, which beforehand, taken together, would have seemed highly improbable. Was this a one-off, or are the general lessons to be learnt about risk mitigation where there are dependencies on advanced technologies? More generally, society’s pressure for energy and other resources implies the need for more innovation, and potentially thereby some risk-taking: how is the tension between economic growth and the risk of failures to be resolved?

More generally, society’s pressure for energy and other resources implies the need for more innovation, and potentially thereby some risk-taking: how is the tension between economic growth and the risk of failures to be resolved?”

b) In developed economies, the scope of institutional and individual responsibility for the consequences of a corporation’s activities is arguably broadening, significantly because of changes in the law and because of a heightened propensity to litigate. This is threatening the ability to limit liability, or to reach rapid settlement. Furthermore the growth and interdependencies in these societies is pushing up the value of such liability. This presents particular challenges for larger companies which, given their net worth, may be more attractive targets. Thus, notwithstanding its endeavour to reach early settlement, BP is facing extensive claims for compensation, which extend far beyond the direct impacts of the disaster and may take years to resolve. Whilst it is entirely understandable that society should want corporations and their employees to be accountable for their actions, if the cost of this appears too high before the event, and resolution too protracted, it is likely to reduce the propensity to take risk,

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As we have seen, a number of well-regarded companies appear to have got these judgements wrong with a very significant impact on firm value – constraining strategic development at least and in some cases destroying the firm entirely. Much media and political comment has focused on the individuals involved and their incentives, but before reviewing this aspect it is worth considering other possible influences. The inherent risk in the environment is one. This implies considering whether there are new factors to take into account, whether the probability of adverse events occurring is increasing and whether their impact in financial terms is likely to be higher.

scope of such consideration is potentially large and appears to be growing. For example the Fukushima disaster has raised questions as to the ability to foresee the scale, force and likelihood of a natural event, such as a tsunami; the adequacy of the safeguards within the plant; the sufficiency of the responses when disaster strikes; and the potential impact on the wider economy, given critical dependencies. BP’s Gulf of Mexico experience is similar, albeit that the disaster was man-made. There have been equivalent issues in the banking sector. These examples have had some specific features, which pose additional questions:

FTA Outlook 2014 | 23

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Risk Management Outlook

and thereby potentially constrain economic development. How should these goals be reconciled? c) In the oil industry, it is common to establish partnerships to share the equity in a particular project. Companies will also sub-contract or outsource specific functions, in which the provider has a specific expertise. Such contractual relationships provide a means of mitigating the risks to which the principal is exposed. Similarly, in the financial institutions, derivatives contracts provide mechanisms to manage the risks to which they are exposed. However, the potential advantages of such arrangements bring with them greater complexity and challenges for effective managerial control. Moreover, in extreme circumstances, the contracts may prove to be undeliverable, at least as intended when they were established. In effect one form of risk has been exchanged for another. How should institutions weigh up the advantages and disadvantages of such risk transfer, and specifically how can they make such arrangements more robust?

BP’s attempts to focus on sealing the well, cleaning-up the released hydrocarbons and provide a fair basis of compensation for those seriously impacted brought little recognition among the media or US politicians. ” 24 | FTA Outlook 2014

d) Both the energy and financial services sectors were subject to extensive regulation. There have been specific instances in these industries of conscious non-compliance, but for the most part responsible companies have devoted considerable and costly effort to meeting regulatory requirements. The response to disaster tends to be calls for even more regulation, yet there are legitimate doubts about its effectiveness. How do we get the cost-benefit equation right here? There is also an issue of moral hazard. If the state steps in, and defines an ‘acceptable’ risk envelope, to what extent should it underwrite the costs of failure? e) The digital revolution has proved to be something of a mixed blessing for companies who have run into trouble. Whilst it has produced significant business benefits, informal, internal exchanges – however intended - have become matters of record, open to legal discovery or release to the media via e.g. by whistleblowers. Externally, the development of the internet and social media has multiplied the channels of communication, thereby presenting new challenges for those trying to get across a company’s message at times of crisis. How should companies adapt to this new environment?

f) It has been well-understood by responsible companies that political and reputational risks can be critical, with impact greater than the direct costs, but these factors appear even more negative than they have been. Thus, BP’s attempts to focus on sealing the well, cleaning-up the released hydrocarbons and provide a fair basis of compensation for those seriously impacted brought little recognition among the media or US politicians. Likewise Barclays attempts to face up to its responsibilities for Libor fixing seemed to backfire, not least in part because it settled in isolation from the others involved. Such difficulties can amplified by a growing tendency for politicians to use house committees as platforms for expressing outrage about corporate actions. How should such developments impact the way companies approach these risks? This summary suggests that Boards and executives face a broadening landscape of risk which they need to manage and on which they need to provide assurance to stakeholders. If, thereby, the cost of corporate setbacks is growing it raises questions as to the adequacy of corporate risk management, and its profile within the Board governance agenda and day-to-day decision making.

STRENGTHENING ORGANISATIONAL DESIGN The organisational principles presented in the 1999 article were intended to balance risk and reward. Which aspects need to be reconsidered? (i) The roles of the Board and the Executive. It is not universally the case that corporations are governed consistently with the principles summarised above. In particular, the balance of influence between the Board and the Executive can vary. There is also long-standing debate about the separation between the roles of the Chairman and Chief Executive – a debate which tends to be resolved differently in different regions. The UK and equivalent models emphasise the distinctions, and in the area of sound risk management offer definite advantages. In particular, the Board, with input from the Executive team, can establish more clearly the corporation’s risk appetite, and the means through which this will be tracked.

This framework will form the basis for setting the degree of delegation to the Executive (which may be extensive); the limits on its exercise; and the reporting requirements. In similar vein, the relationship between the Chairman and the Chief Executive should be clear, especially at times of crisis. It has been noteworthy during BP’s and Barclays’ recent experiences that this was an aspect which came in for much criticism. Recent experience therefore reinforces the need for Boards to tackle risk management explicitly. (ii) Board composition. The selection of non-Executive Board members is a further consideration. The criticisms include a tendency to appoint Board members from too narrow a circle of candidates; lack of experience and training; inadequate time spent on company oversight; and reluctance to challenge prevailing wisdom on company direction. Examples like Enron or the Royal Bank of Scotland have highlighted these issues. But while the criticisms are justified, the solution is not obvious. For much of the time whilst companies were devising and implementing the strategies that ultimately led to their downfall, the pressure from institutional investors, analysts and the media was for growth and shareholder return: the associated risks were not given the same emphasis. Going forward the balance needs to be redressed, but not at the expense of sound risk-taking. In one of its Board Papers, published in 2009, Odgers Berndtson, the executive search firm, made the point well: The best Non-Executive Directors have a subtle mix of skills that allow them to assist, challenge, motivate and mentor the Executive team. Most importantly, they need the courage to question assumptions and speak out when they perceive a problem.

(iii) Board processes and committee structure As part of the review of the Board’s effectiveness,

Focus on associated risks can be particularly critical during periods of change, and especially, as recent experience has indicated, when a company is pursuing growth by acquisition. The imperative for a decision, notably during periods of market euphoria,, tends to override legitimate concerns about potential downsides. Thus recent cases have highlighted tendencies to overstate asset values (and understate potential liabilities), overplay the potential for organisational rationalisation, underestimate the challenges of integrating different cultures and (where foreign acquisitions are involved) give insufficient attention to the management of local profile. Such risks are not new, yet it is surprising how often they are put to one side by experienced Boards when sentiment is running strongly in favour of a deal. The design of a Board’s committee structure and agendas can help create a stronger risk focus. Thus BP has had, for many years, a Board committee devoted to safety, ethics and environmental assurance. Board oversight is complemented by executive responsibilities, committees and processes aimed at maintaining internal controls consistently with UK and US corporate governance codes. This structure has, understandably, been strengthened since the Gulf of Mexico disaster. Likewise responsible financial institutions have been reconsidering the design of key processes and risk-focused committees, and regulators have been giving closer attention to these aspects. At the end of the day, though, such redesign can only help so far: effective oversight still depends on experienced individuals with courage to challenge conventional wisdom.

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The paper went on to highlight the contribution of a good Chairman, and a strengthened company secretariat, in supporting non-Executives and the role of the Nominations Committee in sourcing a sufficiently diverse pool of candidates with experience in the critical aspects of a company’s activities.

it is salutary to consider how it has allocated its time over, say, a twelve-month period; to what extent there has been focus on risk management; how this has been allocated between the full Board and its Committees; and whether such review has influenced strategy and/or delegation to the executive team. Governance codes, such as the Combined Code in the UK, have given greater prominence to risk issues, but compliance can all too easily become a box-ticking exercise.

(iv) Functional assurance Such enhancement of risk governance needs to be supported by strong functional review within the FTA Outlook 2014 | 25

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Risk Management Outlook

Large enterprises, especially in the financial services sector, have clearly lost trust within the wider community... the tendency to rush to judgment, when risks materialise, and to presume companies have acted in bad faith, needs to be challenged.”

26 | FTA Outlook 2014

company. Thus resource companies have reviewed their capabilities and review procedures in the wake of the Gulf of Mexico disaster, to ensure that facilities are operated to best practice standards and comply with all relevant regulatory requirements. Attention has also been given to emergency responses, including the management of communications which can set the tone for a company’s reputation during a crisis. Likewise financial institutions are giving attention to the effectiveness of their control and compliance organisations, which is likely to create more focus on individual behaviours in the risk-taking parts of the business. In all such cases, risk management should be expected to claim more executive time, and increase costs. The challenge will be to achieve this optimally – avoiding bureaucracy, ensuring focus on critical areas, ensuring action in response to identified problems but avoiding undue risk aversion.

read. Companies do need to encourage wider dissemination of this understanding, in a way that is more accessible. And journalists and politicians need to seek a more objective, evidence-based view of adverse events, rather than work within their prevailing mindset about a particular industry.

(v) Communication and reporting Large enterprises, especially in the financial services sector, have clearly lost trust within the wider community. Once lost, a company’s reputation is hard to restore, not least because of a tendency to rely more on archives for reporting in order to meet shortening media deadlines, enabled by dependence on digital technology. As mentioned, there is a paradox that sits at the heart of this situation. Developed societies rely heavily on these enterprises to meet their needs for resources and service, and to generate financial returns to fund state services and retirement pensions. Such wealth creation inevitably means taking on risk, and as populations grow and resources come under pressure, innovation is likely to become more critical. Responsible companies with developed capability are more likely to be able to meet these needs successfully. There are clearly some issues around behaviours and incentives, considered below, which will need to be tackled as part of the process of restoring trust, but companies need to do more to re-establish, among the general public, an understanding of the nature of business and the choices that have to be made. In particular the tendency to rush to judgment, when risks materialise, and to presume companies have acted in bad faith, needs to be challenged. Formal public reports now include far more description of governance and risk management, and the responsible authorities are encouraging this to move beyond boiler-plate statements, but such documents are not widely

The framework of reward for senior executives has been a major factor in undermining trust in large corporations. The so-called ‘bonus culture’ is cited as a major factor encouraging excessive risk taking and short-termism. This is compounded by concerns over the rigour of performance evaluation, and the ability of senior executives to walk-away unscathed from corporate disasters. Remuneration committees are criticised for the narrowness of their membership, and their vulnerability to concerns about the ability to retain senior executives. At its worst the system is seen as one which ratchets up senior executive reward to the detriment of shareholders, other employees and the wider society.

