FTA Outlook 2015

FINANCE AND TREASURY ASSOCIATION

OUTLOOK

2014 2015

LO O K I NG OVER THE HOR I ZON

FINANCE AND TREASURY ASSOCIATION

OUTLOOK

2015

FTA Outlook is published by CommStrat

CONTENTS 3 4

President’s Message CEO Report

on behalf of the Finance and Treasury Association

ECONOMIC OUTLOOK

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

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

Andrew Roberts, Head of European Macro

CAREER FEATURE

6

Research, RBS

RATINGS OUTLOOK

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

A global fintech career in the front lines of gender diversity

by Kimberley Cole, Head of Sales

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

Specialists, Asia, Thomson Reuters

Maurice O’Connell, Vice President and

Elevating Australia’s Finance Learning Standards In Higher

Senior Credit Officer at Moody’s Investors

10

Education

38

TAX OUTLOOK Globalisation and Profit Allocation – The Tax Noose Tightens

Andrew Brown CFTP, Head Australia &

14

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

FINANCE EDUCATION FEATURE

Monash University

Valuing Derivatives Under AASB 13 Fair Value Measurement

New Zealand, Chatham Financial

18

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

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

REGULATORY OUTLOOK

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

Regulatory Reform: 2015 and Beyond

David Olsson, China Practice Consultant,

20

42

CASH MANAGEMENT OUTLOOK

CHINA OUTLOOK

King & Wood Mallesons

34

by Associate Professor Kevin Tant FFTP,

RISK OUTLOOK

Accounting Advisory Services and

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

30

Bank

Steve Castleton, Global Co-Head

ABN 31 008 434 802

Debt Markets in 2015 – Timing Will Be Everything

2015 – Accelerating Global Disinflation Drives Currency Wars

Service

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

DEBT MARKETS OUTLOOK

44

Pieter Bierkens, Executive Director, Rates Regulatory Strategy, CBA

48

Bringing cash back from China

TREASURY OUTLOOK

Matthew Clarke CFTP, Group Treasurer,

Aligning the Treasury Value Add from Back Office to Board

Intertek Group

23

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

by Alistair McLean FFTP, Group Treasurer, Metcash Limited

52

2015 FTA Partner Directory 54

By Stephen Barnes FFTP, Director, Byronvale Advisors

26

FTA Outlook 2015 | 1

outlook2015

WORKING CAPITAL OUTLOOK

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

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PRESIDENT’S

MESSAGE

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

W

elcome to the FTA Outlook 2015 magazine.

This is the second year of this magazine and I am sure that you will find it a useful reference point for current and new issues that we treasury and finance professionals will face in the coming year.

The Finance and Treasury Association is committed to continuing to build on the 30 year foundations of this organisation and to provide a relevant, enjoyable and productive membership offering for all of our members. In 2015, we will continue to provide forums for face to face learning and discussion across a number of issues. We will also build on the 2014 launch of the FTA Academy which is another membership offering for those who due to time pressures do not always have the opportunity to get out of the office to attend specific events. The FTA Academy also contains articles on topics of relevance for researching or looking for different perspectives of Treasury.

The key networking and Professional Development offering of the FTA is our annual Congress. This year it will be in Melbourne, and we again look forward to a successful and well attended event. I encourage all members to attend the Congress. It is the one forum where you can touch base with your peers, meet with new people and also have the opportunity to listen and interact with professionals who share their thoughts and experiences across many different topics in a condensed period of your time. If you walk away with just one new idea or solution to a potential conundrum you face within your work environment, it should be regarded as successful.

Similarly, I encourage attendance at all of the events that the FTA puts together for its members across Australia; you will see a range of differing events throughout the year. Participation by way of presentation or attendance to FTA events by our members helps make us a stronger more relevant and better offering for everyone.

Lastly, I would like to thank all of the contributors to this magazine. I also thank all of you that continue to sign up as FTA members. Personally I am looking forward to what I hope is a challenging and ultimately successful 2015.

FTA Outlook 2015 | 3

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

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

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FTA Outlook

EDITOR'S

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

T

he theme of this year’s FTA Outlook magazine is “Looking over the Horizon” where we have asked our authors to extrapolate on current trends and to consider developments barely on the horizon.

In our first article Andrew Roberts RBS Economist asserts that the “number one global macro theme remains … global disinflation” which is sourced in part from the erstwhile growth engine in China. Roberts indicates that despite US growth, global wages growth will be minimal and oil prices will fall further.

Falling inflation will affect corporate pricing power in most markets except the US. With rates zero bound in Europe and Japan, “currency wars” will hot up.

NAB’s Steve Boyd notes on debt markets “a common view that the sustained rally in credit spreads globally over the past 18 months is overdue for a correction and … that the correction could be major”. While liquidity is expected to remain mostly plentiful it will be more prone to dry up in periods of uncertainty. Timing of deal execution will be critical given heightened volatility.

Meanwhile, Maurice O’Connell of Moody’s Investors Service highlights that in aggregate corporate Australia is currently buffered from a return of financial market volatility by “strong balance sheets and liquidity, while leverage and refinancing needs are low”. The article highlights sector-specific challenges and canvasses “possible downside risk for credit profiles next year [and] the potential for M&A and shareholder-friendly activity”.

4 | FTA Outlook 2015

“While liquidity is expected to remain mostly plentiful it will be more prone to dry up in periods of uncertainty.

Timing of deal execution will be critical given heightened volatility.”

The article on Financial Regulation by Pieter Bierkens of CBA is an important read to get an overview of the next stage of regulation of derivatives notably the impact of Basel-IOSCO margin requirements for noncentrally cleared derivatives. While Australia appears to have learnt some of the lessons from Europe’s experience here, FTA considers that the capital penalty to banks for transacting with corporates on non-centrally cleared derivatives is excessive and will further raise the cost of corporate risk management.

Bierkens and Boyd both highlight how overall financial system liquidity risk has been heightened by a combination of regulations notably, the Volcker rule which limits dealer inventory.

Andrew Brown CFTP of Chatham Financial highlights the benefits of a process for qualitative assessment of Credit Value Adjustment (CVA) under AASB13 which helps an entity determine whether to explore a “robust” (system and process-intensive) approach, or a simplified approach. They also note “if an entity is relying on periodic valuation statements from dealer counterparties for fair value measurements in its financial statements, it is very likely that entity is not complying with the requirements in AASB 13”.

I am always delighted when practising treasurers take pen to paper even if it is only figuratively these days. In “Aligning the Treasury Value Add from Back Office to Board” Alistair McLean FFTP Group Treasurer at Metcash offers nine tips for treasurers and their staff to add value and get noticed by internal and external stakeholders - for the right reasons.

One new thing more treasurers in Australia will do in 2015 will be to transact in Renminbi (RMB) for the first time. David Olsson of King & Wood Mallesons details Australia’s responses to the internationalisation initiatives of the Chinese government and regulators. He argues that although RMB is still far from being an international currency, Australian companies should be paying closer attention to its evolution. “The use of RMB is fast becoming both an immediate competitive advantage and vital to future strategy for companies with any form of commercial exposure to China”.

London-based FTA member Matthew Clarke CFTP is Group Treasurer of Intertek Group plc which operates in over 100 countries including China. Intertek provide an illuminating case study of Cash management in China where they have implemented RMB pooling structures to concentrate cash in China and RMB accounts in offshore RMB centres.

Clarke suggests that the recent regulatory changes make now a good time for companies operating in China to review existing cash management processes.

Nels Mortensen CFTP of First Treasury argues cash visibility is the “basis of accurate cash flow forecasting” and is enhanced by establishment of “internal bank” structures and payment factories.

While Intertek’s Clarke reserves SWIFT “for the accounts we can actually control from treasury”, First Treasury are proponents, in general, of greater SWIFT (and ERP) integration by Australian corporations.

Perhaps the key transformative change for treasurers in 2015 will be the Cloud which is revolutionising core technology for treasurers - their treasury system.

Reval’s Chief Technology Officer, Philip Pettinato maintains that Software-as-a-Service (SaaS) allows companies to standardise their workflow across the global treasury organisation, across functions, geographies and time zones. With all of the application’s users working on a common technology platform, scope for collaboration is enhanced.

With no sign that the pace of globalisation is slowing, former FTA VicePresident Stephen Barnes FFTP interviews Catherine Mallanack and Ryan Fernandes of ANZ about working capital management opportunities for treasurers from cross-border supply-chain financing (SCF). While traditional export and import trade in goods and services continues to grow, the SCF is opening up new growth opportunities by facilitating cross-border business-to-business collaboration.

Tertiary education in business and finance is now one of Australia’s major sources of service sector export income. The number of courses and providers has grown rapidly adding variety and competition.

But the quality is variable which has implications for how finance is practiced in this country, and also the reputation offshore of an

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

“Perhaps the key transformative change for treasurers in 2015 will be the Cloud which is revolutionising core technology for treasurers their treasury system.”

Chris Kinsella and Stephen Green of Minter Ellison highlight how Governments around the world are addressing erosion of their tax base, and the ramifications for Australia's corporates of the G20/OECD action on Base Erosion and Profit Shifting (BEPS).

Kinsella and Green highlight three key action areas for finance and treasury professionals – hybrid mismatches, interest deductions and the digital economy. They note the Australian Tax office is currently investigating 86 multinational companies over their tax planning arrangements, including concerns over intangibles; offshore marketing and procurement hubs; hybrid entities and transfer pricing outcomes.

On the last point, the focus of future ATO enforcement activity related to BEPS may well depend on the outcome of a Federal Court case heard in October 2014 on which the judge has to date reserved his decision. ATO is pursuing US oil company Chevron for $258m in unpaid tax plus penalties for claiming tax-free interest on inter-company loans which the ATO asserts were not at arms-length.

My brief summary does not do justice to the great analysis in the 2015 FTA Outlook. I hope you like it!

As technical and professional issues emerge throughout the year, you will benefit from being part of the FTA network. Join FTA for discounts on professional development and password-protected information.

Subscribe at www.finance-treasury.com to our fortnightly FTA Update for my own CEO Comment on emerging developments and FTA advocacy for the profession.

FTA Outlook 2015 | 5

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

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

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Economic Outlook

2015 – ACCELERATING GLOBAL DISINFLATION DRIVES CURRENCY WARS

BY ANDREW ROBERTS, HEAD OF EUROPEAN MACRO RESEARCH, RBS

So what are the developments in 2015 that are not yet in view? Or, perhaps, are here, but not fully recognised as here to stay, or to deepen as issues for corporates/policymaker/fund manager alike?

It is clear – at least through my lens - that the no.1 global macro theme remains that which I have been pushing for nearly two years now – global disinflation. Indeed, it took centre stage in the article we wrote in this document 12 months ago.

It is clear – at least through my lens - that the no.1 global macro theme remains that which I have been pushing for nearly two years now – global disinflation.”

6 | FTA Outlook 2015

However, the theme in this document is ‘Looking over the Horizon’, at events which have not yet appeared, or not yet appeared at least in full form.

I would argue vociferously that disinflation fits into this camp.

Yes, we all know that inflation globally is low right now. It entered deflation for the first time in the Eurozone in January.

But we have to remember that even at such low levels, with CPI rates continuing to decelerate throughout 2014, market forecasters have adamantly refused to take on board the shifting nature of the global economy, and to believe that this theme is a) here to stay, and is b) set to deepen.