CULTURE, INCENTIVES AND PERFORMANCE MANAGEMENT The implication of the preceding discussion is that improvements to structure and processes can assist sound risk management – but by themselves are unlikely to be sufficient. They need to be complemented by an organisational ethos that emphasises the correct behaviours. How things get done is then just as important a consideration as the creation of shareholder return itself.

There are increasing signs in Europe – but not so strongly in the US – that politicians, responding to public sentiment, are seeking action on this issue, at least as far as the financial services sector is concerned e.g. the European Parliament’s initiative to cap bonuses, and the pressure put on firms in the UK to withdraw bonuses and shares already awarded or, in the case of Barclays, to remove the Chief Executive. The situation is unsatisfactory because the responses are based on limited, arguably flawed analysis. In particular there is confusion between the quantum of senior executive packages, and their structure. Most senior executives are rarely driven e.g. to pursue an acquisition because of the variable pay component. Rather remuneration structures are important as signals of relative standing among peers

and recognition by company Boards. The variable element conveys flexibility, and if used carefully it can emphasise attention on sound risk management. However, as has been said, the signals sent to Boards and senior executives, certainly before the crash, were rather different, stressing shareholder value and growth, with the charismatic CEO as hero. The rapid growth in the overall quantum of senior executive remuneration that resulted is hard to justify in the light of subsequent events and the downturn in economies, and the judgments on specific awards do not seem to take sufficient account of reputational impacts. Whilst it may be difficult for any one company to reverse the situation, the alternative – greater state intervention - may be less-welcome medicine. The arguments for the corporate sector to be more positive in its response to public concerns are strengthening therefore.

framework in individual business units needs to reflect appropriately the holistic view of risk and reward, which the Board is trying to establish. And in this regard it may be necessary to depart from a balanced-scorecard kind of assessment, given that the downside from corrupt or unsafe activity may be much greater than the upside from extra percentage points of return.

•

Developments in the environments in which larger companies are operating are tending to increase the costs of failures, justifying more focus on the risks associated with their activities.

The tone set at the top – the sense of what really matters, and what is less important – cascades throughout an organisation. Most employees want to do the right thing, but there is good evidence that the frame of reference they observe locally can be a strong influence on behaviour. Many companies have established codes of conduct which aim at reinforcing the right values, but there is variable experience of their application. The potential for distortion, or worse corruption, is inherent in any chain of command, and needs continuing attention. Thus the Libor-rigging contagion which seems to have infected a number of major banks is a telling example of a how unethical practice can gain adherents when it is clearly prejudicial to an organisation’s broader interest, and despite formal control and audit processes. Likewise, unsafe practices can develop in a local industrial operation, notwithstanding the conflict with company policy and the direct interest of the employees involved.

•

The principles of organisational design described in the earlier article remain relevant, but Board governance needs to be adapted to create this greater focus, and there needs to be a strengthening of functional review. Greater attention to political and reputational risks is a particular need.

•

Changes to structure and processes can only do so much. Further consideration needs to be given to culture, incentives and performance management. At senior levels, the structure of reward is a significant issue in the public’s mind, threatening to undermine companies’ licences to operate. Companies need to be more pro-active in tackling this. And more attention need to be given to the signals being sent down through the organisation to verify that they are consistent with companies’ ethical values.

This review suggests three general conclusions:

There is one further point. Companies reflect the values of wider society, and are staffed by ... ourselves. We all have responsibility, collectively and individually, for getting this right, therefore.

Note: This article was previously published as the Featured Article on FTA’s website www.finance-treasury.com FTA would like to thank FTA Technical Committee member Bronwyn Wellings CFTP, Group Treasurer, Oz Minerals who once worked with Dr Hinkley when he was treasurer at BP and who reached out to him to suggest he might like to write a follow-up article.

Many companies have established codes of conduct which aim at reinforcing the right values, but there is variable experience of their application. The potential for distortion, or worse corruption, is inherent in any chain of command, and needs continuing attention.” FTA Outlook 2014 | 27

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The design of the performance management process can help counteract such decay. For example, if performance contracts emphasise profit or production, and there is insufficient attention to the risks of the organisation, it should not be a surprise if local employees respond consistently. Likewise, if performance recognition, through variable pay or otherwise, emphasises return, and there is no challenge on wider corporate values, should we surprised if more junior staff absorb such a strong signal? The performance management

CONCLUDING THOUGHTS

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Technology Outlook

ALIGNING COMPANY GROWTH AND TREASURY EVOLUTION AT SEEK HOW SEEK, AN ASX-LISTED ONLINE EMPLOYMENT WEBSITES PROVIDER INCREASED AUTOMATION AND VISIBILITY IN CASH AND RISK MANAGEMENT THROUGH IMPLEMENTING A NEW TREASURY SYSTEM. BY EDDIE COLLIS, GROUP FINANCE DIRECTOR, SEEK LIMITED

Three years ago Seek´s treasury function looked quite different. As the company was operating in Australia and New Zealand and held only minority investments in offshore businesses, treasury operations were rather simple. At that time, the one to two transactions per quarter could be handled with spreadsheets by a part-time resource.

Seek quickly realized that these higher volumes and the complexities of their changed operations could no longer be handled efficiently and securely with spreadsheets.” 28 | FTA Outlook 2014

However, the treasury landscape changed significantly when the leader in the online employment and training market in Australia and New Zealand moved to controlling stakes in its businesses in South East Asia, Brazil and Mexico in the years 2011 to 2012. With the ownership of online career platforms in these markets, the complexity of treasury operations increased drastically. Due to the continued growth of Seek´s international business, it became more challenging to consolidate financial data on an enterprise level, gain visibility into cash flows (actual and forecasted) in different currencies, understand foreign exchange and interest rate exposures, and centrally manage more complex funding and borrowing arrangements for the whole group. The number of transactions increased, and up to 25 different types of transactions were used in treasury on a regular basis. Additionally, a dozen different currencies had to be considered in planning and valuations. Seek quickly realized that

these higher volumes and the complexities of their changed operations could no longer be handled efficiently and securely with spreadsheets. In 2012, Seek started evaluating different treasury systems to automate and streamline transactional processes, risk management and hedge accounting. After a thorough selection process, the company selected Reval´s Software-as-a-Service (SaaS) solution for Treasury and Risk Management (TRM) due to its rich capabilities, but also for its SaaS technology. Interestingly, SaaS was not a key criterion in the selection process, but it was quickly identified as a real value-add for the international corporation. Cloud-based SaaS technology makes the platform easily accessed anywhere there is an internet connection, not only for finance professionals in Melbourne headquarters, but also for those in Seek’s subsidiaries from Beijing to Hong Kong and Brazil. SaaS also proved to be highly scalable from a user, transaction volume and capability perspective. Seek also found Reval’s SaaS delivery attractive because it will enable the company to remain current on every version of the platform as upgrades are available immediately to all Reval users at the same time and does not require the involvement of internal IT departments.

About Seek SEEK Limited (ASX code: SEK) is the leader in the online employment and training market in Australia and New Zealand. SEEK has expanded its reach internationally by identifying and acquiring controlling interests in five online employment websites which operate in countries across South East Asia, China, Brazil and Mexico. Our international investments complement our portfolio, offer opportunities to leverage the expertise gained in the Australian and New Zealand markets, and provide SEEK with a global footprint of #1 and #2 players in the online recruitment market with exposure to over 2 billion people and approximately 20% of global gross domestic product.

Seek’s implementation ran very smoothly. The company decided to take a phased approach: After only five months, in April 2013, phase one went live at Melbourne headquarters with capabilities to perform advanced cash and liquidity planning in multi currencies and manage and hedge related risks. In phase two, roll out to the company´s subsidiaries began. The aim was to automatically feed into the system account balances from more than 200 accounts at approximately 70 banks around the world. Today, all accounts in Australia and New Zealand, Brazil and South East Asia have been connected, with another 100 in China scheduled for integration. In the third and final project phase, Seek will integrate its general ledger.

30m 25m 20m 15m 10m 5m 0

Jan 10

Aug 10

SEEK (site + mobile + app)

Aug 11 CareerOne (site + mobile)

Aug 12

Aug 13 MyCareer (site + mobile)

SEEK platform growth in Australia January 2010-August 2013

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Seek is already seeing benefits from its new SaaS TRM solution, as all financial transactions are captured and recorded in a single, robust platform. Drill-down capabilities from liquidity forecasts to individual transactions make cash flows transparent. At the same time, analyses and reports are available in seconds, consolidating data and providing an overview on enterprise-wide exposures and key metrics. Such visibility into global cash and risk provides the treasury team with the confidence to be able to support the company´s growth plans for today and for the future.

Strong visits growth to SEEK

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Technology Outlook

TREASURY SYSTEMS THE PAST AND FUTURE: PIERCING THE CLOUD OF UNCERTAINTY BY TIM HART CFTP, Director at INFACT Consulting

It is now 2014 and like every year a number of finance and treasury professionals will be thinking about the need to replace or upgrade their treasury system, which is the most vital piece of infrastructure for many corporate treasuries being the primary source of functionality for addressing key cash, funding and risk management tasks.

In 2014, treasurers have increasingly pressing systems decisions to make including the key security versus functionality question of degree to which it is prudent to migrate business critical functions and high value transactions to “the Cloud”. They will also be ensuring that systems are ready for multiple changes flowing from new derivative and financial reporting rules. For instance, which treasury systems can model credit curves for AASB/IFRS 13? Which systems will be ready for corporate OTC derivative trade reporting? How would corporate cash management systems cope with increased collateralisation and margining? However, what is a treasury system? The early treasury systems performed basic deal capture, treasury accounting and settlements preparation. Typically, the treasury accounting acted as a sub-ledger to the accounting system and this was required because no accounting systems had that specific functionality. The settlement function did not actually make payments; these were generally entered manually into payment system terminals. Deal capture was only data

entry across a limited set of asset classes usually FX, Money Market and some (what we now call) vanilla derivatives.

THE STORY SO FAR Over time, other functionality was added and there were changes in the vendor approach to the challenges. •

Front office systems were developed that added position keeping, basic sensitivity analysis and portfolio management. These were standalone and interfaced to the systems noted above that became known as back office systems. Similarly, standalone risk systems evolved initially in the area of credit limits.

•

Both front and back office systems gradually morphed into what we now know as a treasury system i.e. an integrated system to which was added risk functionality.

•

Risk functionality in treasury systems was added and this has become a continuous process driven by regulatory, market and treasury professionals’ requirements. Risk was articulated into types of risk e.g. credit risk, market risk, liquidity risk ALM risk and settlements risk etc.

•

Initially asset class support was achieved by the development by vendors of separate systems e.g. securities, commodities. Gradually systems became cross asset class though stand-alone system in some asset classes remain common e.g. commodities.

the sell side but this division has become increasingly blurred with so with many systems that are in use by both categories. This in part due to demand from the buy side for greater functionality. •

Therefore, we have a category of “traditional” vendors that have followed the above approach.

WHERE ARE WE NOW AND WHERE ARE WE GOING?

•

There always was an overlap between treasury systems used by the buy side and treasury/trading systems used by

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The approach adopted by “traditional” vendors as articulated above is to create a monolithic integrated system that covers all key areas of functionality across multiple asset classes. However there have been other developments and these are just some examples:

Over the same period of time, there has been growth in “online” systems from both vendors and financial institutions. These cover a range of functions from trading through to payments. Initially these were used by the sell side starting with FX but increasingly by the buy side. This appears to be an area of focus for the vendors as they strive to handle the whole transaction lifecycle in their system. These systems come in a variety of forms including Private Hosting, Cloud, Software as a Service (SAAS). They also come with a range of issues including Single Sign On, Security, Confidentiality, Technical Standards, Disaster Recover and most importantly “Where is the Data? Readers might find this link useful: www.treasurers.org/node/9799 FTA Outlook 2014 | 31

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Technology Outlook

•

On the trading/dealing front then the online market is now well established across FX, Equities, Securities, Money Markets, Commodities and some Derivatives. Gradually every asset class/instrument will be covered as more standardised marketplaces (or exchanges) develop. The likely exception will be more complex structured transactions. These functions are moving from a standalone workstation to integration with the in-house system. This leads into the question of where is the function actually being performed e.g. for fixed income the online platforms have functions including portfolio management and pricing that are duplicated in the “treasury” system.

•

Cashflows are now recognised for their value in analytics and modelling. Previously cashflows were treated as state secrets, however modern systems use these as the basis of valuations and sensitivity analysis (notwithstanding the complications of yield based instruments) and are available for export into everyone’s favourite tool (Excel)

•

Systems in general have become more workflow driven and often there is a need to have an enterprise workflow approach using off the shelf systems. This has implications for the traditional implementation approach, and specifically in the area of testing

On the payments front SWIFT, once the domain of the banks, has become more widely used by the buy side often using a SWIFT service provider. OTC Clearing is producing a number of new alternatives for this part of the market. In addition, there is the evolution of a multiplicity of non-bank payment systems specifically for financial markets but also “retail” approaches that are moving up the value chain. Interfacing to these systems is simply a message that meets ISO standards. Again, we have an overlap of functionality with the “treasury” systems.

HOW DO WE DEAL WITH THIS?

In the area of accounting, we are seeing the evolution of online “hubs’ that act as a treasury sub ledger to the enterprise accounting system. These are very common in Europe and are gradually seeping into the Asia Pacific market. Whilst these vendors tend to exist outside of the mainstream accounting system vendors it is expected that acquisitions and internal development by the major accounting system vendors will produce “treasury” sub ledgers the same way that accounts payable, accounts receivable exist today. This has effectively already happened with one of the leading vendors. So again we see overlap in functionality with the “treasury” system. Similarly, there are the same trends in pricing, risk etc.

Implementing a treasury system is like organising a celebrity wedding. The same team of disparate players are involved and the often the whole process ends up with inglorious divorce. These are some of the parallels to keep in mind in the whole process: 1. Are they “the one”? What do you want in a partner = requirements Look into their background = know your vendors Unrealistic expectations = unrealistic expectations Know your requirements: •

Assess your business requirements in terms of overall functionality and think outside of the square of traditional “treasury’ systems. Carefully assess current and future asset class/instrument requirements.

•

Look at related aspects such as ALM and particularly look closely at cash management.

•

What functionality are you going to achieve through “online” approaches.

•

What functions does the enterprise accounting system perform and how does the treasury functionality relate to this e.g. which one does payments?

•

What is the consequent shape of the required system?

•

Should you have separate treasury and risk systems?

•

How should it be hosted? Vendor or cloud hosting is a trend that is accelerating

Know your vendor. What’s going on at the vendor? Are they in a takeover or reorganisation mode? When is their end of financial year? 2. The pre-nuptial What if it all goes wrong = what if it all goes wrong. I want the puppy! = want my money back. Use your own contract, not the vendor’s that you should have drawn up by specialist legal counsel. Make this a condition of the RFP. Include their commitments in the sale process in the contract.

6. The hangover Little things going wrong=big things going wrong Disillusionment=Disillusionment. Learning to love them with all their faults = Getting the system in Remember that even after all the requirements gathering and testing things will still be overlooked or go wrong. Expect that this will happen and prepare for it with a strong support team and focus on the benefits that you will gain. 7. Happy ever after – or at least for the next six or so years. Some pointers to analysing the high level approach to replacing or upgrading your system: •

Carefully assess current and future asset class/instrument requirements.

•

Look at related aspects such as ALM and particularly look closely at cash management.

•

What functionality are you going to achieve through “online” approaches.

•

What functions does the enterprise accounting system perform and how does the treasury functionality relate to this e.g. which one does payments?

•

What is the consequent shape of the required system?

•

Should you have separate treasury and risk systems?

•

Should it be hosted? This is a trend that is now accelerating.

3. The wedding organiser The running sheet = The project plan. Find a good project manager, preferably an outsider with no political baggage or need to curry favour. They must have a good track record. 4. The dream team Swan wrangler-monkey handler-flower arranger=multi skilled tech specialist bridesmaids-groomsmen=business specialists. Staff your team with right skill sets – don’t try to make do. These people are expensive so make sure that the management structure is right and that they are working on their specialties.

Finally go-live is the culmination of months of planning and hard work. Again, the project manager is key to this so ensure that adequate support is available. Decisions will need to be made so ensure that the right people to make the decisions are available.

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5. The big day The day = go-live.

Staff your team with right skill sets – don’t try to make do. These people are expensive so make sure that the management structure is right and that they are working on their specialties.”

Finally, define the Current Operating Model/ Current State Systems and the transition to a Target State Operating Model/Target State Systems. Many Thanks to Warren Murray, CIO of Treasury Corporation of Victoria assisting with this article. FTA Outlook 2014 | 33

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Ratings Outlook

ASIA-PACIFIC CORPORATES TAP CAPITAL MARKETS BUT BANK LOANS REMAIN DOMINANT BY CRAIG PARKER, DIRECTOR OF CORPORATE & GOVERNMENT RATINGS, STANDARD & POOR’S RATINGS SERVICES

Despite the regulatory imposts on banks’ funding, we believe bank loans will continue to dominate the region’s corporate financing landscape, despite the growing reliance on capital markets.” 34 | FTA Outlook 2014

Changing capital and regulatory controls are spurring Asia-Pacific banks to modify their lending approach. Banks are increasingly offering companies a wider array of products and facilitating access to non-traditional sources of finance from various capital markets. In fact, Standard & Poor’s Ratings Services has observed that Asia-Pacific corporates in some countries are gradually relying more on capital markets. As a result, companies have multiple debt options that satisfy their needs and diversify their funding sources, as well as reduce the cost of debt. At the same time, banks are able to expand and broaden their business mix. In particular, we are seeing an emergence of non-bank and institutional investors participating alongside banks in syndicated loans. This is not surprising given the flow of funds into the nonbank and institutional sector. Also, this development eases the reliance on traditional bank funding and reduces individual banks’ counterparty exposures. Moreover, it can assist in refinancing existing bank debt or enable lenders to participate in new financings arising from Asia-Pacific corporates’ swelling debt appetite. Despite the regulatory imposts on banks’ funding, we believe bank loans will continue to dominate the region’s corporate financing landscape, despite the growing reliance on capital markets.

Asia-Pacific’s relatively better growth prospects compared to other parts of the world will broadly underpin the robust credit consumption. Indeed, Standard & Poor’s expects the region’s corporates will contribute half of the world’s demand for US$49 trillion-US$53 trillion in new and refinancing of corporate loans and bonds over 2013-2017. We rate bank loans and bonds, with the average rating for bank loans in Asia-Pacific falling in the ‘BBB’ category. We expect that the banking sector will accommodate Asia’s voracious debt appetite. Within Asia-Pacific, the relatively less mature bond markets in some countries provide the banks with a healthy supply of lending opportunities. Developed markets such as Japan, Australia and New Zealand (Australasia), on the other hand, have active bond markets. Nevertheless, we believe banks will still be the largest provider of corporate funding in these markets. Australia and New Zealand form the largest share of rated bank loans in Asia-Pacific We rate some 1,400 companies’ bank loans globally that total more than US$2.1 trillion, with Australasia comprising a significant majority of Asia-Pacific’s share. For Australasia, consumerrelated corporates are the largest borrowers, amassing about A$30 billion of drawn bank debt at June 30, 2013 (see chart). The banking sector

has also lent to the airline; utilities; materials and energy; project finance; and real estate sectors in Australasia.

DRAWN BANK DEBT FOR RATED AUSTRALASIAN CORPORATES AND INFRASTRUCTURE

Drawn bank debt

Other drawn debt

Interestingly, Australian companies have recently raised about US$10 billion in the U.S. Term Loan B (TLB) market, which offered longer-term loans that are more flexible than Australian banks’. These institutional markets have offered more favorable terms to speculative-grade issuers, than loans from banks for such issuers. To a lesser extent, we are seeing some issuance from Asian corporates. TLB funding is usually of longer tenor, more heavily focused on incurrence rather than maintenance covenants, and overall, costs lower. It also diversifies borrowers’ funding bases. Still, we believe the Australian and New Zealand bank loan markets will continue to be the funding mainstay of corporate borrowers. Due to Australia’s loan markets’ size and scale, bank loan documentation is standardized, enabling transactions to be drafted, priced, and sold down to a wide pool of lenders. The preferred loan tenor is between three to five years. Nevertheless, we are witnessing borrowers choosing two-year tenors as part of a refinancing strategy, with the prospect of a takeout via capital markets or alongside debt of longer tenors.

70,000 60,000 50,000 40,000 30,000 20,000 10,000 0

Airports

Australian Utilities

Consumer Related Corporates

Materials & New Zealand Energy Utilities

Project Finance

Real Estate

WHAT IS A BANK LOAN RATING? Bank loan ratings are on issue-specific corporate loans from banks, and reflect the likelihood of ultimate repayment of the loan. Typically, bank loans are arranged on a bilateral, club, or syndicated basis. Bank loan ratings complement Standard & Poor’s traditional corporate credit ratings, which focus on the overall credit risk of a company. How is a bank loan rating determined? Bank loan ratings are assigned based on Standard & Poor’s globally recognized rating scale ranging from ‘AAA’ to ‘D’, as are our corporate credit ratings. Furthermore, bank loan ratings factor in ultimate loss and recovery in addition to default risk (recovery ratings are currently only available in the Asia-Pacific region for Australia, Hong Kong, and Singapore). The analysis takes into account covenants, collateral, and other protective features that may impact post-default repayment, and the rating may be notched-up from (i.e. assigned a higher rating than) the corporate credit rating.

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About two-thirds of the lending is to refinance Australasian corporates’ debt, with the bank loan market making up the majority of nonrated corporate debt capital raisings. We believe incremental growth in loan volumes will be affected by: liquidity in the banking system, the margins that banks are seeking to charge the corporate over the reference rate, and the level of commitment fees charged. Moreover, the volume of mergers and acquisitions (M&A) activity would fuel loan growth in the short term.

80,000

(Mil. A$)

In calendar 2013, bank loans in Australasia’s syndicated market reached US$100 billion. This is a jump of 25% from US$80 billion in 2012, but is still down 7% from that in 2011, when it reached a peak of US$107 billion (source: Thomson Reuters LPC). Japan is Asia’s biggest loan market with US$276 billion in 2013, followed by China at US$117 billion.

FTA Outlook 2014 | 35

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Ratings Outlook

Bankers can use the bank loan rating in cases whereby collateral and other protective features are considered relevant to the credit decision. Bank loan ratings go beyond simply rating the overall corporate creditworthiness of the borrower, as they assess the credit impact of repayment protections provided specifically to holders of senior bank debt. In many instances, a bank loan rating will actually be higher than the borrower’s corporate credit rating. Bank loan and recovery ratings are likely to be most useful when obtained before the loan is syndicated, allowing syndicators and investors to incorporate the Standard & Poor’s rating and analysis into their structuring, distribution, and

credit-decision process. Bank loan and recovery ratings typically are assigned by the same committees that rate the issuer’s bonds and other debt instruments. This is particularly useful in transactions whereby a bond and loan are being arranged in a coordinated fashion. What is the importance of recovery ratings? Recovery ratings are determined based on their own rating scale (1+ to 6). They focus exclusively on expected loss and recovery in the event of default, with no relationship to the underlying default likelihood of the borrower (i.e. corporate credit rating). Each recovery rating level is defined in terms of an expected recovery range, as outlined below.