You can witness this by the fact that the move into deflation was with yet another data release which came in sub consensus. The actual inflationary impulse is lower than forecasters think it is, even here.

I believe that 2015 will be the year when there is more acceptance that some central banks may have as much trouble getting inflation back up to target over coming years, as they did getting it down to targets through the 1970s and 1980s.

This has major implications, but first, the pillars that support my view: 1) China. China is slowing. More to the point, China is exporting deflation to the rest of the world. The most important data point in the world in my view is arguably Chinese producer price inflation, not US payrolls. Yet the latter garners far more attention globally. Indeed, both sets of data came out in the same week as I write this. Rather neatly, Chinese PPI decelerated sharply to now run at -3.3%yoy (previously -2.7%yoy), and – yet again – came in lower than the markets had expected. Compare this to US payrolls, coming in 60k above consensus (including revisions), and what do bonds do? Bring forward rate hikes? No, 10y USTs rallied -7bp on the day, because wages were expected to be running at 2.2%yoy and actually came out at a very weak 1.7%yoy.

FIGURE 1. CHINESE PPI DEFLATION IS ACCELERATING. TAKE NOTE. VERY GLOBAL BOND BULLISH, BEARISH FOR GLOBAL GOODS PRICES, WATCH FOR MORE GLOBAL DEFLATION SHOCKS IN 2015 PPI

CPI

10.0

5.0

% 0.0

-5.0

-10.0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

Jan-12

Jan-13

Jan-14

Jan-15

Source: RBS; Bloomberg

I do not wish to dwell on one month’s data. But the uncertainty in global macro in 2015 for us to debate, is NOT whether the US grows ok. Too many bond bearish investors lost money in 2014 thinking that if the US grew, the Fed would hike, and bonds would sell off. It is disinflation that matters most (and the reason there was no hike).

FIGURE 2. GLOBAL OUTPUT GAPS ARE ALL THAT COUNT. SO AS CHINA SLOWS, PREPARE FOR MUCH LOWER INFLATION & WAGES Price Phillips curve 0.3 0.2

So we should focus on wages, not growth. (And yes, I remain a US growth bull as I was in 2014, thus limited or no Fed hikes, plus low inflation, plus strong growth, is a good news story for 2015).

0.0 -0.1 1971-85 1986-98 1999-2013

1971-85 1986-98 1999-2013

Domestic output gap

Global output gap

Wage Phillips curve 1.1972 0.3 0.2

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2) Global output gaps matter. So wages are all that count? Yes. But the most important point I press home in meetings now is that statistically the most important determinant of any country’s CPI rate, are not domestic employment conditions, but global employment conditions. For those who are interested to delve deeper into this, the seminal work was done by the Bank for International Settlements in 2014.

Without wishing whatsoever to bamboozle readers with econometrician jargon, domestic unemployment gaps are just NOT statistically significant anymore in explaining CPI or wages. As such, the latest US employment data fit lovely with this theme, of payrolls being strong yet wages not taking off, despite the consensus expecting so. I expect a 2015 where there continues to be scratching of heads about why wages are not rising, even while payrolls is ticking along fine.

0.1

I expect a 2015 where there continues to be scratching of heads about why wages are not rising, even while payrolls is ticking along fine.”

0.1 0.0 -0.1 1971-85 1986-98 1999-2013

1971-85 1986-98 1999-2013

Domestic unemployment gap

Global output gap

Insignificant at the 5% level Significant at the 5% level

Source: BIS; RBS

FTA Outlook 2015 | 7

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Economic Outlook

3) Oil. I have been a commodity bear all through 2014, mainly due to China. But oil has the extra kicker for being negative thanks to the shale revolution in US and Canada. The key is that 90% of the projects are being done privately, so there has been no official incentive to keep the oil in the ground, as there exists in middle eastern countries (remember that global usage estimates by the International Energy Agency up to 2040 of 760bn barrels is already far lower than the 1700bn proven reserves, I asked in every client meeting last year, ‘why on earth is oil as high as it is’). I introduced a $42 (Brent) forecast when doing my year ahead when it traded at $70, but it looks like being met far sooner than I expected. The big problem is this is not just supply, it is also demand. If we are ‘Looking over the horizon’, the big shock we should all be preparing for is a collapse in oil even from these levels. The chart to the side from the IEA shows just how cheap oil development now is. And note that finding and development (F&D) costs are set-up costs, and as such the marginal cost of supply for each barrel will be far lower.

FIGURE 3. F&D COSTS FOR NEW GLOBAL OIL IN NEXT 20 YEARS. LOW COSTS + ABUNDANT SUPPLY = SELL OIL.

40 35

Middle East conventional

0

100

Onshore conventional

200

300

Deepwater

5

Extra-heavy oil

15 10

Shallow offshore conventional

25 20

Light tight oil

30

EOR

Weighted average F&D cost (Dollars per barrel)

Oil resources developed to 2035 in the New Policies Scenario

400 500 600 Resources developed (billion barrels)

NOTES: Each basin and resource type has its own estimate of F&D costs; the levels shown here are averages, weighted by production over the period to 2035. Average values for shallow offshore production are pulled up by the exclusion of Middle East shallow water production and by relatively expensive developments in Kazakhstan and Norway; deepwater is pulled down by relatively low cost per barrel developments in Brazil.

EOR = enhanced oil recovery.

Source: IEA; RBS

FIGURE 4. 47% OF JOBS AT RISKIN IN COMING COMING 20 YEARS 47% OF JOBS AT RISK 20 YEARS 400m

Low 33% Employment

Medium 19% Employment

Once we reach $42, the next technically driven target is $20.

High 47% Employment

4) Technology is starting to bite, and will keep output gaps wide, wages low, and a major deflationary impulse (see Figure 4).

Employment

300m

Another theme I suspect that will zoom into view in 2015 is that of the role technology is playing in changing labour markets (and so wage pressures).

200m

100m

0m 0

0.2

0.4

0.6

0.8

1

Probability of Computerisation Source: RBS

Source: Frey and Osborne (2013) 8 | FTA Outlook 2015

Management, Business, and Financial Computer, Engineering, and Science Education, Legal, Community Service, Arts, and Media Healthcare Practitioners and Technical Service Sales and Related Office and Administrative Support Farming, Fishing, and Forestry Construction and Extraction Installation, Maintenance, and Repair Production Transportation and Material Moving

The top piece on this was written in 2013, I repeat the chart that shows that in the coming 10-20 years, 47% of all jobs are replaceable by machinery.

Normally long term influences are dismissed by finance experts, because it is tough to pinpoint the moment when everyone should start to focus on them. I would argue that we are now there. Such topics are now being reported in the mainstream media far more.

This theme links directly with the earlier theme of global output gaps mattering more than domestic output gaps. I argue that the invention of the Cloud (without doubt one of the top inventions in history), brings potentially hundreds of millions of

people onto the global labour market that were not there before. Access to such a labour force is now possible thanks to technology, and so it is tough to see how wages will rise in the developed world as a result. There are many ways to monitor this developing eg Google’s Project Loon, looking at giving the internet to the two thirds of the world population that does not have it.

I could include a few other of my pet themes, such as demographics, but space is short. But everything points to one thing.

CONCLUSION 1: DEFLATION IS GOING TO BE A BIG PROBLEM. Everyone knows the well publicised issues in EMU, now officially in deflation (and as with the Roach Motel, it is easier to check into deflation, than it is to check out, I suspect it will be here for some time).

But to this we have to add the entirety of Eastern Europe, grappling with weaker Russia and weaker EMU on their borders. Add to this Sweden, in and out of deflation for 18 months, and Israel. Basically every country outside Russia should see inflation subside.

Even in Australia I am a seller of the consensus of 2.4% for 2015 inflation (source: Bloomberg consensus survey). Even Japan is in trouble, producing a peak of just 2.3% for CPI after a more than 30% debasement of the yen; more to come on this front.

CONCLUSION 3: STAY BULLISH EQUITIES. The fall in oil is equivalent to a large consumer tax cut, and it should be viewed as an economy positive, not negative. I am fading the equity weakness of early 2015.

I have updated my favourite asset class chart in the world that was in last year’s outlook: global central bank liquidity.

As we said last year, call liquidity right and everything else slots into place.

So, what does it tell us? The chart below just shows that the ECB QE that we expect to be announced certainly in Q1, merely takes over the baton for driving global liquidity, handed to it by the Fed. The hiccup in equities in December (eg Australia stocks -4% in one week) was entirely down to market fears that the Fed was ending its QE but the ECB might not be replacing it after all. Such fears are now misplaced, and (non commodity) equities do not look rich whatsoever. I am bullish, favourite market USA.

GLOBAL LIQUIDITY, FLOOD FIGURE 5. GLOBAL LIQUIDITY,ABOUT ABOUT TOTO FLOOD AGAIN. AGAIN. DO NOT BE SHORT RISK/EQUITIES ETC DO NOT BE SHORT RISK/EQUITIES ETC 10

CONCLUSION 2: GLOBAL CURRENCY WAR IS COMING.

I expect the USD to rally against all majors in 2015.

And there is no coincidence that they are the only major that is contemplating raising rates.

8

% change, balance sheet size wighted

3mth rolling cumulative expansion of central bank balance sheets (LHS)

Assuming ECB balance sheet expands to €3 tln

70000

65000

6

60000

4

55000

2

50000

45000

0 BoJ

-2

40000

BoE ECB

-4

35000

Fed SNB

-6

30000

PBOC World equity (rhs)

-8 Jan-09 Jul-09

25000 Jan-10

Jul-10

Source: RBS; Bloomberg

Jan-11

Jul-11

Jan-12

Jul-12

Jan-13

Jul-13

Jan-14

Jul-14

Jan-15

Jul-15

Jan-16

Jul-16

Source: RBS; Bloomberg

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For central banks with rates at 0%, sinking into deflation, the next step is to debase your currency.

So watch out for good falls in 2015 in Scandinavian currencies, the euro, across Eastern Europe, and in the yen. They are all good sells. As we said at the FTA conference in October, we can add Australia to this sell zone, though the country obviously is clearly different to most others in that it still has positive rates and positive inflation. As such, I suspect we should see more weakness in the yen than the A$.

For central banks with rates at 0%, sinking into deflation, the next step is to debase your currency.

So watch out for good falls in 2015 in Scandinavian currencies, the euro, across Eastern Europe, and in the yen. ”

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Ratings Outlook

AUSTRALIAN NON-FINANCIAL CORPORATES: OUTLOOK STABLE, BUT WEAKNESS IN SOME SECTORS

BY MAURICE O’CONNELL, VICE PRESIDENT AND SENIOR CREDIT OFFICER AT MOODY’S INVESTORS SERVICE

In terms of specifics, most Moody’s-rated corporates show strong balance sheets and liquidity, leverage is at manageable levels and refinancing needs are low.”

Moody’s Investors Service sees a stable outlook for Australian non-financial companies in 2015, reflecting our view that domestic macroeconomic conditions will remain broadly supportive of business growth, assisted by historically low interest rates. Corporate earnings and financial profiles should support current ratings, helped by a steady operating environment and lower levels of capital spending.

In terms of specifics, most Moody’s-rated corporates show strong balance sheets and liquidity, leverage is at manageable levels and refinancing needs are low. However, pressures are growing in some sectors, namely those related to mining and natural resources. A further possible downside risk for credit profiles next year is the potential for M&A and shareholder-friendly activity.