RECOVERY RATING SCALE AND ISSUE RATING CRITERIA Issuers With A Speculative-Grade Corporate Credit Rating

Recovery rating*

Recovery description

Nominal recovery expectations

Issue rating notches relative to corporate credit rating

Highest expectation, full recovery

100%§

+3 notches

Very high recovery

90%-100%

+2 notches

Substantial recovery

70%-90%

+1 notch

Meaningful recovery

50%-70%

0 notches

Average recovery

30%-50%

0 notches

Modest recovery

10%-30%

-1 notch

Negligible recovery

0%-10%

-2 notches

*As noted above, recovery ratings in certain countries are capped to adjust for reduced creditor recovery prospects in these jurisdictions. Furthermore, the recovery ratings on unsecured debt issued by corporate entities with corporate credit ratings of ‘BB-’ or higher are generally capped at ‘3’ to account for the risk that their recovery prospects are at greater risk of being impaired by the issuance of additional priority or pari passu debt prior to default. Recovery of principal plus accrued interest at the time of default on a nominal basis. §Very high confidence of full recovery resulting from significant overcollateralization or strong structural features. 36 | FTA Outlook 2014

BANK LOAN AND RECOVERY RATINGS For issuers with a speculative-grade corporate credit rating Recovery ratings can be assigned to any syndicated bank loan for speculative-grade rated companies (‘BB+’ and below), whether it is secured or unsecured, in countries in which we have published an insolvency analysis. Issue-specific recovery ratings are becoming increasingly useful for lenders and borrowers as the syndicated bank loan market expands to include more institutional investors, and as lenders recognize the importance of quantifying default risk and loss-given-default separately. What’s the advantage of a bank loan rating? Bank loan ratings focus on both the risk of default and the likelihood of ultimate recovery in the event of default. The pure risk of default is captured in the traditional corporate credit rating, which focuses solely on the overall creditworthiness of the issuer. Bank loan ratings can help bankers substantiate the degree of extra protection that senior lenders may have above bondholders or other creditors. They may help expand a loan’s initial investor base, improve its secondary-market liquidity, and otherwise increase the comfort level of investors— especially institutional investors, specialized loanfund managers, and other buyers who may not be traditional lenders or do not have large internal credit staff numbers.

•

Providing an objective, third-party credit opinion for institutional investors, specialized loan funds, and other buyers that may not be traditional lenders or have large internal credit teams; Assisting bankers and other investors to determine the appropriate loss and recovery inputs into risk-adjusted return on capital and capital-allocation models;

•

Helping to expand a loan’s initial investor base and improve secondary market liquidity;

•

Enabling investors to differentiate and take advantage of pricing anomalies between welland less-well-secured loans;

•

Opining on senior lenders’ extra protection, compared with bondholders or other creditors; and

•

Opining on the relative protection afforded to investors of unsecured and subordinated debt of speculative-grade issuers.

Bank loan ratings could be especially valuable for: •

Leveraged and other complex credits;

•

Project and infrastructure loans; or

•

Any structured transaction in which collateral or other post-default protection provides a ‘second way out’ in the event of a workout or bankruptcy.

Who benefits from bank loan ratings? What value will a bank loan rating add? There are numerous benefits that a bank loan rating can provide as it may help bankers and investors gain a more precise pricing on syndicated loans by:

FTA Outlook 2014 | 37

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•

Bank loan and recovery ratings are likely to be most useful when obtained before the loan is syndicated, allowing syndicators and investors to incorporate the Standard & Poor’s rating and analysis into their structuring, distribution, and credit-decision process.”

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Cash Management Outlook

CASH MANAGEMENT: CONNECTING CORPORATES TO THE GLOBAL PAYMENTS SYSTEM INFRASTRUCTURE BY KEES MIDDENDORP MFTA, COMMERCIAL DIRECTOR, OCEANIA, SWIFT

Albert Einstein said, “Imagination is more important than knowledge”. As wise as the saying is, many corporate treasurers today are increasingly focused on attaining better knowledge. And they are finding that as globalisation evolves, the number of markets, financial systems, rules, regulations and technology that the corporate treasury function is exposed to continues to multiply. Moreover, recent stress on the Australian dollar and commodities markets has increased the challenge of handling volatility and associated risks. Additionally, the need for efficient trade confirmation and group cash visibility with real-time reporting often leads to internal structural changes in organisation or technology.

Reflecting Australia’s economic ties to the Asia Pacific region, more than 65% of trade transactions sent from Australia are directed to Asia Pacific destinations.” 38 | FTA Outlook 2014

When you add in the demand from internal and external customers to improve the management of an organisation’s financial supply chains – a trend that has not abated since the global financial crisis – the challenges of being in-the-know can seem quite daunting to a corporate treasurer. Fortunately, the financial services sector has been applying imagination to mitigate these challenges, particularly with regard to payments and reporting systems, standards, technology and practices. These critical enablers for high-level visibility and availability of cash are increasingly important in Australia, especially given that overseas markets offer significant opportunities for growth.

THE IMPACT OF GLOBALISATION Cash and liquidity management is particularly difficult for corporates doing business in emerging markets, where banking and reporting capabilities are often fully manual. Furthermore, access to information is difficult. Paying a supplier in a third-tier Chinese city, for example, can be an exacting task. Finding the beneficiary’s bank identification, business code or translating Chinese character sets requires access to a range of constantly evolving financial reference data. For Australian corporates, these challenges – including the need to do business in the Chinese currency – are becoming an implicit part of the daily routine. Within Asia Pacific, intra-regional Renminbi (RMB) trade settlement grew 67% in 2013, and four percent of these volumes are attributed to the China-Australia import corridor. The value of these payments is increasing as well, and the world is quickly adjusting to the fact that the RMB is now the second-most used currency for trade finance in the world. Reflecting Australia’s economic ties to the Asia Pacific region, more than 65% of trade transactions sent from Australia are directed to Asia Pacific destinations. China dominates, with 15% of Australia’s total trade transactions over SWIFT, topping the US as a partner in terms of daily volumes.

Innovation in trade finance: The Bank Payment Obligation

Australian corporate treasurers therefore find themselves dealing with multiple markets, multiple banks and multiple challenges, every day.

An important evolution in the trade space is the emergence of a new payment instrument â&#x20AC;&#x201C; the Bank Payment Obligation (BPO), which was launched by the

A COMMUNITY SOLUTION FOR CORPORATES, FROM SWIFT

International Chamber of Commerce and SWIFT in July 2013. The BPO is an irrevocable undertaking given by a bank to another bank that payment will be made at a specified date after successful electronic matching of commercial or transport trade data. The BPO, which is applied using SWIFTâ&#x20AC;&#x2122;s Trade Services Utility, improves upon existing solutions by combining the best of traditional trade finance with the flexibility of the open account. More than 50 trade

While there is no simple answer to address cash and liquidity management challenges, especially when they include international components, companies can achieve better reliability, operational efficiency and a simplified process by adopting a standardised SWIFT platform and SWIFT integration with their TMS, trade finance and ERP systems.

banks are already committed to BPO over SWIFT, as supporters such as ANZ call it a must-have for a banking leader in trade finance. For corporates, the BPO means that the pain of Letters of Credit is over and that the difficulties of counter-party risk and credit arising from open account are mitigated. Ask your bank about BPO over SWIFT today!

This is a solution created by the financial services industry to take pain and error out of the system. It allows banks to focus on delivering more value to their corporate customers. It allows corporates to move beyond treasury and risk management to a single platform for real-time cash and liquidity management, payments and collections, whether they are domestic or cross-border.

FROM MULTIPLE STANDARDS AND PROTOCOLS TO...

A SINGLE, SECURE, STANDARDISED GLOBAL PLATFORM

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Cash Management Outlook

“One Australian international energy sector company came to SWIFT specifically to drive straight-through-processing across their treasury’s back office, which until now has been largely manual and thereby prone to risk.”

The trend: ISO 20022 The shift to ISO 20022, the ISO standard for financial services messaging, is rapidly becoming reality in the financial world, including for corporates. The global shift is being driven by factors such as the launch of the Single Euro Payments Area (SEPA) and the broader adoption of the standard by financial market infrastructures. Adoption of richer financial standards using the XML syntax, such as ISO 20022, is particularly gathering pace in Asia. India, China, Japan and Brunei are implementing the new ISO standards in order to offer richer data from ordering to beneficiary customers. In Australia, where many local corporates are looking at increasing their overseas exposure, especially in the Asian markets, ISO 20022 is therefore becoming increasingly interesting. Rather than being locked into any of their banks’ proprietary systems, corporates can use ISO 20022 and other open standards to centralise

Help from the NPP In Australia, the banking

Using SWIFT brings benefits beyond treasury and liquidity management. The portfolio of leading transaction banks also includes more systematic identity management and trade services to streamline L/Cs, guarantees and open account trade transactions.

their treasury functions on a common “language” and therefore have more flexibility to adapt to new customers and new markets.

community is working with the Reserve Bank of Australia and APCA to introduce faster payment mechanisms. Labelled the New Payments Platform or NPP, this industry development

To address environmental concerns, large corporations like GE are adopting secure solutions to transmit banks statement electronically and are therefore lowering their carbon footprint with eStatements on SWIFT.

will see the introduction of a new payment system that will give individuals and corporates the ability to send payments from ADI to ADI in near-real time. Important for corporates, the payment instructions will be based on the ISO 20022 standard, which provides the

In Australia, more corporates are turning to SWIFT for gaining visibility on cash, optimising working capital and reducing operational risk. One Australian international energy sector company came to SWIFT specifically to drive straight-through-processing across their treasury’s back office, which until now has been largely manual and thereby prone to risk.

ability for much richer data to accompany the payment instructions. The reconciliation benefits for Australian corporates receiving payments from their

By moving to a new TMS and fully integrating with their three banks via SWIFT’s Lite2 solution, they will have an automated, scalable solution for F/X, payments and statements.

customers will be considerable.

Today, more than 1,000 corporates are connected to SWIFT, for a total of 30,000 40 | FTA Outlook 2014

corporate end points around the world, and the number is increasing rapidly. In fact, 18 of the top 25 Fortune 500 corporates are already on SWIFT, among them Toyota and Samsung in Asia. These companies are seeing tangible returns on investment and are bringing greater efficiency to their treasury operations. Corporate treasurers should feel better knowing that the financial services industry is using its imagination to help provide clear, secure, timely and accurate knowledge about the global financial position of their organisations.

RECENT TRENDS IN US CASH MANAGEMENT: LESSONS FOR AUSTRALIAN CORPORATIONS BY REBECCA DAWSON, DIRECTOR TREASURY & CAPITAL MARKETS, DELOITTE

how much cash is in the business right now’. Typically this was from the FD or CFO, however for some it came from the Federal Government who did not respond well to the answer ‘we don’t really know, give us a few days and we’ll get back to you’, especially where bail-out funds had been requested.

•

Real-time visibility of global cash balances;

1) lost earnings on inefficient cash;

•

Mobilisation and utilisation of idle cash;

2) inaccurate counterparty exposure reporting; and

•

Straight through processing; and

•

Cash forecasting beyond ‘today’.

It is worth exploring each of these and the inherent lessons for Australian Treasury teams.

CASH CONTROL AND VISIBILITY Without exception, every Treasury department I spent time in had received a simple question from senior management, namely: ‘Tell me precisely

Immediate action was required by these organisations and as the Treasury teams set out on their discovery mission, each found idle balances sitting in bank accounts, some of which they were unaware even existed. This reflected poorly on Treasury’s cash management processes for three reasons:

3) accounts being opened and managed independently of Group Treasury. There were a number of mechanisms implemented to mitigate these risks: 1. Treasury policy updated to detail the process for opening bank accounts/services to provide Treasury with control and ultimate ownership of all bank accounts, resulting in a reduction in counterparty exposure risk as all new accounts can only be held at approved banks. FTA Outlook 2014 | 41

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In mid-2013, a SWIFT and TMS implementation helped a global insurance group locate around 350 accounts with a combined balance of close to USD$25 million.”

In the six years since the economic meltdown put US-based financial institutions under considerable public and regulatory scrutiny, many corporations in the US have undertaken some level of Treasury transformation project in order to regain control lost in the crisis. Being based in the US for the past five years, I had a front row seat to this radical market shift and saw many similarities in Treasury future state requirements - no matter their size or industry. Similar goals, infrastructures, systems and regulation meant that every corporate treasury transformation project featured similar cash management goals, most notably:

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Cash Management Outlook

2. Bank and/or account rationalisation to gain efficiencies through consolidating concentration banks/activities, resulting in reduced fees; and

By mobilising bank account balances for use in daily positioning, one top 10 Fortune 500 corporation was lending an additional $120 million within the first month of going live.”

3. SWIFT and/or bank direct connectivity interfacing with the Treasury System to capture all bank account balances. This ensures complete liquidity reporting including for new accounts (which would automatically report upon being opened). In mid-2013, a SWIFT and TMS implementation helped a global insurance group locate around 350 accounts with a combined balance of close to USD$25 million. Adding these to the daily counterparty exposure dashboard was a great find in the first stage of a multi-year, global project. Gaining control of cash is seen as a quick win on all projects and delivering a speedy, quantifiable benefit in Phase 1 of longer term projects is invaluable in helping to garner added support to continue an ongoing transformation project.

MOBILISATION AND UTILISATION OF CASH Following the discovery of idle cash, the next step was to mobilise the funds and make them available for use within the group – a significant undertaking given the typically large number of banks, bank accounts and cash pools held in each continent. With all bank accounts now under treasury’s management, pooling structures were scrutinised to discover where and why cash was not being included in daily sweeping. This was typically a result of bank accounts being managed by the local office/branch and not through the global relationship which resulted in no link between accounts being established nor paperwork completed for inclusion in reporting/sweeping arrangements. This discovery phase was, for some organisations, the perfect opportunity to complete a long overdue review and tender of their cash concentration arrangements with the aim of finding new bank services as well as more 42 | FTA Outlook 2014

competitive fees. A US-based multinational overhauled their European bank accounts by implementing a multi-currency, cross border Zero Balance Agreement pool which enabled centralised management of their cash out of the USA. Others looked to cross-border notional pooling with virtual accounts held in the overlay bank or to late day offshore Money Mark Fund sweeps – both services provided for reduced bank transaction fees and an increase in interest earned as well as more efficient FX management of the now centralised cash. As new processes and cashpool structures were implemented, it was critical that every global account owner was advised of their requirement for compliance with the updated cash management policies, along with the consequences of non-compliance. By including these teams in wider project discussions, their

STRAIGHT THROUGH PROCESSING A great deal of work and significant benefits hide behind these three small words. Even though many treasury processes are simple, STP is critical in reducing risks around fraud and error as well as enabling more efficient use of staff time; system connectivity provides the tools to achieve these benefits. In order to transition from an operational focus to a strategic one, corporations sought to remove manual processes such as bank balance entry, bank interest/fee GL voucher creation, settlement instruction entry, and deal and payment re-keying from Excel or the system to bank/trading portal. This was achieved in each case through the use of new technology which in turn facilitated automated reporting, thus eliminating the need to export to and manipulate in external reporting programs. In conjunction with the Treasury System implementation, each client undertook connectivity with additional internal and external systems to achieve the goal of ‘as few touches as possible’. Some of the systems included:

involvement in the longer term transformation vision allowed them to take ownership for areas where they would be involved in the future, such as In-House Banking. Engaging both internal teams and external banking relationships early in the project proved critical to the success of the Treasury Transformation – knowing the impact of the changes helped people to adapt earlier and become involved in the project rather than opposing it.

Market data services to import prices, volatilities, instruments and credit ratings, allowing for faster trading, ‘what if’ analysis, and real time breach reporting;

•

FX and Money Market Fund trading portals to enable faster trading as well as automatic GL trade and interest accrual postings;

•

Trade confirmations through SWIFT, Misys or similar services using fully authorised and secured SSIs, greatly reducing settlement risk caused by delayed payments due to incorrect or incomplete SSIs;

•

Payment file delivery to banks in multiple formats, as well as ACK/NACK error messaging, removing the risk in the re-key or cut & paste of payment instructions into bank portals.

Creating an interface from the Treasury System to the accounting General Ledger system provides for one of the most quantifiable benefits of STP: passing vouchers to the GL as a new daily process

Creating an interface from the Treasury System to the accounting General Ledger system provides for one of the most quantifiable benefits of STP. ” FTA Outlook 2014 | 43

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By mobilising bank account balances for use in daily positioning, one top 10 Fortune 500 corporation was lending an additional $120 million within the first month of going live. Given historical interest rate lows, the additional revenue was less important than the control now taken over previously unknown exposures. This resulted in one very happy Treasurer.

•

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Cash Management Outlook

has reduced the Accounting Close period for one company from day 12 to day 2. They have now revised their system goal to a Day 1 close. One great lesson for all clients was that, due to the often complex interface requirements, the full involvement of the IT department is critical to project realisation given the insfrastructure, connectivity, testing and post go-live administration tasks. The collaboration between Finance and IT teams is vital to the success of any transformation project and the achievement of STP goals.

The recent financial crisis proved that, for the few companies that were forecasting both Operational and Financial cash requirements, knowing longer term cash availability was critical in better weathering the storm.” 44 | FTA Outlook 2014

CASH FORECASTING Historically, treasury cash forecasting has meant ‘late today, and maybe tomorrow if we have time’. The recent financial crisis proved that, for the few companies that were forecasting both Operational and Financial cash requirements, knowing longer term cash availability was critical in better weathering the storm. Planners generally came out better than those who had no idea of working capital requirements until they were happening, and the result is that cash forecasting has moved to the top of the table of Treasury to-dos. As the market has started its recovery, treasuries are realising the benefits of accurate forecasts through lower borrowing costs and transaction fees, reduced FX gain and loss volatility, and less counterparty and credit risk. Accurate forecasting models can also be used to influence other areas within the business to achieve both cost and time efficiencies, with some recent examples including:

•

Accounts Payable teams updating their standard processes to streamline payment flows after being shown just how much their ad-hoc, unforecasted payment runs were costing in both transaction fees and interest costs;

•

Global netting programs overhauled to make use of total cash in consolidated forecasts rather than guessing based on when, say, dividends were paid last year; this resulted in significant reduction in FX costs as all currency balances in the group were utilised in each netting cycle.

Cash forecasting typically takes the longest to get right and needs to be actively managed to ensure accuracy. For local teams who have never taken notice of cash outside of what’s in the bank account today, trying to form predictions based on events or cycles takes some practice and we are now in an environment where once predictable cycles can no longer be relied on. Simply looking at the annual budget is not sufficient, given the often wide anomalies between date earned and date received figures. Providing participants with clear procedures and tools for forecast submission allows Treasury to complete consolidation more expediently, and also allows them to be on top of their cashflows should some market change demand an immediate position update.

WHERE TO FROM HERE? Despite all the talk of recovery and promising signs of growth, many Corporate Treasurers are still wary of their role in this new environment. Some companies have been slow to react and whilst acknowledging their Treasury functions are in need of an overhaul, they are not yet convinced that Treasury Transformation is beneficial or necessary. Those who see the future in simplification and automation are well on their way to becoming thought leaders in the industry, not to mention being better placed under the conditions of a stressed market. Knowing how much cash you have and being able to use it effectively is more important than ever before. Being in this enviable position will go a long way in making Treasury indispensible.

Trade Outlook

DIFFERENCES MATTER BY GORDON SPARROW, EXECUTIVE DIRECTOR OF TRADE AND SUPPLY CHAIN FINANCE / FI SALES, WESTPAC INSTITUTIONAL BANK

John F Kennedy frequently borrowed the idiom, “a rising tide lifts all boats” - a view that had application in the largely homogenous and synchronised western economies of the early 1960’s.

What does Australian business need to do in order to ride this rising tide of globalisation? Do differences really matter and what strategies should business adopt to compete on difference in a rapidly changing global environment? Countries and firms compete for value and a value advantage arises when a provider delivers more value to a consumer, at a given cost, relative to a competing provider. As physical and financial supply chains converge and become increasingly interconnected, forces of competition intensify. Tomorrow’s treasurer faces the challenges of choosing how to achieve this

MAKING DIFFERENCES MATTER IS A SIMPLE FORM OF ARBITRAGE. Most treasuries have well developed financial arbitrage strategies, developed over time and aligned to the ever shifting dynamics of global financial markets. The rising tide of technology has however exposed market participants to other differences and unintended consequences of globalisation, brought about by the variable rate of adoption and change of the structure of the global market place. These differences bring alternative arbitrage opportunities, such as Labour Arbitrage, Regulatory Arbitrage, Ratings Arbitrage and Jurisdictional Arbitrage. A little like the “impossible trinity” or “trilemma” in which central banks juggle Fixed Exchange Rates, Free Capital Flows and Independent Monetary Policy - in a relationship where all three of the policy objectives mentioned above cannot be pursued simultaneously - it is unlikely that firms FTA Outlook 2014 | 45

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Despite the regulatory imposts on banks’ funding, we believe bank loans will continue to dominate the region’s corporate financing landscape, despite the growing reliance on capital markets.”

The rapid surge of technology-enabled global connectivity has however led to a greater inequality and increased competitive tension higher than what the early architects of globalisation envisaged. Today’s reality is perhaps best described by Gene Sperling (Bill Clinton’s former economic advisor and currently the Director of the National Economic Council in the Obama government), when he expressed the view, “that in the absence of appropriate policies, the rising tide will lift some boats, but others will run aground”.

relative value advantage. Recognising drivers of cost and developing strategies to create advantage, will be high on the corporate agenda. For corporate Australia to be a leader in the coming century, it needs to understand and adapt to a new context. Global competence, in the face of unprecedented change, increasing complexity and global mobility, includes leveraging differences to achieve advantage.

y = 1.2232x + 80.548

Trade Outlook

A – BB (Linear)

y = 0.9286x + 54.238

A – BBB

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(Linear) y = 0.2946x + 26.31

BBB – BB

be r1 3

Se pt em

ar ch

be r1 2

ec em D

12 y ar Fe br u

ct ob er 11

ar ch M

ec em

be r1 0

9 Fe br u

ct ob er 0

0 y ar nu Ja

8 0 ne Ju

y ar nu Ja

(Linear)

The evolution of the physical and financial supply chains will see them converging over time

THE EVOLUTION OF THE PHYSICAL AND FINANCIAL SUPPLY CHAINS WILL SEE THEM CONVERGING OVER TIME Supply Chain management

Computerisation

gets a name in 1982

and ERP’s

The Internet

E-Commerce

BPO, Bolero,

and EDI

ISO 200022

Specialisation

Globalisation

Integration

Buyer pull channels open

Customers start to influence the supply chain and pull forces develop (CISCO) Inventory push dominant (WalMart)

Sell side logistics gain prominence

Start Outsourcing and 3rd Party Logistics

Cost of Legislation

Cost of Legislation 10 9

Labour Cost 10 9 8 7

Labour Cost 10 9

Labour Cost

Figure 1 Cost of Legislation

Cost of Legislation

Cost of Legislation 10 9

Labour Cost 10 9 8 7

Labour Cost 10 9

Labour Cost

10 9 8 10 7 69 58 47 10 36 9 25 814 273 6 32 51 4 4 52 633 724 815 926 37 10 48 59 6 10 7 8 10 9 9 10 8 7 10 69 58 47 10 36 9 25 814 273 6 32 5 4 1 4 52 633 724 815 926 3 10 7 4 8 5 9 6 10 7

1956 to 1990

1990 to 1996

Ratings Cost 3

7 8 9 10 Ratings Cost

Ratings Cost 8

Cost of Legislation

Perhaps the most publicised consequence of globalisation has been the rise, up the value chain, of labour arbitrage, in the wake of advances in technology and the lowering of barriers to international trade. As the movement of goods and information becomes more efficient, producers move their production to locations where labour and the cost of doing business is less expensive than in the target markets for the goods and services in which they trade.