The overall stable outlook – which applies to all sectors – assumes a modest improvement in domestic GDP growth of close to 3% and the continuation of accommodative monetary policy settings.

Furthermore, weakness in the Australian dollar, which is well off last year’s highs against the US dollar, will benefit exporters and the resource sector. At the same time, continuing growth in China remains supportive of the overall

10 | FTA Outlook 2015

Australian corporate sector, although the slowdown in the Chinese economy will pressure the credit quality of companies in mining and mining services, in particular those exposed to coal and iron ore.

Currently, with Moody’s-rated corporate portfolio for Australia, 77% of all ratings are stable, 19% are negative and 4% are positive. However, the proportion of negative outlooks — which outweighs positives — indicates a negative bias. Mining and mining services companies account for the majority of negative outlooks.

Moody’s-rated corporates span the sectors of metals & mining; retail & consumer; real estate investment trusts; airlines; and building & construction.

Under Moody’s stable scenario, the aggregate EBITDA of investment-grade corporates is likely to grow around 1%-3% in 2015. The airline sector will benefit from an improving competitive environment and lower fuel costs, although its recovery will remain fragile.

Meanwhile, with the metals & mining sector, EBITDA will fall by more than 15%. Construction will also record a fall, but others sectors — including airlines — will see a rise in EBITDA.

DISTRIBUTION OF RATING OUTLOOKS FOR AUSTRALIAN ISSUERS AS OF END 2012, 2013 AND SEPT 2014

■ 2012

100% 90%

88%

■ 2014

84% 77%

80% Share of Total

■ 2013

70% 60% 50% 40% 30% 14%

20%

19% 7%

5%

10%

4%

2%

0% Stable

Average leverage will remain steady throughout 2015, based on Moody’s forecast of modestly higher EBITDA in aggregate, and continued conservative levels of capital spending; offset by our expectation of slightly higher shareholder returns.

Interest cover will improve on EBITDA growth and slightly lower interest expenses.

A change in the outlook to negative for the corporate sector — a scenario which is unlikely at this stage — would require a further softening in Chinese growth towards 5% in the next 12

Positive

months, and increased downward pressure on the metals & mining sectors, with knock-on effects.

Another factor for change would include a weakening in domestic economic growth to less than 1% annually. A move to negative would also involve the total of negative issuer ratings exceeding 30%.

By contrast, a change to a positive outlook for the corporate sector would require Australian GDP growth to surpass 4%, with an increased contribution from the non-resource sectors. In addition, negative issuer ratings would have to exceed 30% of Moody’s total portfolio.

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A key downside risk in Moody’s stable scenario is — as indicated — that limited organic growth opportunities and the low cost of debt could encourage M&A or shareholder-friendly initiatives and lead to higher financial leverage.

Negative

In terms of the specifics for each sector, our analysis is as follows: FTA Outlook 2015 | 11

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Ratings Outlook

YOY % CHANGE IN ADJUSTED EBITDA BY SECTOR

■ 2012–2013

■ 2013–2014

■ 2014–2015F

30.00% 20.00% 10.00% 0.00% -10.00% -20.00% -30.00% Airlines

Construction

Metal & Mining

Others

Metals & Mining (Stable) – Softer Chinese and global economic growth are driving down prices for key commodities, and most singlecommodity producers will likely face further pressures, with knock-on effects on the mining services sector. Moody’s does not expect a material improvement in demand.

Indeed, some commodities, such as iron ore, face significant supply increases which will outstrip the growth in demand. Ongoing cost reductions will be necessary to support margins and liquidity. However, the larger and more diversified mining companies will prove more resilient.

Retail & Consumer (Stable) – Steady growth will be supported by continued non-discretionary spending. But the discretionary retailers will experience patchy growth in earnings. In general, consumer sentiment remains volatile, 12 | FTA Outlook 2015

REITS

Retail

Telco

and competition continues to spur high levels of discounting activity.

Australian Real Estate Investment Trusts (Stable) – The presence of contracted fixed rental lease structures will support earnings visibility, while robust liquidity levels and staggered debt maturity profiles will support ratings. However, earnings growth will be restrained by subdued fundamentals, including headwinds from high CBD office vacancy levels and negative rental renewals for the office and retail sectors.

Airlines (Stable) – The outlook for the sector is stable. Although Issuers face operating challenges, such as tough levels of competition and an overhang in capacity. Other challenges include the fragile and price-sensitive state of demand. There are indications of an improvement and lower fuel prices will support operating margins.

Building & Construction (Stable) – Building activity should hold up in 2015, helped by the strength of demand for residential properties.

However, high office vacancy levels will limit commercial construction. Government spending on roads and rail infrastructure should help lower the impact of lower private-sector engineering spending.

has led to a significant deterioration in earnings and credit metrics. Continued execution of the company’s transformation program — combined with further improvements in the competitive environment and lower fuel prices, if sustained, will lead to improving profitability and credit metrics. Adjusted debt/EBITDA falling to 4.75x or below and maintaining its high cash balances would likely lead to a stabilisation of the rating.

ISSUERS OF INTEREST IN 2015

Leighton Holdings (Baa3 stable) – Project execution, working capital management and ownership by a weaker parent are key challenges.

The company’s business profile is evolving, as it has sold assets and is looking to expand into the public private partnership sector.

BHP Billiton (A1 stable) – Continued success at reducing operating and capital costs and raising production levels should help preserve margins and cash flow, despite soft commodity prices.

Debt reduction to offset lower earnings should help stem the deterioration in credit metrics, which has caused the previously large cushion in the company’s rating to fall.

Fortescue Metals (Ba1 stable) – Credit metrics have improved following the completion of expansion activities and debt-reduction initiatives.

However, lower iron ore prices, if sustained, will limit further debt reduction and begin to pressure metrics for its current rating level.

Qantas (Ba1 negative) – The intense competition in both the international and domestic markets

Boral (Baa3 positive) – The company’s credit profile should improve in 2015 on the back of its improving US earnings and the recovery in Australian residential housing. Exposure to road infrastructure will also help its credit profile.

Lend Lease (Baa3 stable) – Investments in multiple projects will increase financial leverage and reduce the headroom within the company’s rating to absorb further pressures. Successful project execution, asset sales and delivery of sustainable EBITDA generation are key to supporting its current rating.

A change to a positive outlook for the corporate sector would require Australian GDP growth to surpass 4%, with an increased contribution from the non-resource sectors.”

AVERAGE DEBT/EBITDA

5.0 4.0

2.0 1.0 0.0 FY06

FY07

FY08 FY09 FY10

FY11

FY12

FY13

FY14

FY15F

FY16F

FTA Outlook 2015 | 13

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3.0

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Risk Outlook

VALUING DERIVATIVES UNDER AASB 13 FAIR VALUE MEASUREMENT

BY STEVE CASTLETON, GLOBAL CO-HEAD ACCOUNTING ADVISORY SERVICES AND ANDREW BROWN CFTP, HEAD AUSTRALIA & NEW ZEALAND, CHATHAM FINANCIAL

Because accurately estimating CVA/ DVA is not a trivial exercise, qualitatively assessing the factors that have the largest impact on the size of CVA/DVA is a good place to start.”

14 | FTA Outlook 2015

INTRODUCTION

•

AASB 13, Fair Value Measurement (“AASB 13”) was issued in 2011 and became effective January 1, 2013. Even though the standard has been effective for nearly 2 years, many companies are either still grappling with how to implement the standard with respect to derivative valuations or need to continue to refine their process based on feedback from auditors or an evolving derivative portfolio.

This article discusses three essential steps to successfully implementing this standard. These steps balance both the need for compliance with the cost of compliance while considering overall materiality.

This standard is difficult to implement for a number of reasons: •

•

•

AASB 13 requires that non-performance risk (primarily credit risk) be incorporated into derivative valuations, which is difficult to do because, unlike debt, credit exposure changes over the life of the contract AASB 13 doesn’t specify a method for calculating credit exposure, only that an entity must use the same assumptions market participants use (i.e., the calculation cannot be an entity-specific measure, but must comply with the market’s best practices and with prevailing financial theory) The market’s methodology for calculating CVA/DVA can be complex and costly to implement

While CVA/DVAs may be small when compared to the overall fair value of derivatives, in certain circumstances they can be significant and even lead to breaches of hedge effectiveness

1.

Qualitatively assess the potential CVA/DVA and make an initial determination about the type of implementation necessary;

2.

Identify and understand the inputs and assumptions market participants use and the factors that distinguish between a robust and a simplified implementation approach;

3.

Decide whether to build the model in-house or to outsource.

QUALITATIVELY ASSESS THE IMPACT OF CVA/DVA Because accurately estimating CVA/DVA is not a trivial exercise, qualitatively assessing the factors that have the largest impact on the size of CVA/ DVA is a good place to start – and it can be done

relatively easily with very little time and almost no cost.

UNDERSTAND HOW MARKET PARTICIPANTS CALCULATE CVA/DVA

This qualitative assessment of CVA/DVA helps an entity determine whether to explore a robust approach or a simplified approach. The key factors that drive the value of CVA/DVA are listed in Table 1 below.

The decision between implementing a robust or simplified CVA/DVA model matters because the results and costs of implementing the two models can be significantly different.

The list below highlights the key inputs and assumptions market participants use in valuing derivatives and that should be considered when implementing AASB13. An understanding of these key inputs and assumptions will help an entity distinguish between a robust and simplified approach to calculating CVA/DVA.

By considering the factors below, an entity can begin to contemplate which type of CVA/DVA model is best suited for its needs. A more robust implementation may be warranted for those entities with derivative portfolios consisting of larger notional amounts, higher current fair values, longer-dated trades, minimal netting, multiple asset classes (especially when portfolios have products like cross currency swaps that require an exchange of principal at the end of the contract), lower or no collateral requirements, and/or high credit spreads. If an entity’s portfolio has characteristics that suggest a smaller CVA/DVA, then a more simplified approach may suffice.

Note: Due to the complexities of calculating CVA/ DVA and the interactions of the variables involved, this table is intended to provide an indication of the general impact of the individual factors identified. If an entity is unsure after this initial assessment, they may want to contract with a third-party provider to obtain additional insight.

Credit Exposure: The most critical implementation decision and the decision that will have the greatest impact on calculated CVA/DVAs is the method used to estimate the credit exposure of a derivative or portfolio of derivatives. CVA/DVA models are generally based on either a current exposure (“CE”) or potential future exposure (“PFE”) approach. A CE approach is based only on the current termination value of the derivative as of the reporting date and does not consider how credit risk changes over time. The PFE approach is widely used by dealers and sophisticated derivative users because it more accurately represents the way these entities evaluate and price nonperformance risk and is more theoretically sound because it estimates the credit risk of the derivative over time.

Using a more advanced method not only leads to closer compliance and fewer auditor concerns, but it can also reduce CVA/ DVA volatility.”

KEY FACTORS THAT IMPACT CVA/DVA FACTORS

INCREASES CVA/ DVA

DECREASES CVA/DVA

DESCRIPTION

Large

Small

Both notional amount and the number of trades affect the CVA/DVA.

In or out-of-themoney

At-the-money

The current fair value influences the credit exposure; whether a contract is significantly in or out of the money has a direct impact on the CVA/DVA.