Ratings Cost 2

7 8 9 10 Ratings Cost

Cost of Legislation

8 10 9 9 Cost of Legislation 10 Figure 2 8 7 Cost of Legislation 10 6 9 5 48 Ratings Cost Cost of Legislation 10 37 9 26 10 9 8 7 6 5 4 3 2 815 2 3 4 5 6 7 8 9 10 274 Ratings Cost 6 33 Labour Cost 52 4 10 9 8 7 6 5 4 3 2 4 51 2 3 4 5 6 7 8 9 10 Ratings Cost 632 Labour Cost 723 10 9 8 7 6 5 4 3 2 814 2 3 4 5 6 7 8 9 10 5 92 36 Cost of Legislation 10 Labour Cost 47 58 69 10 7 Cost of Legislation 8 Cost of Legislation 10 9 9 Cost of Legislation 10 8 7 Figure 3 Cost of Legislation 610 59 48 Ratings Cost Cost of Legislation 10 37 26 9 5 2 3 4 5 6 7 8 9 10 10 9 8 7 6 5 4 3 2 1 8 46 | FTA Outlook 2014 274 Ratings Cost 33 6 Labour Cost 4 52 Cost of Legislation

Financial Supply Chains

Rolls sells as agent for Royce

can compete on all four differences and so the challenge is to identify the greatest drivers of value with the least risk. 2

Physical Supply Chain

Warren Buffet explores 3rd Party Logistics

1904 to 1956

Cost of Legislation

Gap between the Physical Supply Chain and the Financial Supply Chain is a cost Expressed as the time value of money

As producers follow cheaper labour markets, prosperous nations such as Australia with high labour costs, remove barriers to international trade. In isolation, shifting cost of production from an $8 - $9 per hour market to a $2 - $3 per hour achieves an immediate saving to the producer of $6 per hour Cost of Legislation 10 9 (see Figure 1). 8 7 10 6 9 5 48 Ratings Cost Cost of Legislation 10 37 296 10 9 8 7 6 5 4 3 2 8 1 5 2 3 4 5 6 7 8 9 10 274 Ratings Cost 363 Labour Cost 452 10 9 8 7 6 5 4 3 2 54 1 2 3 4 5 6 7 8 9 10 Ratings Cost 632 Labour Cost 723 10 9 8 7 6 5 4 3 2 81 4 2 3 4 5 6 7 8 9 10 5 92 36 Cost of Legislation 10 Labour Cost 47 58 69 710 Cost of Legislation 8 Cost of Legislation 10 9 9 Cost of Legislation 10 8 7 Cost of Legislation 610 59 48 Ratings Cost Cost of Legislation 10 37 296 10 9 8 7 6 5 4 3 2 8 1 5 2 3 4 5 6 7 8 9 10 274 Ratings Cost 363 Labour Cost 452

Cost of Legislation

This strategy however exposes the producer to risks, over time, of upward wage pressure in the cheaper market. Labour markets are fluid and so we see Australian manufacturers moving production offshore at the same time as selected American corporations are on shoring their production, indicating that whilst labour arbitrage can drive value, adopting an offshoring strategy in isolation is not sustainable. The combinative effect of cost drivers needs to be balanced.

1996 to 2000

2000 to 2007

2008 and beyond

If the early 2000’s was characterised by rapid advances in technology, the post GFC era might be regarded as the era of regulation. Taking advantage of the differences between economic and regulatory capital, as well as the national differences in interpretation and variable rates of adoption and change in regulation, provides opportunity for a company to achieve regulatory arbitrage by choosing a nominal place of business with a regulatory, legal or tax regime with lower costs. The Australian financial system reflects the value of early and stringent adoption of financial regulation and this is reflected in its well rated and attractive banking and financial markets infrastructure. This however comes at a higher cost of capital and liquidity than in other key markets in which Australian businesses compete and so producers either need to be able to offset this cost in their own market or move to markets in which the cost of regulation is lower. This applies not only to the elements such as the translation cost of capital in the financial sector, but is equally true of aspects such as tax rates, cost of environmental controls, etc. Once again, a shift from high ($8 - $9 / unit of production) cost locations to regions where the cost of regulation is lower ($4 - $5 per unit of production) represents and immediate cost saving of $4 per unit of production (see Figure 2). Following the rapid changes in regulation and the related rising capital cost for financial institutions,

Trade Outlook Cost of Legislation

10 9

Labour Cost

AVERAGE MARGIN MOVEMENT BY RISK GRADE 2007 – 2013 Average Margin Movement by Risk Grade 2007 – 2013

10 9 8 7 6 5 4 Ratings Cost 3 2 2 1 2 3 4 5 6 7 8 9 10 2 3 4 5 6 7 8 9 10 Cost of Legislation

Cost of Legislation

y = 1.2232x + 80.548

10 9

Labour Cost A – BB (Linear)

y = 0.9286x + 54.238

A – BBB

10 9 8 7 6 5 4 Ratings Cost 3 2 2 1 2 3 4 5 6 7 8 9 10 2 3 4 5 6 7 8 9 10 Cost of Legislation

(Linear) y = 0.2946x + 26.31

BBB – BB

10 9

Labour Cost

10 9 8 7 6 5 4 Ratings Cost 3 2 2 1 2 3 4 5 6 7 8 9 10 2 3 4 5 6 7 8 9 10 Cost of Legislation

10 9

Labour Cost

Cost of Legislation

2 51 2 3 4 5 6 7 62 37 4 8 5 9 6 Cost of Legislation 10 7 8 9 10 Cost of Legislation

Cost of Legislation

10 9

Labour Cost

Ratings management has taken on a new focus and SO, IN A RAPIDLY CHANGING GLOBAL Integration ENVIRONMENT, DO DIFFERENCES with it has come the awareness of how to leverage Buyer pull Customers start to influence the supply MATTER? differential ratings of suppliers and buyers in the channels open chain and pull forces develop (CISCO) Gap between the Physical Supply Chain supply chain. This ratings arbitrage allows treasurers and the Financial Supply Chain is a cost Cost of Legislation 10 Inventory push dominant (WalMart) 9 Expressed as the time value of money Sell side logistics Chain to develop strategies that not only help to manage A marginally rated firm, basedPhysical in 8a Supply highly Warren Buffet explores 3rd Party 7 gain prominence Financial Supply Chains Cost of Legislation 10 Logistics 6 the risk associated with their own rating, but opens regulated, high labour cost market 9 5 that adopts 8 4 Rolls sells as agent for Royce Outsourcing and 37 theStart door to leverage the gap between buyer and appropriate strategies can significantly alterRatings itsCost 62 3rd Party Logistics 10 9 8 7 6 5 4 3 2 51 2 3 4 5 6 7 8 9 10 supplier risk grades. Increasingly suppliers are looking cost base (Green overlay) by executing strategies 4 2 Ratings Cost 3 Labour Cost 1956 1956 to 1990 1990 to 1996 1996 to 2000 2000 to 2007 2008 and beyond 2 to gain advantage1904 bytoleveraging more highly rated that exploit the difference in markets and enable it 4 10 9 8 7 6 5 4 3 2 51 2 3 4 5 6 7 8 9 10 62 buyer’s risk grades through receivables finance to ride the rising tide of globalisation (see Figures 37 Labour Cost 4 8 structures and buyers seek to use their ratings to 5 and 6). 5 9 6 Cost of Legislation 10 7 achieve term and other relief from less well rated 8 9 suppliers, through supplier finance programmes (cost 10 Cost of Legislation Cost of in Legislation 10 of debt moves from $7 - $8 to $4 - $5) (see Figure 3). Note: (i) Cost base examples this article are for 9 8 illustrative purposes only. The views expressed in this 7 Cost of Legislation 10 article are those of the author. (ii) On 695an illustrative scale of 1 (low cost) to 10 (high cost), firms 4837are able to adjust Ratings Cost 62 their overall cost footprint by adopting strategies that 10 9 8 7 6 5 4 3 2 51 2 3 4 5 6 7 8 9 10 4 2 leverage the differences in labour, regulatory, ratings Ratingsand Cost 3 Labour Cost 2 4 legislative costs in diverse 10 9 8 7markets, 6 5 4 3 relative 2 51 2 3 4to5 their 6 7 8home 9 10 62 / target markets. Typically to keep one 37 Labour Costfirms will seek 4 factor constant, e.g. move production 985to a geography 6 Cost of Legislation 10 with a similar legal framework to the home country. The 7 8 final illustration highlights a lower cost9 footprint, achieved 10 Cost of Legislation by lowering labour, regulatory and ratings costs in an equivalent legislative environment.

10 9 8 7 6 5 4 Ratings Cost 3 2 2 1 2 3 4 5 6 7 8 9 10 2 3 4 5 6 7 8 9 10 Cost of Legislation

10 9

Figure 4

Cost of Legislation

10 9 8 7 Cost of Legislation 10 6 9 5 8 4 37 62 10 9 8 7 6 5 4 3 2 51 4 2 3 Labour Cost 2 4 10 9 8 7 6 5 4 3 2 51 62 37 Labour Cost 4 8 5 9 6 10 7 8 9 Figure 5 10

Ratings Cost 2

Cost of Legislation

10 9 8 7 Cost of Legislation 10 6 9 5 8 4 37 62 10 9 8 7 6 5 4 3 2 51 4 2 3 Labour Cost 2 4 10 9 8 7 6 5 4 3 2 51 62 37 Labour Cost 4 8 5 9 6 10 7 8 9 10

Ratings Cost 2

Cost of Legislation

Figure 6

FTA Outlook 2014 | 47

Labour Cost

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Globalisation implies multiple jurisdictions and so it comes as no surprise that discrepancies between competing legal jurisdictions can lead to jurisdictional arbitrage. The cost of transacting in different legal jurisdictions can differ vastly. Aspects such as unrestricted emigration and liquidity of assets can significantly lower the cost of exiting a particular jurisdiction and therefore drive relocation decisions.