Duration to Maturity

Longer

Shorter

Credit exposure of longer-dated contracts is more significant that shorter-dated contracts.

Netting

No or low number of offsetting positions

Higher numbers of offsetting positions

If an entity executes pay and receive fixed swaps or buys and sells the same currency pairs with the same counterparty, netting will decrease credit exposure.

Complexity of Portfolio

Multiple asset classes

Single asset class

When a portfolio consists of derivatives based on multiple asset classes (interest rates, FX, and commodities), netting of positions is more difficult to achieve. Also, CVA/DVA volatility can be higher because different asset classes have different exposure profiles. For example, interest rate exposures tend to decline after about one third of the tenor has passed; on the other hand, FX and commodity exposures can stay elevated through maturity.

Collateral

No or little collateral

Collateral is posted

When trades are fully collateralized, CVA/DVA is generally zero; when no collateral is posted, counterparties are fully exposed to counterparty credit risk.

Credit risk

High level of credit Lower level of risk risk

The degree of risk in own or counterparty nonperformance risk has a direct impact on CVA/DVA.

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Portfolio size Current Fair Value

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Risk Outlook

approach. Also, CVA/DVAs calculated under a pure CE approach can be larger than those calculated under a PFE approach because there is no consideration of the “decay� of the exposure over time or the potential offsetting of exposures for forward based contracts.

CHART 1: PFE vs CE 40,000,000 20,000,000

J-19

0-19

F-19

0-18

J-18

F-18

J-17

0-17

F-17

J-16

0-16

F-16

J-15

0-15

F-15

J-14

0-14

F-14

0-13

J-13

F-13

J-12

(20,000,000)

0-12

_

(40,000,000) (60,000,000) (80,000,000) PFD - Entity Exposure to Counterparty

PFE - Counterparty Exposure to Entity

PFE - Net Exposure

PFE - Current Exposure

TABLE 2: CROSS CURRENCY SWAP CVA/DVA USING BOTH CE AND PFE APPROACHES Inception Date

Period 1

Period 2

Period 3

Period 4

Period 5

Period 6

12/31/09

6/30/10

6/30/11

6/30/12

6/30/13

6/30/14

12/31/14

10

9.5

8.5

7.5

6.5

5.5

5

0.8989

0.8416

1.07245

1.0236

0.9147

0.9431

0.81625

Termination Value

0

1,597,089

(45,150,900)

(62,482,898)

(34,745,346)

(44,073,357)

(15,997,486)

PFE (CVA)/ DVA

666,158

873,311

4,811,332

6,319,461

3,077,547

3,076,538

1,142,199

0

(58,450)

7,528,217

10,106,284

4,982,895

5,514,859

1,858,633

666,158

931,761

(2,716,885)

(3,786,823)

(1,905,348)

(2,438,321)

(716,433)

Years to Maturity Spot Rate

CE (CVA)/DVA Difference

While the PFE approach is more complicated and costly to implement, many audit firms believe this approach is preferable over the CE approach because it results in a more economically defensible valuation.

Chart 1 shows the credit exposure using both a PFE and CE approach for a 10-year, $200 million, AUD-USD cross currency swap with a fair value of nearly $62 million.

While implementing a CE approach may reduce cost and complexity, there are significant drawbacks. For example, a CE approach can result in a more volatile CVA/DVA than a PFE 16 | FTA Outlook 2015

Table 2 shows how the CVA/DVA changes over time for the same 10-year, $200 million, AUD-USD cross currency swap (where credit spreads are held constant and are 50bps for bank/counterparty and 250bps for entity) and compares the actual CVA/DVA under both PFE and CE approaches.

Portfolio Level Unit of Account: When a master netting arrangement exists (for example, an ISDA Master Agreement), the appropriate unit of account is the counterparty portfolio level. Credit exposures should be calculated at that level so the impact of netting offsetting exposures is appropriately considered.

Collateral and Other Credit Enhancements: Collateral arrangements should be considered when calculating CVA/DVA because they can significantly impact credit exposure. For example, when trades are fully collateralized the CVA/DVA is generally zero. Other credit enhancements like mutual puts, mandatory cash settlements, and guarantees also reduce credit exposure and should be incorporated into CVA/ DVA calculations.

Unfortunately, credit enhancements are often overlooked because their implications are less obvious. For example, if a ten-year interest rate swap requires mandatory cash settlement after six months, the credit exposure is reduced by nine and a half years.

Bilateral Credit Risk: Counterparty and own credit risk should be considered when calculating overall credit risk. However, this may be easier said than done depending on the availability of credit spread information.

For example, while CDS spreads may be readily available for some counterparties, they may be non-existent for others. A lack of credit spread information would force entities to estimate credit spreads when calculating CVA/DVAs.

Incorporating the key assumptions that market participants use is complex. An entity will want to weigh the materiality of the potential CVA/ DVA against the requirements of AASB 13 based on the specific characteristics of its derivative portfolio to produce compliant valuations that meet the expectations of management, audit committees, auditors, regulators and shareholders.

DECIDE WHETHER TO BUILD IN-HOUSE OR TO OUTSOURCE Generally only the largest derivative users develop in-house models. The benefit of building models in-house is that an entity has control over model development and can keep them updated for market changes. The down side to in-house development is cost and time.

Creating in-house models from scratch can take thousands of hours and most entities simply don’t have the capacity or expertise.

Due to the complexity of calculating CVA/ DVA, some entities simply rely on counterparty (dealer bank) valuation statements. However, very few counterparty valuation statements actually incorporate CVA/DVA because banks typically view their CVA/DVA models as proprietary. Because of this, if an entity is relying on periodic valuation statements from dealer counterparties for fair value measurements in its financial statements, it is very likely that entity is not complying with the requirements in AASB 13.

For those entities electing to employ a thirdparty provider, it is important to understand the inputs and assumptions being used in the valuation. This can ensure that valuations are fully compliant with AASB 13 and that the entity isn’t simply using a “black box” valuation service.

While using an outside service provider does not completely relieve an entity from the work and challenges surrounding CVA/DVA calculations, it can greatly reduce the time, resources, and cost it takes to get up to speed and comply with the standard.

CONCLUSION Compliance with AASB 13 is not optional and its requirements necessitate a serious evaluation of the options available to implement CVA/DVA calculations. Using a more advanced method not only leads to closer compliance and fewer auditor concerns, but it can also reduce CVA/ DVA volatility.

Rapid changes in market inputs (due to either FX, interest rates, credit spreads) require continual attention for each reporting period to ensure what may previously have been ‘Not Material’ does not suddenly become an issue at the next reporting period. While implementing a CVA/DVA can be very complex, using the steps above will ensure you are implementing a model that is appropriate for your portfolio.

For those entities electing to employ a third-party provider, it is important to understand the inputs and assumptions being used in the valuation. This can ensure that valuations are fully compliant with AASB 13 and that the entity isn’t simply using a “black box” valuation service.”

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Some entities look to auditors for guidance on implementing CVA/DVA methods. However, auditors are not an appropriate source to help calculate CVA/DVAs due to independence concerns. While some accounting firms do have robust CVA/DVA models, they are typically only used to serve non-audit clients. Auditors can, however, recommend service providers and discuss their preferences regarding various CVA/DVA methods.

on the expertise of a third-party provider tends to improve controls, enhance the sophistication of the model, and increase independence – all of which address common auditor concerns.

The best service providers have vetted their approach with auditors and regulators, provide a report on internal controls, and have built systems that address many of the most difficult implementation problems.

ABOUT THE COMPANY Chatham Financial provides CVA adjusted valuations for over 1000 companies globally, from ASX200 and Fortune 500, to

Many entities employ independent, third-party valuation experts to calculate CVA/DVAs. This can be a very cost effective alternative. Reliance

many small and medium sized enterprises. Services also include derivatives advisory; where our experts advise on derivatives execution, accounting and regulatory issues.

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Technology Outlook

UNDERSTANDING A TRUE SAAS: WHAT YOU DON’T KNOW CAN COST YOU IN A TRANSITIONAL PERIOD FOR TREASURERS, WHEN OLD TECHNOLOGY STILL EXISTS, NOT UNDERSTANDING WHAT A TRUE SOFTWARE-AS-A-SERVICE (SAAS) OFFERING IS AND HOW IT CAN BENEFIT YOUR BUSINESS CAN COST YOU PARTICULARLY WHEN ‘ALTERNATIVES’ OR ‘CHOICES’ ARE THIN DISGUISES FOR STOP-GAP MEASURES USED BY PROVIDERS OF OLD TECHNOLOGY.

BY PHILIP PETTINATO, CHIEF TECHNOLOGY OFFICER, REVAL

SaaS solution is a single-version, multi-tenant application that hosts a community of users on a common platform.”

18 | FTA Outlook 2015

Managing treasury in a transitioning economy was the central theme at last year’s FTA Congress.

Conference organisers were encouraging attendees that it was time to face a change - and those who embrace change receive the benefits.

When it comes to treasury technology, it is the SaaS model that supports change.

These benefits are felt inside every company and across all users. It allows economies of scale for both the provider and, therefore, the user community. No one company has to wait for an upgrade because all users are kept current on the same version of the application, at the same time.

But ‘cloud’ is not enough to understand what a true SaaS really is. What some are calling SaaS applications are really application service provider (ASP) applications or a mix of old installed applications with new front-ends.

In addition, a true SaaS community can extend beyond users to integrate connectivity seamlessly into third party solutions, enhancing an all-in-one treasury workflow.

COMMUNITY DEFINES A TRUE SAAS Technology has progressed from mainframes, to personal computers, to installed client/ server systems, and now to the cloud. SaaS is the way to deliver software in the cloud. A true SaaS solution is a single-version, multi-tenant application that hosts a community of users on a common platform.

Community is the fundamental feature of a true SaaS because all of the application’s users benefit from working on a common technology platform.

Treasury professionals want to know that the software they are working on represents the best practices of the industry. With a SaaS solution, it is the work of its community of users that continually feeds the ongoing development of the solution and the richness of its functionality over time.

This, in turn, allows companies to standardise their workflow across the global treasury organisation, across functions, geographies and time zones.

Ironically, it is the standardisation that a true SaaS solution provides that is often misunderstood, keeping companies tied to old technology and old ideas of customisation.

STANDARDISATION IS NOT ABOUT RIGIDITY, IT IS ABOUT CONFIGURABILITY There are many ways an organisation is structured, depending on its industry, its size, its regions, and whether it is centralised or decentralised. A SaaS solution enables companies to standardise workflow across the enterprise, while enabling them to configure a set of parameters to meet their own unique needs.

Getting the entire enterprise on a common platform is necessary for global visibility into positions and exposures, setting controls, and assimilating new business entities into the organisation. Companies really don’t want to customise themselves into an island that, given time or a change in leadership, would leave even a support team unable to figure out their version.

This approach is not scalable and not sustainable.

WHAT YOU NEED

ROOM TO GROW

PROVEN SECURITY

FAST UPGRADES

HOW MISTAKING ASP FOR SAAS CAN COST YOU You cannot simply substitute ASP for SaaS, or think that they mean the same thing. Be aware of what a SaaS should look like. Below is a chart to demonstrate how a SaaS offering should satisfy your needs:

ASP HOUSE-TO-HOUSE

SAAS THE POWER OF COMMUNITY

Economies of scale are limited – if you require additional users, you need to pay for it. This creates an unpredictable expense stream.