Labour Cost

Ratings Cost

corporate treasuries are faced with the risk of Similarity in legal systems can also act as an The evolution of the physical and financial supply chains will see them converging over Cost of Legislation increasingly steep borrowing cost curves as anchor for globally mobile firms that seek to limit Cost of Legislation 10 9 business move up and down the risk rating matrices. their risk to uncertain legal environments and so 8 7 Supply Chain management Computerisation The Internet E-Commerce Cost of Legislation BPO,10 As risk ratings deteriorate, the comparative cost of firms will often locate to markets 6Bolero, with similar legal gets a name in 1982 and ERP’s and EDI ISO 200022 9 5 8 4 debt has increased disproportionately over time, jurisdictions as their home market, to anchor their Ratings Cost 37 62 making Specialisation the borrowing cost of a ratings downgrade risk (see Figure 4).10 9 8 7 6 5 4 3 2 51 2 3 4 5 6 7 8 9 10 4 2 Ratings Cost 3 Labour Cost in 2013, much higher than in 2007. 2 4 Globalisation

10 9

pt em

Ratings Cost

ec em

ar ch

11 er ct ob O

10 9 8 7 Cost of Legislation 10 6 9 5 8 4 37 62 10 9 8 7 6 5 4 3 2 51 4 2 3 Labour Cost 2 4 10 9 8 7 6 5 4 3 2 51 62 37 Labour Cost 4 8 5 9 6 10 7 8 9 time 10

Fe b

11 M

ar ch

0 be ec em D

9 0 y ar ru Fe b

er ct ob O

8 0 Ju

(Linear)

Cost of Legislation

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Tax Outlook

TAX STORM CLOUDS FOR THE FINANCE INDUSTRY BY CHRIS KINSELLA, PARTNER AND STEPHEN JONES, SPECIAL COUNSEL, TAX CONTROVERSY, MADDOCKS

In the 1980’s and 1990’s tax based financing was an active and recognised industry. But the ATO and the Government got smarter and today much greater care is required with financing arrangements, particularly where they involve related parties and particularly where they are cross border. More recently new storm clouds on the tax front are emerging for the finance industry. Group treasurers, CFO’s and senior finance managers may find that what has worked in the past may not work in the future. In late January 2014, even the Prime Minister has joined this tax debate (where normally tax matters are left to the Treasurer or Assistant Treasurer).

THE STORM ITSELF In late November 2013, the ATO indicated that it was increasing its focus on the following areas: •

Debt push down and excessive interest arrangements;

•

Tax arbitrage via hybrid entities and hybrid instruments;

•

Base erosion via related party leveraging;

•

Migration of intangibles and intellectual property offshore;

•

Creation of offshore hubs;

•

Tax effective supply chains; and

•

Tax treaty abuse.

The ingredients for this tax storm are as follows:

Group treasurers, CFO’s and senior finance managers may find that what has worked in the past may not work in the future.” 48 | FTA Outlook 2014

•

Post GFC government deficits;

•

The rise of the digital economy and growth of the internet;

•

A tax system built on foundations with jurisdictional and source limitations;

•

Recent publicity for various global groups of their low tax bill;

•

Australia’s presidency of the G20 in 2014.

In part, the ATO’s increasing interest in these areas is driven by new transfer pricing legislation which came into effect from 1 July 2013. In essence, the old transfer pricing provisions took a “transactions based approach” where the new transfer pricing provisions take a “profits based approach”. This change in focus means that if the ATO believes that a taxpayer’s Australian taxable profits are too low and this is attributable in whole or part to related party

dealings on non-arms-length terms, then the Commissioner may use the new transfer pricing provisions to impose arms-length terms and increase Australian taxable profits. In addition to the new Australian transfer pricing provisions, there is an increase in focus of governments on “base erosion and profit shifting” (BEPS). Governments are concerned that “as businesses increasingly integrate across borders and tax rules often remain uncoordinated, there are a number of structures, technically legal, which take advantage of asymmetries in domestic and international tax rules” In September 2013, a meeting of the G20 identified 15 actions to address BEPS. Australia is at the vanguard of these actions through its presidency in 2014 of the G20. Another trend worth noting is that the ATO is strengthening its data collection activities. It has recently developed a “reportable tax positions” schedule where certain large taxpayers are required to disclose their uncertain tax positions. The ATO is also engaged in more pre-lodgement compliance reviews of taxpayers and has strengthened the international dealings schedule of the annual tax return.

SHELTERING FROM THE STORM What does this mean for you, the CFO, group treasurer or senior finance manager? Step one is to accept that the world has changed and is changing – what has worked in the past may be questionable now.

You should test your related party interest rates, guarantee fees, service hub charges, management fees, royalty charges, etc. What can you prove if the Commissioner wants to take you to court?

Finally, one should note that it is not just Australia that has become more active in this area. For example, India has recently become particularly active in the field of transfer pricing including taking a number of taxpayers to court.

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Step two should be to obtain some independent, objective advice from someone who was not involved with establishing or advising on the cross border related party transactions and financings and who knows what the latest ATO thinking on these topics is.

Step three should be to document what you have done and why you are comfortable with it. Even if you are ultimately wrong, such documentation assists to keep penalties down. But the documentation needs to be relevant and ideally have evidential value if a tax dispute were to end up in court.

So taxpayers should be careful that in reducing Australian tax risk, they do not trigger a foreign tax exposure. At least Australian tax generates Australian franking credits, foreign tax does not. FTA Outlook 2014 | 49

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Debt Markets Outlook

CORPORATES REACH FUNDING NIRVANA AS 2014 DEBT MARKET COMPETITION HEATS UP BY BRAD SCOTT, HEAD OF CORPORATE BOND ORIGINATION, NAB

Australian corporate treasurers have good reason to be optimistic as they plan their 2014 funding programs knowing that balance sheets are in solid shape and debt markets are firing on all cylinders, with the real dilemma being whether they really need new debt and if so, which market to choose.

The pull-forward effects of the strong debt market conditions seen in 2013, notably in the fourth quarter of last year will likely have the impact of dampening the strength of the 2014 supply pipeline, at least until the end of the 2014 financial year.” 50 | FTA Outlook 2014

Getting to this 2014 ‘funding nirvana’ is the result of multi-year efforts to bullet-proof balance sheets, via the funding strategies they have adopted, which have diversified funding sources and extended debt maturity profiles via the global debt capital markets. This, combined with a lack of recent acquisition activity and capital expenditure constraint, now sees corporate balance sheets under-geared with the debt financing requirements for 2014 manageable and ostensibly modest. As evidence of this, Reserve Bank of Australia business credit numbers suggests corporate lending is tracking around the levels last seen in 2009 . The combined effect of these factors will most likely temper aggregate new corporate debt funding needs and activity, at least in early 2014.

SUPPLY PIPELINE ERODED BY STRONG PRIOR YEAR ISSUANCE The pull-forward effects of the strong debt market conditions seen in 2013, notably in the

fourth quarter of last year will likely have the impact of dampening the strength of the 2014 supply pipeline, at least until the end of the 2014 financial year. Additionally, from a supply perspective, the steady stream of financing activity seen in recent years could take a toll on the transaction pipeline for 2014. 2013 for example was a banner year across the debt capital and loans market, but ‘like borrowing from Peter to pay Paul’, partial pre-financing of 2014 maturities may stymie funding activity levels this year. Equally, 2013 saw around $100B of syndicated loans printed from Australian corporates, with a massive $50B transacted late in Q4 alone, and already follows the peak year of debt financing seen in 2012.

STRONG INVESTOR DEMAND AMID ELEVATED DEBT MARKETS COMPETITION For those corporates looking to access debt markets, they will be pleasantly surprised to see the heightened level of competition across an increasingly wide array of debt market options. In turn, this scarcity factor should ensure that quality issuers who do undertake financings, will receive a strong reception from bank and bond financiers. Tight credit spreads, continued low base interest rates, and a growing local and global pool of bond investors that are emerging,

set the scene for issuers to be strongly placed to achieve strong deal outcomes in the year ahead.

that of 2012 when 5 year issuance dominated (53% of A$ corporate bond supply).

Banks remain eager to lend, but capital markets including the A$ corporate bond market, USPP market and Euro markets are all offering some of the most aggressive pricing outcomes seen since before the Global Financial Crisis (GFC), boding well for competitively priced transactions throughout 2014.

The visible effect of this was indeed most evident in 2012 as short-dated 3 year bank loans minted post the GFC, were refinanced increasingly in the capital markets. In the past two years in fact, 30% to 40% of corporate debt financing has found its way towards debt capital markets, more than 3 fold than was printed in 2007 (see Fig 1).

Against the backdrop, the top 5 key themes for 2014’s debt markets outlook are as follows: (1) Continued shift towards tenor provided by debt capital markets

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2007

2008

2009

2010

2011

2012

2013

Source: Bloomberg, NAB Corporate Debt Markets Origination

Loans Bonds - Offshore Bonds - Domestic

Domestically, 7year issuance has become the ‘new sweet spot’ for investors from 5yrs, accounting for 40% of issuance in 2013, double

No. of Total Bonds

FTA Outlook 2014 | 51

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Recent changes in funding strategy towards debt capital markets should gain further momentum in 2014 based on the trend of corporates issuing inaugural and repeat transactions. A key part of this has been a clear issuer preference to target longer maturities, while investors have also obliged by showing strong appetite to buy longer-dated maturities across all markets. In the USPP market, life insurer bond investors remain willing to often lend out to 15 years and beyond, while in the Euro market maturities out to 10 years will be popular, and in the Sterling market 24% of issuance in 2013 was seen beyond 30 years.

FIG 1: CORPORATE LENDING: UPWARD TREND IN BOND V LOAN RATIO

(Bond vs Loan)

TOP 5 THEMES FOR 2014

Validating this view for the year ahead, NAB’s survey of funding approaches expected to be used by attendees of the FTA’s 2013 11 Congress last November, showed a solid 93% of respondents expected to use debt capital markets more in 2014 (42%) or at the ‘Same’ level (51%) as in 2013. Considering that the local medium term note market (MTN) for example, saw a record 16 debut corporate issuers print deals in 2013 alone, this speaks loudly to the funding trends that lay ahead.

% of Aust corporate issuance volume

To that effect, capital expenditure requirements notably around the infrastructure, resources and energy sectors will continue to look for debt funding solutions across different currencies and tenors. Similarly, the flow-on funding requirements stemming from mildly rising merger and acquisition activity in property, consumer and infrastructure, utility sectors, combined with financings related to new and previous government asset privatisations could also see debt financing activity increasing later in 2014.

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Debt Markets Outlook

FIG 2: CAPITAL MARKET USAGE: 93% EXPECT TO MAINTAIN OR INCREASE THEIR USE OF CAPITAL MARKETS

Does your firm expect to use debt capital markets more, less or the same to diversify your funding in 2014?

More 42% More 42% Less 7% Same 51%

Same 51%

Less 7% Source: NAB Proprietary Survey FTA 2013 Congress Participants, November 2013

FIG 3: CORP DCM USAGE IS RISING, WITH A$MTNS GROWING THE FASTEST A$BN

A$MTN

EMTN

USPP

35% 19% 13% -16%

2010

2011

2012

(4) RENAISSANCE OF THE DOMESTIC CAPITAL MARKETS Global Corp Debt Markets CAGR 9% since 2009

2013

Source: Bloomberg, NAB Corporate Debt Markets Origination

(2) FUNDING DIVERSIFICATION IS AN EVOLVING THEME Funding diversification remains high on the agenda of many treasurers. What has changed for 2014 is that increasingly many corporates are looking to issue in one, two, or more debt capital markets to target issuance sweet spots. We expect issuers to continue to explore multiple markets to discover where opportunities to term out debt, be they in a private placement or public style format in local and offshore currencies. In doing so, issuers are ensuring they maintain funding headroom and ample excess capacity in key markets in a trend that is particularly relevant for issuers with material debt funding requirements. 52 | FTA Outlook 2014

2013 marked an inflection point for a wide array of Australian corporates seeking to access debt capital markets, notably triple B rated entities who were able to access longer tenors and capital markets for the first time. In the Australian corporate bond market, 37% of issuance was BBB rated, almost 3 fold the proportion recorded in 2011.In the USPP market, 67% of 2013 issuance was triple B equivalent. Local and offshore investors remain yield focused and more willing than in prior years to invest further down the curve, in part due to a chase for yield and also as they seek to diversify their own investment portfolios. Given the stable outlook for credit quality, investors are even starting to show a preference for lowerâ&#x20AC;&#x201C;rated issuance to enhance their returns to offset the dampening effect of low overall global interest rate settings.