An annual subscription fee with no hidden costs. Your subscription should already include upgrades, data, security and integrated services. An annual fee ensures you control the subscription requirements as your business grows.

Minimum security is provided. Clients must dictate their security requirements to the ASP provider at an additional fee.

SaaS environments provide the highest level of security.

Ongoing monitoring and testing should be performed by internal and external parties. Users will benefit from SSAE16 compliant security protocols, including encryption, intrusion and penetration testing at no extra cost.

Upgrades are individually deployed to meet many single-instances of the application.

These upgrades are installed in your individual environment for a fee and on a first come first serve basis. Quality assurance and post-upgrade testing costs are your responsibility.

There are no costs or investment of time when it comes to SaaS upgrades. Upgrades should come with standard service and should be rolled out at pre-defined periods. As every SaaS client is on the same version of the application, timely upgrades allow you to respond fast to market demands. Quality assurance and testing is the responsibility of the SaaS provider.

Additional managed services, such as trade portals, general ledger, market data and bank connectivity are your responsibility to select, implement and maintain.

SaaS solutions are designed from inception to be open and easy to integrate with standard web service technologies, such as trade portals, general ledger, market data and bank connectivity. SaaS providers should integrate and maintain value-added services as part of the core service offering, removing the costs and hassle of maintaining disparate systems, relationships and contracts.

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INTEGRATION WITH OTHER SYSTEMS

As companies begin to grow out of their old technology, they will want to adopt SaaS solutions. SaaS remains the most popular form of cloud service and adoption has more than quintupled to 74% of surveyed respondents in 2014 from 13% in 2011, according to North Bridge Venture Partners´ 2014 Future of Cloud Survey. But as companies begin to evaluate SaaS offerings in treasury, they should make sure they can identify a true SaaS in the mix.

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China Outlook

CHINA’S RENMINBI: IT’S HIGH TIME FOR DECISIVE ACTION

BY DAVID OLSSON, CHINA PRACTICE CONSULTANT, KING & WOOD MALLESONS

China is the world’s largest trader and is on track to surpass the United States as the world’s largest economy. Despite its recent slowdown, it is still the largest contributor by far to global economic growth.

So, as China takes its place as the biggest economy on the globe, will its currency, the Renminbi (RMB), become the most widely used international currency as well?

If headlines translated into trading volumes and influence, the RMB would be well on its way to dominating the world’s currency markets. It graces the front page and business headlines consistently - and with good reason.

If headlines translated into trading volumes and influence, the RMB would be well on its way to dominating the world’s currency markets."

20 | FTA Outlook 2015

The RMB has vaulted ahead of the euro and Japanese yen to become the second most widely used currency in international trade finance. In 2013, companies used China’s currency for 8.7% of all credit agreements tied to global trade, up from 4.4% a year earlier, according to SWIFT, which monitors international currency flows.

to 9th at the end of 2013 (with a 2.2% share). In volume terms this is significant growth for the RMB, but the US dollar is still by far the most traded currency, with an 87% share.

A third measure of the rising use of RMB is its use as a payment (or trade settlement) currency.

The RMB now ranks 7th position, up from 35th less than four years ago. Despite this increase, the currency still holds a relatively modest 1.5% share of overall global payment flows, according to mid 2014 data from SWIFT. One explanation of why the RMB’s role in overall payment lags its role in trade finance is that Chinese companies may be using RMB denominated Letters of Credit finance as way to borrow money more cheaply offshore.

While the rise in RMB globally is significant and points to the RMB’s evolution from a trade settlement currency to a trade finance and treasury management currency, it will not be a true global currency until it is fully convertible.

This puts the RMB well ahead of the euro (6.64%) and the yen (1.36%) but still far behind the US dollar which backs 81.1% of global trade finance.

Chinese government policies and regulatory reform have supported this ambition. Over the past decade, we have witnessed the complete opening up of cross-border RMB trade settlement and the proliferation of offshore RMB-denominated (dim sum) bond markets.

The adoption of RMB for trade is reflected in the rising importance of the RMB in global foreign exchange markets, rising in rank from 17th position in 2010 (with a negligible 0.9% share)

The launch and expansion of inbound and outbound investment programs for institutional investors are acting as a catalyst for market participants to use the RMB not just for trade

FIGURE 1: DEVELOPMENT IN RMB INTERNATIONALISATION

Offshore RMB Development

Onshore RMB Liberalisation

Offshore RMB Clearing (currency swap agreement, direct FX cross, appointed clearing banks)

Interest Rate Liberalisation (Lifting lending rate restriction, FCY deposit rate in SH)

A Deepening Offshore RMB Market (offshore FX deliverable market, liquidity pool)

Greater Exchange Rate Flexibility (onshore FX trading band, FX spread/pricing)

Rising International Presence as a Trading and Investment Currency (Senior Officials, country level dialogues/visit)

Capital Account Liberalisation (2-way sweeping, XB borrowing, Q’s schemes RQFII, QFII, QDII, FDI, ODI, SH-­HK Stock Connect)

Source: Standard Chartered Bank

settlement but also for investment, asset allocation and diversification.

The list keeps getting longer, with the latest additions being the inception of the pilot Free Trade Zone in Shanghai and the launch of the Shanghai - Hong Kong Stock Connect allowing mutual access between the stock exchanges in Shanghai and Hong Kong.

Such developments come against a broader backdrop of growing market confidence and deeper financial market integration.

In November 2014, Sydney joined London, Singapore, Frankfurt and a small number of other international financial centres where RMB transactions can be settled directly, confirming Sydney’s status as an official offshore RMB hub.

What’s driving the RMB rise? Two key factors lie behind the currency’s continued advance.

Second, there are commercial benefits to be gained from settling obligations of Chinese

In addition, for foreign companies with a growing presence in the country, adopting the RMB enables them to self-fund investments and/or expand their market share with greater flexibility than if they had to raise RMB from the market.

SWITCHING TO RMB Of course, as with any new initiative, there are challenges, including tax, legal, and operational issues that have prompted some companies to delay their full participation until some of the uncertainties are resolved.

The adoption of a new currency is not an easy task requiring Corporate Treasurers and Chief Financial Officers to assess the scope and cost of a move to RMB, as well as determining how precisely RMB can be leveraged to the benefit of their organisation.

Critical to this assessment is the fact that the internationalisation process is a policy driven initiative linked to China’s overall development goals. This requires a clear understanding of the RMB’s policy driven trajectory and the multi-faceted legal, regulatory and operational environment.

The launch and expansion of inbound and outbound investment programs for institutional investors are acting as a catalyst for market participants to use the RMB not just for trade settlement but also for investment, asset allocation and diversification."

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The first is China’s determination to use on-going financial reforms to pursue its national goal of growing a broader based consumer economy. A determination to internationalise the RMB as a means to economic growth goes hand in hand with the liberalisation of interest rates, the widening of the RMB trading band, the growth of the bond market and the development of a stronger institutional, regulatory and legal framework.

enterprises in RMB. Today, companies around the world are using the RMB to achieve better terms of trade with China and more effective treasury management of China-related cash pools.

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China Outlook

FIGURE 2: KEY CONSIDERATIONS FOR RMB INVOICING

Change Management Legal and Taxation

Accounting and Finance

Procurement and Sales

KEY CONSIDERATIONS TO START RMB INVOICING

USING RMB FOR COMPETITIVE ADVANTAGE Collections and Receivable Management

Operational Process and Procedure

FX Liquidity Management Risk Management

Source: Standard Chartered Bank

For example, while the RMB is a single currency, FX controls and regulations mean companies need to separate RMB funds into two distinct onshore and offshore pools. In practical terms, this means treating RMB as two currencies: CNY (renminbi held onshore) and CNH (renminbi held offshore).

Companies need to make every effort to stay abreast of regulatory developments. All of the major banks (local, international and Chinese) operating in Australia and legal and accounting firms with strong China capability are well placed to provide education and consultative support.

A recurrent theme in surveys undertaken over the course of the last two years in Australia is the importance of internal engagement and buyin to an RMB strategy. Ensuring that in-house operations and thinking are aligned across all parts of the organisation is a vital consideration.

22 | FTA Outlook 2015

There is also the more practical question of technology. Corporates will need to upgrade their treasury and accounting systems to make them RMB-ready. The good news is that developments at the market level such as the new RMB settlement platform set up by ASX/ Austraclear and Bank of China and the new RMB Clearing Bank arrangements in Sydney plus other policy initiatives put Australian corporates in a strong starting position.

Understanding all these changes is undoubtedly a challenging task and carries with it an element of risk. For many, there is a tendency take a reactive approach and neglect market trends. They are stuck in the rut of thinking that the western focussed market will remain dominant.

With the rise of the RMB and importance of Chinese companies to global supply chains set to continue, such hesitant companies run the risk of losing business as the ability to settle in RMB becomes not only a competitive advantage but a minimum requirement.

RMB is already a major trade finance and trade settlement currency. The continued breakdown of onshore/offshore barriers heightens the RMB’s use and importance as a treasury management currency. And ongoing financial reform and capital markets expansion mean the RMB’s progress as an investment currency is picking up pace.

Although still far from being an international currency comparable to the US dollar or euro, Australian companies should be paying close attention to these developments. The use of RMB is fast becoming both an immediate competitive advantage and vital to future strategy for companies with any form of commercial exposure to China.

ABOUT THE AUTHOR David Olsson is China Practice Consultant at King & Wood Mallesons. He chairs the private-sector led Australian RMB Internationalisation Working Group and the recently established NSW government steering committee to drive Sydney’s ambitions as an offshore RMB hub.

China Outlook

BRINGING CASH BACK FROM CHINA

BY MATTHEW CLARKE CFTP, GROUP TREASURER, INTERTEK GROUP

As a service provider, Intertek is not a capital intensive company. “Our biggest investment is our people,” says Matthew Clarke, the company’s UK-based group treasurer. “We’re in over 100 countries; we tend to be profitable in all those countries. The main treasury challenges lie in repatriating cash and profits back to the UK, as well as the currency risk management which arises from being in so many countries.”

As a result, when Clarke joined in 2010, increasing visibility over Intertek’s cash, and repatriating cash back to the UK more effectively were key objectives. But, with around £150 million held in almost 1,000 bank accounts, with over 100 banks around the world, gaining better control over the company’s cash would be a significant challenge.

“We had visibility through the accounting consolidation process once a month, but that couldn’t tell us in which banks the cash was held with or what currency it was in,” Clarke explains.

“It didn’t give us anything we needed to manage that cash from a risk management point of view.”

In order to increase visibility, Clarke oversaw the development of an online reporting tool which is used by the entities to report their bank balances.

The new tool provided the treasury team with weekly visibility over the company’s group wide cash. “Arguably, anything more than that is unnecessary at this time,” says Clarke. “It’s would be nice to know how much cash we’ve got in Bangladesh each morning, but I can’t really do a lot with it from London. SWIFT

The next step was to tackle the repatriation of cash. While some of Intertek’s entities were able to send surplus cash to treasury in the form of short term loans, others were subject to various currency restrictions. In the countries with freely convertible currencies, Intertek took advantage of cash pooling techniques such as zero balancing in order to replace manual cash movements with automated sweeping. Working with Bank of America Merrill Lynch (BofA Merrill) and Deutsche Bank the company implemented USD and EUR cash sweeping structures in Europe and North America.

In the meantime, the company began working to repatriate cash more effectively from countries with restricted currencies. A particular focus was China, where Intertek has over 100 offices and labs in more than 30 cities. China accounts for nearly 20% of the company’s revenue and a greater percentage of its operating profit and cash flow.

Until recently, cash had been repatriated from China in the form of an annual dividend. “We could have done it more frequently, but for us the process was quite onerous with numerous regulatory sign-offs,” says Clarke.

FTA Outlook 2015 | 23

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Knowing what I have once a week means that if there’s a significant market event I can quickly check how much I’ve got in a particular country and take some action.”

based daily reporting is expensive for so many bank accounts and not even available in some countries. Knowing what I have once a week means that if there’s a significant market event I can quickly check how much I’ve got in a particular country and take some action. We reserve SWIFT based reporting solutions for the accounts we can actually control from treasury.”

outlook2015

China Outlook

Intertek China

●

9,000+ people

●

30 cities,

●

Urumchi

100+ labs and offices

Beijing Tianjin

Shijiazhuang

Weihai Zhengzhou

Xian

Zhangjiagang Nanjing

Chengdu

Wuhu Wuhan

Dalian

Qingdao Rizhao Lianyungang Wuxi Suzhou Shanghai Hangzhou

Yuyao Ningbo Wenzhou

Kunming

Dongguan Guangzhou Qinzhou Beihai Hainan

“So we paid an annual dividend in June or July, and the cash would then start to build up over the course of the year. We would place the cash on deposit and achieve the regulated rate, but there wasn’t much else we could do with it.”

In order to send funds back to China, I can draw RMB direct down from my revolver and send it back for a period of time – or I can draw in USD and swap it into RMB. So there are options available and I’m very pleased with the outcome.”

24 | FTA Outlook 2015

In order to optimise its China balances, Intertek worked with BofA Merrill to put in place an entrusted loan structure allowing the company to move cash more effectively between entities.

But over the next couple of years, a series of regulatory developments paved the way for the company to move cash out of China more effectively.

The first significant development came in late 2012, when Intertek was invited by Bank of China to take part in a pilot cross-border inter-company loan programme being run by the Peoples Bank of China (“PBOC”). Under the programme, companies could apply for a quota for their onshore entities to lend to related offshore entities. “We did one of these transactions in Shanghai with Bank of China and then with the help of BofA Merrill we were able to apply the same process to the other provinces,” says Clarke. “We were one of the first ten companies to get the approvals in Shanghai, and the first in Guangzhou.”

Ningde

Xiamen Huizhou Shenzhen Yangjiang

Zhanjiang

The new structure, which was approved in April 2013, enabled the company to achieve a significant reduction of its trapped cash in China.

It did, however, have some limitations: loans had to be provided via a one year bullet arrangement and any cash returned early couldn’t be redrawn.

Further developments were to follow. When Intertek’s loans came up for renewal in 2014, greater flexibility was available: the company was able to use a revolver structure, whereby cash could be repaid and then redrawn as required.

The loans are also now subject to an annual review rather than annual maturity.

Further regulatory developments allowed the company to implement RMB pooling structures to concentrate cash in China. At the same time, the need for approval direct from the PBOC was relaxed, with companies now able to gain the necessary approvals via their banks.

As a result of these changes, Intertek is now putting the finishing touches on a structure which will allow funds to be swept automatically to an account in the UK once a week. A target balance of RMB will be left in the pool, and sweeping will take place on a one-way basis.

“It’s partly due to the timings,” says Clarke.

“At present we only have the one treasury centre, in London. By the time we know there’s a shortfall in China, it’s too late to fund with same day value.”

Instead, the company will rely on its cash flow forecast and target balancing structure to keep the necessary level of cash in China, and will send back cash manually if required.

The next piece of the puzzle was the effective management of the company’s RMB balances in the UK. When the company’s first loan quota was obtained in 2013, the company opened accounts in the UK so that cash could be converted to dollars or pounds using swaps in order to pay down loan facilities. Intertek has since opened a standard header account with BofA Merrill in the UK which will be linked to the China cash pool.

In the meantime, the company is also working to broaden its sources for RMB liquidity in the UK. “As our core revolver facility was up for renewal in 2014, I asked our core banks if we could have a separate tranche under that facility that could be drawn in either USD or RMB in the UK,” says Clarke. “In order to send funds back to China, I can draw RMB direct down from my revolver and send it back for a period of time – or I can draw in USD and swap it into RMB. So there are options available and I’m very pleased with the outcome. As far as we are aware this is the first time this has been done outside of Asia.”

Clarke says that the company’s strong local management and local finance team has been instrumental in the success of the project so far.

While there has been a lot of documentation to process, this has largely been handled by the company’s local teams. “On at least one occasion Bank of China arranged for our local team to meet with PBOC to talk through some of the challenges that arise and come up with solutions,” he explains.

“The international banks have helped a lot as well by streamlining documentary requirements.”

Looking forward, Clarke says there may be room for further improvement where other currencies in China are concerned. “Most of our revenue in China is in RMB, but we do have some USD income as well,” he concludes.

“There’s some new flexibility available in the Shanghai Free Trade Zone to make payments on behalf of and collections on behalf of. This will allow us to improve the efficiency of processing our foreign currencies in China – so that’s probably the 2015 project for the local team.”

ABOUT INTERTEK GROUP

If you looked at the situation 18 months ago and decided there wasn’t much you could do, you need to look at it again now because there’s quite a bit of flexibility available.”

Intertek Group plc is a leading global quality solutions company providing testing, inspecting and certification services across a wide range of industries. The company is listed on the FTSE 100 and employs more than 36,000 people in over 100 countries.

Cash management China

2013

2010

2014

• Pilot cross border RMB intercompany loans • RMB intercompany settlements

• Entrustment Loan • Annual dividend

• Domestic RMB pool • Cross border RMB sweep • RMB revolver in UK

China cash as % of China annual revenue

30% 25% 20% 15% 10% 5% 0%

Dec-09

Jun-10

Dec-10

Jun-11

Dec-11

Jun-12

Dec-12

Jun-13

Dec-13

Jun-14

FTA Outlook 2015 | 25

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As an early adopter of the new regulations, Clarke has a clear insight into the impact the latest developments have had for cash management in China. “In the last 24 months there has been a real drive to internationalise the currency,” he observes. “There are now quite a few options available. Eighteen months ago, most companies were broadly taking the same approach – but today companies are using a lot of different products.”

For other companies operating in China, Clarke suggests that the recent regulatory changes make this a good time to review existing cash management processes. “If you looked at the situation 18 months ago and decided there wasn’t much you could do, you need to look at it again now because there’s quite a bit of flexibility available,” he says.

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Working Capital Outlook

SUPPLY CHAIN FINANCE– OPPORTUNITIES & CHALLENGES FOR TREASURERS AN INTERVIEW WITH ANZ

BY STEPHEN BARNES FFTP, DIRECTOR, BYRONVALE ADVISORS

Globalisation has dramatically altered the supply chains of corporations. Goods are ‘now made in the world’ with design, manufacturing and assembling happening in multiple countries before the final sale to customers. ” 26 | FTA Outlook 2015

Supply Chain Finance (SCF) is a term that is gaining a lot of attention and momentum at present. So I talked to Catherine Manallack and Ryan Fernandes, two ANZ Bank specialists in Supply Chain Finance, to understand more about SCF - why it is attractive at the moment and why treasurers should look at SCF as a tool in their treasury department’s management.

SCF can be traced back to the 1980s when competition in the apparel and textile industry intensified. A US industry group ‘Crafted With Pride’ commissioned Kurt Salmon Associates to do a supply chain study. The study found the length of the supply chain (from raw material to consumer) was 66 weeks, of which 40 weeks were spent in warehouses or in transit. The long supply chain resulted in high working capital costs and the lack of the right product in the right place at the right time.

Move forward 30 odd years and the world is in the midst of the Global Financial Crisis, credit and financing is tight, everyone is using computers and technology advances are moving at lightning speed.

Globalisation has dramatically altered the supply chains of corporations. Goods are ‘now made

in the world’ with design, manufacturing and assembling happening in multiple countries before the final sale to customers.

SB: Catherine, what is your elevator, layperson description of what Supply Chain Finance (SCF) is?

CM: "SCF provides cost effective liquidity for open account trade flows between buyers and suppliers. The key to SCF is that the supplier is able to access funding which leverages the buyer’s credit rating. SCF is run through smart technology linking the buyer/supplier and provides for Days Sales Outstanding and Days Payable Outstanding to be improved and for customers to unlock working capital, reduce costs and risks."

SB: Why, now, do you think SCF is becoming increasingly prevalent? What factors have brought this about?

RF: “We have been operating on Letters of Credit and funded solutions for a long time, but the GFC was the tipping point when companies started to want to actively manage their working capital. From an external lender perspective the supply chain itself is changing

– it has gone a lot more global, there is much more fragmentation with corporates trying to manage suppliers and customers in many different locations. There is more risk that companies are looking to manage.

I think the need for liquidity has become a priority, especially when dealing with counterparties in Asia for example where their cost of funding or access to liquidity may not be as reliable so they are looking to benefit from better, cheaper funding. Another impetus to SCF has been advancement in technology compared to ten years ago.”

CM: “Companies now have a mandate to look for alternative sources of funding and not be so reliant on debt, and look at ways to fund themselves in ways that are more aligned to the trade flows of the company.”

RF: “The regulatory landscape has also changed, and with changes like Basel III that is coming up that will potentially push the cost of vanilla debt up, companies are looking for smarter solutions.”

SB: When you call a Treasurer to ask to see them about implementing a SCF process, what are the reasons they would want lock in time to see you?

CM: “It provides flexibility. If you are a buyer, it gives you flexibility in that you can change your payment terms with suppliers, and it gives you the flexibility to reduce the risk in your supply chain by allowing suppliers to have access to liquidity.”

RF: “It may also affect your gearing ratios because SCF may not be seen as debt (subject to auditors opinion), and it may help you negotiate better pricing from the supplier. Also from a risk management perspective, especially if you are dependent on a few suppliers and the suppliers are struggling to get enough liquidity, you can help inject liquidity into their business and make them and the supply more certain.

It also brings a lot more visibility and efficiency to your account payables or receivables.

Everyone can see when invoices are approved and paid, and with the technology nowadays everyone can see at what stage the invoice is at.

Buyers want to extend their payment terms as far as possible, and sellers want to shorten their payment terms as much as possible.

SCF facilitates both these aims.”

CATHERINE MANALLACK GLOBAL PRODUCT MANAGER, SUPPLY CHAIN FINANCE, INTERNATIONAL & INSTITUTIONAL BANKING, ANZ Since joining in 2008, Catherine is responsible for structuring innovative supply chain finance solutions, assisting clients to maximise efficiencies while reducing risk within their business. With an emphasis on growth throughout Asia, Catherine draws on her extensive knowledge of legal, technology and country regulations to ensure ANZ’s capabilities are fit for market. Catherine holds a Bachelor of Commerce (Finance / Economics) from Monash University.

RYAN FERNANDES

outlook2015

GLOBAL PRODUCT MANAGER, SUPPLY CHAIN FINANCE, INTERNATIONAL & INSTITUTIONAL BANKING, ANZ With over 10 years’ experience, Ryan is responsible for deploying and implementing domestic and cross border Supply Chain Finance capabilities across the ANZ network of 33 markets. Ryan works with large corporate clients to help them optimise working capital, manage risk and achieve greater operational efficiencies across their financial supply chain. Ryan holds a Bachelor of Commerce and Master of Science in Technology Management & Systems from Monash University.