144A

70 60 50 40 30 20 10

2009

(3) STRONG INVESTOR DEMAND FOR BBB RATED CORPORATES AND YIELD

Australian corporates maintained a healthy diversification into global capital markets this year, but with more reliance on the A$ MTN market: ~28% of global capital market issuance was into the domestic market in 2013 compared to 20% last year. The popularity of the domestic market in 2013 means that this was the biggest debt capital market used by Australian corporates last year. Against the backdrop of very competitive offshore markets, we expect the trend to broadly continue in 2014, with the local market on a hat trick to potentially achieve its 3rd double digit primary corporate volume outcome this year. This highlights the strength of the market and its ability to provide competitive pricing, volume and tenor and the chances of follow on issuance from the many debut issuers of the past 2 years. If we had to pick a sector likely to feature in 2014, it is likely to be infrastructure and utility financing which has in recent years received much publicity. 2013 marked an inflection point

for that supply to start to emerge across capital markets and this trend should continue based on the capital expenditure plans of the airport, port, toll road and rail sectors. After accounting for zero percent of the A$ corporate bond supply pie in 2012, infrastructure financing accounted for 27% of issuance in 2013. We expect this trend to continue over 2014, and be augmented also by the recurrent network augmentation capital expenditure needs of the utility sector.

(5) GROWING OFFSHORE DEBT INVESTOR INTEREST IN AUSTRALIAN CORPORATES The strong credit quality of many larger Australian corporates continues to draw material investor attention from offshore, notably Asia and the Northern Hemisphere to participate in debt transactions in a trend that will prevail in 2014. While Australian corporates have a long and positive reputation as quality issuers offshore, this trend has stepped up in recent years. Whether it be bond investors from Hong Kong, the US or Europe, or bank lenders in Taiwan, interest will remain strong for Australian corporate issuance in 2014, as these investors seek diversification across international boundaries. We have seen in medium term note (MTN) transactions, Asian interest tending towards 30% to 40% of some order books, providing extra price tension and volume to order books. As tangible evidence of this, in October 2013 National Australia Bank (NAB) published a FinanceAsia/NAB survey of Asian debt investor expectations which showed 74% of respondents intended to increase their allocations to Australian and New Zealand corporates. Similarly, a significant 76% of investor respondents indicated they include Australia as part of their Asian portfolio investment strategy.

The 2014 funding outlook for corporate treasurers is as positive as it has been in years, with all debt markets offering competitively priced debt across different tenors, with capital seemingly abundantly available.

EMTN

A$MTN 16%

25%

EMTN 35%

USPP 11%

144A 48%

144A 17%

2009 A$24B * Excludes BHP Billiton’s US$5B issuance

A$MTN 35%

USPP 13%

2013 A$34B* + Includes Maple

Source: Bloomberg, NAB Corporate Debt Markets Origination

“Australian corporates maintained a healthy diversification into global capital markets this year, but with more reliance on the A$ MTN market: ~28% of global capital market issuance was into the domestic market in 2013 compared to 20% last year.” Competition between markets has also stepped up markedly at the start of the year, while attractive bank pricing will present issuers with the challenge of getting the bank/bond mix right at a time when base rates have started to trend upwards. Issuers should nevertheless avoid the risks of complacency, and note the risks associated with an expected focus on tapering as it affects market confidence, access and pricing, particularly given the unnerving emerging market unwind experience of mid 2013. Pleasingly though corporate Australia is well funded and is the beneficiary of funding diversification strategies put in place in prior years, with the only question for 2014 being, whether they will really need debt capital or not?

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CONCLUSION

FIG 4: AUSTRALIAN CORPORATES CONTINUE TO DIVERSIFY, AS A$ MTNS DOUBLE SHARE SINCE 2009

FTA Outlook 2014 | 53

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2014 FTA Partner Directory 360T Contact | Sally O’Keefe Phone | +61 3 8610 6676 Email | sally.okeefe@360t.com Website | www.360t.com 360 Trading Networks, based in Frankfurt/Germany, is one of the leading global providers of web-based trading technology for OTC financial instruments, particularly currency exchange, short term money market loan/ deposits and interest rate derivatives. Based on its proprietary core technology, 360T’s platform is offering a deep liquidity of more than 125 global and regional market makers used by over 1500 client organizations worldwide. The company offers also a professional white-label trading technology for electronic trading services to a closed group of users on a proprietary branded platform. 360T has a global presence with customers and offices in America, Asia-Pacific and the Middle East.

Aon Australia Contact | Colin Hay Phone | +61 2 9253 7694 Email | colin.p.hay@aon.com Website | www.aon.com.au Aon is Australia’s leading insurance broking, risk consulting, people and reinsurance firm, providing solutions to all sectors of Australian business. Through our more than 3,000 colleagues in Australia and New Zealand, and 26 regional branches, Aon has the local expertise to match our Global reach and help deliver the business results you are looking for. As an Aon client, you will benefit from our experience, market leverage and depth of resources not available anywhere else from a single source. We offer you market-leading client advocacy and contestability to ensure the most effective protection of your business, your assets and your people.

Goldman Sachs Asset Management Contact | Birgit Haas Phone | +61 3 9924 0571 Email | birgit.haas@gs.com Website | www.gs.com Goldman Sachs Asset Management (GSAM) is one of the world’s leading investment managers with over 1,900 professionals across 32 locations worldwide, including Sydney and Melbourne. GSAM provides institutional and individual investors with investment and advisory solutions across all major asset classes, industries, and geographies. The GSAM Global Liquidity Management team has been providing liquidity solutions for over 30 years with a wide range of pooled vehicles and separately managed accounts available in seven major currencies, including AUD. Data as of 30 September 2013. GSAM leverages the resources of Goldman, Sachs & Co. subject to legal, internal and regulatory restrictions.

KPMG Contact | Kevin Smout Phone | +61 8 9263 7105 Email | ksmout@kpmg.com.au Website | www.kpmg.com.au KPMG provides a holistic approach to risk to help our clients’ risk framework align to their business agenda, especially as people prepare to drive growth into their business based on increasing business pressures. We work to protect and enhance business value by helping our clients reduce risk, cut costs and improve business performance. To us, risk and compliance is more than a box-ticking exercise, it is a critical investment that can underpin an organisation’s long-term growth, value and sustainability. Our experienced, risk and compliance professionals offer timely and practical advice, drawing on KPMG’s risk services including Financial Risk Management.

54 | FTA Outlook 2014

Moody’s Investors Service Contact | Paul Ovnerud-Potter Phone | +61 2 9270 8115 Email | paul.ovnerud-potter@moodys.com Website | www.moodys.com Moody’s Investors Service is a leading provider of credit ratings, research, and risk analysis. The firm’s ratings and analysis track debt covering approximately 115 sovereign nations, 10,000 corporate issuers, 22,000 public finance issuers and 82,000 structured finance obligations. Moody’s was voted as “Asia’s Most Influential CreditRating Agency” in the 2013 FinanceAsia poll, as well as the “Best Credit Rating Agency” in both the Asiamoney and Institutional Investor US polls for two consecutive years -- 2012 and 2013. Moody’s Investors Service is a subsidiary of Moody’s Corporation (NYSE: MCO), which employs approximately 8,300 people worldwide and maintains a presence in 31 countries.

Reval Contact | George Chapman Phone | +61 2 9224 5905 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. The scope and timeliness of the data and analytics we provide allow chief financial officers, treasurers and finance managers to operate more confidently in an increasingly complex and volatile global business environment. Reval is headquartered in New York with regional centers across North America, EMEA and Asia Pacific.

Standard & Poor’s Ratings Services Contact | Daniel Antman Phone | +61 3 9631 2145 Email | daniel.antman@standardandpoors.com Website | www.standardandpoors.com.au Standard & Poor’s Ratings Services, part of McGraw Hill Financial (NYSE:MHFI), is the world’s leading provider of independent credit risk research and benchmarks. We publish more than a million credit ratings on debt issued by sovereign, municipal, corporate and financial sector entities. With over 1,400 credit analysts in 23 countries, and more than 150 years’ experience of assessing credit risk, we offer a unique combination of global coverage and local insight. Our research and opinions about relative credit risk provide market participants with information and independent benchmarks that help to support the growth of transparent, liquid debt markets worldwide.

SunGard Contact | Franca Robutti Phone | +61 3 9982 5570 Email | franca.robutti@sungard.com Website | www.sungard.com/avantgard

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SunGard’s AvantGard is a leading liquidity and risk management solution for corporations, insurance companies and the public sector. The AvantGard solution suite includes credit risk modeling, collections management, treasury risk analysis, cash management, payments system integration, and payments execution delivered directly to corporations or via banking partners. AvantGard solutions help consolidate data from multiple in-house systems, drive workflow and provide connectivity to a broad range of trading partners including banks, SWIFT, credit data providers, FX platforms, money markets, and market data. The technology is supported by a full range of services delivered by domain experts, including managed cloud services, treasury operations management, SWIFT administration, managed bank connectivity.

FTA Outlook 2014 | 55

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SWIFT Contact | Kees Middendorp 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 10,000 banking organisations, securities institutions and corporate customers in 212 countries and territories. SWIFT enables its users to exchange automated, standardised financial information securely and reliably, thereby lowering costs, reducing operational risk and eliminating operational inefficiencies. SWIFT also brings the financial community together to work collaboratively to shape market practice, define standards and debate issues of mutual interest.

Visual Risk Contact | Richard Hughes Phone | +61 2 9262 6969 Email | richard.hughes@visualrisk.com Website | www.visualrisk.com Visual Risk is a leading treasury solutions provider for corporates and financial institutions. Through combining our deep treasury expertise with innovative technology, we deliver a distinctive brand of forward-looking risk analytics, asset-liability management, hedge accounting and treasury management software. This provides treasuries and management with a critical strategic edge. When coupled with our deep commitment to delivering market-leading client Support and Service, our Total Treasuryâ&#x201E;˘ solutions have proved highly popular with treasurers in this region. Founded in 2001, we are based in Sydney and service over 100 clients across Australasia, S.E Asia and Europe.

Westpac Contact | Gordon Sparrow Phone | +61 2 8254 1943 Email | gsparrow@westpac.com.au Website | www.westpac.com.au/corporatebanking Westpac Institutional Bank (WIB) delivers a broad range of financial services to commercial, corporate, institutional and government customers with connections to Australia and New Zealand. WIB operates through dedicated industry relationship and specialist product teams with expert knowledge in transactional banking, trade and supply chain finance, debt capital markets, specialised capital, and alternative investment solutions. Westpacâ&#x20AC;&#x2122;s Global Transactional Services team partners with clients to optimise the management of working capital in line with industry trends and economic environments. Global Transactional Services: Australia, New Zealand, United Kingdom, United States, China, India, Hong Kong, Singapore

56 | FTA Outlook 2014

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