FTA Outlook 2015 | 27

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Working Capital Outlook

SB: I suppose from a treasurer’s perspective and as a supplier, having the bank in the middle ensures I’m going to get paid, which may be more important than the reduction in DSO or the lowering of the cost of funds.

CM: “SCF facilities that we put in place are limited recourse agreements – we don’t take performance risk if say the product doesn’t work, we take the default risk only.”

SB: SCF facilities also change the relationship dynamic between the buyer and seller – the seller doesn’t have to worry that every time the buyer places an order that they may not get paid or not paid when the invoice is due. There is no requirement for additional collateral to support the purchase or additional terms and conditions.

RF: “Correct, it’s not all about the financing – it impacts the other aspects like the relationship and even pricing of the product.”

CM: “If you’re a supplier and you’re tendering for a contract with a buyer, you don’t have to compete on price, and you may be able to offer the buyer better payment terms than the other tenderers.”

On the seller side you may be able to access the buyer’s lower cost of debt, especially if the buyer is a far bigger entity as the SCF cost of funds utilises the buyer’s cost of funds based on the buyer’s payment risk. It can also improve your liquidity by reducing your DSOs (Days Sales Outstanding).”

SB: I hear SCF being described as a win: win for both the supplier and the buyer. How is this so?

CM: “Buyers want to extend their payment terms as far as possible, and sellers want to shorten their payment terms as much as possible. SCF facilitates both these aims.

Buyers can negotiate longer payment terms with the supplier, but for the supplier they can access their receipt of funds as soon as the buyer accepts the invoice and loads it into the technology platform.”

28 | FTA Outlook 2015

SB: What tips would you give corporate treasurers who were looking at implementing a SCF process in their organisation? How would you help them sell a SCF process into their organisation?

RF: “The first thing we would ask you is what your drivers are for implementing a program.

We would look at how a SCF program would unlock some working capital for you and use SCF as the enabler. We would talk to you about how you would roll the SCF process out in your organisation. Who was going to ‘sponsor’ the SCF program at a C-level in the organisation?

You would also need to understand the drivers within the other parts of the business such as accounts receivable, procurement or finance area so you could demonstrate the benefits to these areas.

Engage your legal team and auditors early on and get them comfortable with the contracts

and the implications of the contracts. Lastly get alignment of KPIs to ensure the success of the SCP process.”

SB: You mentioned getting the legal team and auditors engaged early. Why? What types of things as a treasurer should I be aware of that the legal team or auditors may come back with?

CM: “Legal is going to be looking at the assignment issues. With regard to the auditors, these SCF contracts are often deemed to be balance sheet effective. On the buyer side it may change the mix between trade payables and shortterm debt. On the supplier side the mix between trade receivables and cash.”

RF: “Each auditor may have a slightly different view as to how the SCF contracts should be treated. They will also be interested in the legal aspects and the fee and interest components.”

CM: “How is this different from factoring? It’s different in a number of areas. Rather than looking at a pool of debtors or the whole debtor book, it looks at discrete debtors – chunky individual debtors. It is limited recourse typically – so the

Lastly it is generally cheaper than factoring due to the discrete debtors with generally better credit rating than the pool of debtors.”

RF: “On the payable side, it is more about selling the benefits to your suppliers, particularly if they are in different markets. Treasurers ask how they go about selling the SCF to the suppliers.”

With working capital management a priority of Boards and senior executives, Supply Chain Finance is a useful tool in managing working capital, with the additional benefits of assisting other areas of the organisation such as procurement, and sales, the reduction of risk, and through the use of technology become operationally more efficient and effective. Through the implementation of the SCF process, treasurers are value-adding to the organisation and broadening their knowledge and understanding of the entire enterprise.

ABOUT THE AUTHOR Stephen Barnes has worked as a corporate treasurer, capital markets consultant, CFO, company director, and currency and derivatives trader, and is the immediate past Vice-President of the Finance and Treasury Association.

Through the implementation of the SCF process, treasurers are value-adding to the organisation and broadening their knowledge and understanding of the entire enterprise.”

FTA Outlook 2015 | 29

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SB: What sort of push back questions do you get from potential clients?

bank takes on the debtor’s insolvency risk and not your insolvency risk (in a seller-led SCF facility).

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Debt Markets Outlook

DEBT MARKETS IN 2015 – TIMING WILL BE EVERYTHING

BY STEPHEN BOYD, HEAD OF CORPORATE DEBT MARKETS ORIGINATION, NATIONAL AUSTRALIA BANK

The outlook for global debt markets in 2015 poses an interesting dynamic between fundamental and technical market forces, with the winning influence likely to shape market conditions in the year ahead.

Undoubtedly, the high level of global investor liquidity competing for a relatively scarce universe of corporate exposure will continue to underpin the favourable issuance environment we have experienced over the past 18 months. However, despite this positive technical market backdrop, headwinds are likely to arise over the course of 2015 as global markets digest event driven volatility, the reality of slower global economic growth, particularly in Europe and the impact of the impending rise in US interest rates.

Timing to market to take advantage of windows of relative market stability is likely to be of greater importance in 2015.�

30 | FTA Outlook 2015

On the whole, the outlook remains positive and global debt markets are expected to continue to provide constructive issuance conditions for corporate borrowers in 2015, with a wide array of funding options available. However, as we have seen recently, market conditions remain susceptible to sudden shifts in investor sentiment and associated periods of heightened volatility. As such, timing the market to take advantage of windows of relative market stability is likely to be of greater importance for issuers in 2015.

UNDERSUPPLY OF CORPORATE CREDIT While the majority of 2014 provided a relatively stable market backdrop - ideal for primary issuance, a key theme across global debt markets has been

the general lack of corporate new issuance relative to demand. This is in part a result of the prudent funding strategies adopted by corporate Australia to strengthen their balance sheets over recent years - diversifying sources of funding and extending debt maturity profiles, but also reflects the lack of credit growth seen amidst limited capital expenditure and sluggish merger and acquisition activity.

FIGURE 1. CREDIT GROWTH REMAINS LIMITED

BUSINESS CREDIT GROWTH Year-ended

%

%

20

20

10

10

Business 0

-10

0

-10 2002 2006 2010 2014 Sources: APRA; RBA

This theme is expected to continue across corporate Australia generally into 2015; however a key change anticipated to result in a material increase in additional supply is likely to arise in the form of the privatisation of government owned assets.

Privatisations such as the proposed sale by the New South Wales and Queensland government of their respective “Poles and Wires” electricity transmission and distribution businesses represents a significant amount of potential new financing. While the associated increase in funding requirements tied to these prospective privatisations can be adequately met through the bank and various global debt capital markets without materially impacting the capacity for other issuers, borrowers will need to consider their targeted debt raising timeframes and sequencing of markets within the context of avoiding competing with these larger financings, particularly utility and infrastructure borrowers of a similar nature.

HIGH LEVELS OF INVESTOR LIQUIDITY SUPPORTING ISSUANCE Throughout 2014 Australian corporates enjoyed the benefits of having a choice of competitive funding alternatives across global markets. Tight credit spreads, coupled with low base interest rates and a high level of investor liquidity combined to set a highly attractive environment for both inaugural and repeat issuers.

The historically low interest rate environment has driven investors to seek yield by increasing the duration of their exposures and by investing further down the credit rating spectrum. Domestically, this has seen the rise of BBB-band rated issuance and also led to an extension of the ‘sweet spot’ of the A$ MTN market for corporate issuance from 5 to 7 years, and further resulted in some encouraging signs of investors increasing their willingness to provide tenor out to 10 years.

FIGURE 2. BORROWERS CONTINUE TO DIVERSIFY FUNDING AMIDST A BROAD CHOICE OF COMPETITIVE ALTERNATIVES EMTN 43% A$MTN 27%

~A$35bn

USD 8%

USPP 22%

Source: Bloomberg, Private Placement Monitor, NAB

The traditional debt markets accessed by Australian corporates – loans, A$MTN, EMTN, 144A and US Private Placement are all expected to offer competitive financing alternatives in 2015, providing corporate treasurers choice in terms of both markets and execution.”

In the Euro market, which has seen notable growth in issuance from Australian corporates over the Source: Bloomberg, NAB Debt Markets Origination last two years, traditional investors of publically Page 2 issued benchmark bonds are now seeking to further diversify their portfolios and increase their corporate exposure via participating in private placements, sub-benchmark issuance and Institutional Term Loans. This trend is expected to continue, further underpinned by systemic liquidity generated by the expansion of ECB’s Quantitative Easing programme.

Similarly, in the US Private Placement market – a core source of longer term funding for Australian corporates, a structural lack of supply has seen investors provide more accommodative and flexible structures such as providing foreign currency, longer delayed funding and non-standard tenors, allowing issuers to further tailor their issuance.

While a potential increase in financing activity is likely to draw additional focus on execution, ample liquidity and a search for yield will continue to offer constructive issuance conditions for corporates in the medium term. The traditional debt markets accessed by Australian corporates – loans, A$MTN, EMTN, 144A and US Private Placement are all expected to offer competitive financing alternatives in 2015, providing corporate treasurers choice in terms of both markets and execution.

outlook2015

In addition to historically low yields, a common theme across debt markets overriding corporate issuance has been the heavy oversubscription of transactions, which has subsequently led to scaling of investor allocations below their desired exposure. Aided by excess liquidity created via supportive monetary policy, the high level of investor demand relative to new issuance supply has driven a number of positive developments for corporate issuers as investors seek ways to obtain their desired level of corporate exposure, creating an increased number of funding options and more issuance flexibility.

Figure 2. Borrowers continue to diversify funding amidst a broad choice of competitive options

FTA Outlook 2015 | 31

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Debt Markets Outlook Figure 3. Markets are displaying an increased susceptibility to periods of volatility

FIGURE 3. MARKETS ARE DISPLAYING AN INCREASED SUSCEPTIBILITY TO PERIODS OF VOLATILITY 30

120

25 100 20

15

80

10 60 5

40 Jan-14

Mar-14

May-14

Jul-14

Sep-14

Nov-14

5yr Australian Investment Grade iTraxx (LHS)

5yr European Investment Grade CDX Index (LHS)

5yr North Amercian Investment Grade CDX Index (LHS)

Chicago Board Options Exchange Volatility (VIX) Index (RHS)

0

Source: Bloomberg, NAB Source: Bloomberg, NAB Debt Markets Origination

Page 3

INCREASED POTENTIAL FOR PERIODS OF HEIGHTENED VOLATILITY

Looking ahead into 2015, global markets are likely to display an increased focus on events surrounding geopolitical tensions, slower global growth and other headline risks such as weaker oil prices and their associated repercussions.”

32 | FTA Outlook 2015

In recent times a number of geo-political events that could have destabilised markets had little effect on market sentiment, with investors seemingly increasingly hardened to this peripheral noise, with little change in investor sentiment seen. However, collectively these events, coupled with emerging concerns of slower global growth, eventually resulted in a softening of investor risk appetite and increase in volatility, culminating with the ‘Flash Crash’ experienced in mid-October in the US Treasury markets which had broader adverse effects on fixed income market conditions.

Looking ahead into 2015, global markets are likely to display an increased focus on events surrounding geo-political tensions, slower global growth and other headline risks such as weaker oil prices and their associated repercussions. In addition, any unexpected change in the projected path of the US Fed Fund Rate and/or other change in central bank intervention will be closely monitored, with any unforeseen shift viewed adversely likely to similarly cause a market disruption or impact liquidity.

Underpinning this heightened focus is a common view that the sustained rally in credit spreads globally over the past 18 months is overdue for a correction and the possibility that this correction could be major. In addition, there is growing concern in the Euro and US markets that increased banking regulation surrounding Basel III capital requirements, Volcker Rule and other trading restrictions may have the unintended consequences

of increasing market volatility - exacerbating credit spread weakness through a lack of liquidity and at the very worst potentially leading to frozen capital markets. Liquidity returning to the secondary market is integral to markets recovering following a destabilising event, and if these concerns eventuate this could lengthen the time needed for markets to recover and normalise - potentially leading to extended periods of market dislocation, associated higher credit spreads and increases in new issuance premiums required.

SUMMARY The heightened susceptibility of markets to an adverse change in sentiment will be a key consideration for borrowers planning to issue into the debt markets during 2015, with issuers recommended to position themselves with adequate flexibility and the ability to move quickly in order to take advantage of constructive windows of opportunity for issuance. However, the strong lending appetite of banks and global debt investors alike for high quality corporate exposure is expected to continue to support a positive borrowing environment. To that effect, corporates seeking to raise funds should continue to have a wide array of competitive local and offshore debt market alternatives open to them in 2015, and we expect that short of a marked deterioration in the broader environment, the structural under supply of corporate borrowing across global debt markets and the associated scarcity factor should ensure transactions remain well supported throughout 2015.

M I SSE D AN EVENT?

Watch it in FTA’s ftaacademy.com.au

outlook2015

Career Feature

A GLOBAL FINTECH CAREER IN THE FRONT LINES OF GENDER DIVERSITY

BY KIMBERLEY COLE, HEAD OF SALES SPECIALISTS, ASIA, THOMSON REUTERS

The two regions that have the most companies complying with regulations dealing with gender diversity also have the fewest controversies so perhaps another good reason to drive for more diversity.”

Source: Thomson Reuters, Climb to the Top Study 34 | FTA Outlook 2015

Diversity and women in leadership are topics close to my heart. They attract a lot of column inches but in my view still not enough action, and certainly not enough results. The pace of change remains glacial.

There has been a focus on women on Boards and we have seen slow improvement but the executive ranks now pose the bigger challenge (see Figure 1).

My own journey has been a positive one and one that has allowed me to become a truly global citizen in what is increasingly an interconnected world.

However, the question of how to continue to climb the corporate ladder and help others is often full of conflicting ideas and advice.

Gender diversity is in the spotlight and we have both men and women involved in the cause. We have the He for She campaign with the wonderful speech by the actress Emma Watson, the great work in Australia by the Male Champions of Change and many publications now focused on raising the gender issues and pushing for change from The Women’s Agenda to Women on Boards. Still progress is slow. Different perspectives are crucial to limit group think shown often to be the cause of corporate risk issues. Women have been noted to challenge traditional thinking in the Boardroom, and being associated with lowering of corporate controversies.

In our Thomson Reuters Climb to the Top study we look at the rate of adoption over the past five years by companies of processes to promote

diversity and equal opportunity to see if any link exists between the number of controversies published in the media relating to diversity and equal opportunity. Although across the board Asia Pacific companies have shown increased implementation of processes for equal opportunity and diversity, Australian companies have shown the greatest improvement, followed by Indian and South Korean firms.

It should be noted that the dramatic rise in Australian companies having such processes and policies is driven by the “comply or explain” approach adopted by the Australian Stock Exchange in January 2011 in which companies disclose in each annual report the objectives for achieving gender diversity.

You can see in Figure 2 that the two regions that have the most companies complying with regulations dealing with gender diversity also have the fewest controversies so perhaps another good reason to drive for more diversity.

However, it could be argued that training has done more to develop women to better succeed in their current organisation and we have done little to adapt or change organisational cultures to accommodate more flexibility or inclusiveness.

A study published in December 2014 by Oliver Wyman, a consultancy, found that the proportion

Global Trends in Board Diversity 2009 – 2013 (Percent)

64%

59% 56%

62%

Corporate Diversity Policy and Processes Adoption by Region 80% 70%

56%

60% 40%

40%

44%

48%

51%

50% 40%

13%

13%

15%

18%

20%

2009

2010

2011

2012

2013

30% 20%

Companies with >20% women on the board

10%

Companies with >10% women on the board

2009

Companies with any women on the board

2010

2011

2012

2013

EMEA

Global Trends in Board Diversity 2009 – 2013 (Numbers) 4109

Asia Pacific

4255

Corporate Diversity Compliance and Controversy by Region

3946

1731

2099

2336

2548

1978

2710

2155

1230 403

1503 486

1743 600

746

863

2009

2010

2011

2012

2013

Companies with >20% women on the board Companies with >10% women on the board

Number of Companies

3066

2000

60 50

1500 40 1000

30 20

500 10

Companies with any women on the board

Number of Controversies

3724

Americas

ASSET4 Universe

0

0 Asia Pacific

Figure 1 (a) and (b)

Americas

Total Does the company describe, claim to have or mention processes in place to drive diversity and equal opportunity?

Does the company comply with regulations regarding the gender diversity of the board?

Is the company under the spotlight of the media because of a controversy linked to workforce diversity and opportunity?

Figure 2 (a) and (b) FTA Outlook 2015 | 35

outlook2015

of women on executive committees of big financial institutions at 13%, having risen by only 3 percentage points between 2003 and 2013. At this rate it will take women 120 years to achieve executive parity! However, Australia is 5th in the ranking of Exco members in front of the UK, USA, Singapore and HK. What will it take to move faster and how and why do we help women on the journey?

EMEA

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Career Feature

Returns Comparison: Women on Boards and No Women on Boards to Benchmark 200

200

150

150

100

100

50

50 2009

2010

2011

2012

2013

10% Women on Boards MSCI WORLD 0% Women on Boards Thomson Reuters Global

50

50

40

40

30

30

20

20

10

10

0

0

-10

-10 2009

2010

2011

2012

2013

>10% Women on Boards Difference to MSCI World 0% Women on Boards Difference to MSCI World Source: Thomson Reuters Datastream

of this was a global workforce who travelled and was sent on assignment which removed boundaries and nationalistic sentiments. Our Melbourne office was a united nations with citizens of USA, Spain, Poland, NZ, South Africa, Hong Kong, Malaysia, Korea and a couple of Aussies. So cultural diversity was always there and my view that globalization and global mindset are key success factors for companies and individuals started then.

A global mindset and cultural diversity I think can also help us in the journey to improve gender diversity. As a company we institute programs globally with a local overlay. We have a strong focus on emerging women leaders with 120 women each year progressing through an 8 week program. We have strong support from the top of the organisation and mandates on diverse slates among other initiatives.

So to continue the journey, from Melbourne I focused on gaining a role in Singapore to build my exposure to Asia. To win this role I had already moved into a sales position managing my own sales territory and book of clients, with clear goals on revenue and retention along with customer satisfaction.

I knew frontline experience was a key criterion for progression. After this I set my sights on head office in London and to expand my experience from sales to a more strategic role in product management. I secured a role as Product Manager for Commodities and Energy. In this role I learned a lot about the end to end process of data collection and distribution which is at the heart of our business.

Figure 3

My career began in Melbourne. Leaving Monash University with my Bachelor of Economics I secured a role at Reuters as a client specialist. My role was to provide training and support on our systems and content to all the end users from traders to brokers including corporate treasurers. Reuters was a very global organization, and diversity and “freedom from bias� were core and part of our DNA and the Trust principles that the company was built on.

This all stems from our editorial background for unbiased and accurate reporting. The demonstration 36 | FTA Outlook 2015

After a couple of years in that role I was transferred to transaction products to lead product management of the next version of our FX dealing service, the first electronic dealing service in the world and one of the main revenue streams for the company. Commodities and Energy was high growth but our transaction products were highly strategic and attracted board level attention. This was a fascinating role where customer engagement to build our next generation product was key.

During this time in the UK I was also lucky enough to give birth to both my daughters. Reuters had a scheme that meant maternity provision was better

than the statutory requirements with 21 weeks paid and 15 unpaid allowing most mothers a great opportunity to balance birth and a successful return to work if they wished and the returnship was high.

I remained career focused and had the belief that the corporate norm required me to work full-time in order to keep progressing. However understanding the challenges has meant a desire to look for ways to support women who want more flexibility so we maintain talent. One example during my time as Head of Sales for Aust & NZ was when 2 of my best AM’s wanted to return to work 4 days a week following their maternity leave. Both were excellent at collaborating and communicating with their broader account teams and ensured full knowledge and coverage even when they were not in the office.

One customer complained when initially told of the 4 day coverage however after a 3 month trial was happier than he had been with all previous account managers. So supporting flexible work patterns and continuing to sponsor career progression was something I focused on and feel was well informed by my own experience.

After almost 6 years in London I returned to work in Australia. Firstly, based in my old hometown of Melbourne to move back into a sales management role for the southern States and then to Sydney to manage sales for Australia and New Zealand.

Returning to Australia was a great joy but after 5 years my husband and I were ready for the next move. This was a surprise to many and needed to be stated openly or else the assumption would have been that I had done my overseas posting and was now home for good. I was also fortunate to have a globally mobile husband who managed to move his career in parallel.

My journey has allowed me to develop certain skills and qualities of leadership that I have found valuable in dealing with diverse teams. Generally my style would be assessed as one with more traditional

Global mindset is defined as one that combines an openness to and awareness of diversity across cultures and markets with a propensity and ability to see common patterns across countries and markets. In a company with a global mindset, people view cultural and geographic diversity as opportunities to exploit and are prepared to adopt successful practices and good ideas wherever they come from. Having a true global approach along with a focus on gender diversity I see being factors that will make companies and leaders truly sustainable and successful. The expectations of what a future leader will look like are expanding to require more and new traits. A global outlook is a key but I feel the next generation will value even more highly trustworthy, candid and collaborative leaders who promote flexibility and inclusiveness.

Their demands will require diverse leadership teams in order to meet all expectations.

The case for gender diversity has been well stated in many studies.

Companies with gender-diverse boards showed better performance results in the Climb to the Top survey of 4,255 companies in our 2013 ASSET4 Universe. Just over 2,700 report gender-diverse boards, but only 863 report 20% or more of their boards are female (see Figure 3). Once again this shows how much further we have to go to achieve real gender diversity at the Board or the executive table.

The case for gender diversity has been well stated in many studies.

Companies with gender-diverse boards showed better performance results in the Climb to the Top survey of 4,255 companies in our 2013 ASSET4 Universe.�

Will an increasing focus by investors on screening for companies with gender-diverse boards and robust diversity policies increase the trends? And if there is value-add, even alpha generation in having a diverse board, might even greater diversity increase the performance gap between companies that enable women to climb to the top versus those that do not?

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Our next posting was Hong Kong where we find ourselves again, having had 4.5 years along with a 3 year assignment in London only to return to the gateway to China 18 months ago. Moving between roles in marketing and now back into sales the journey has taught me a lot about life, leadership and being a global citizen with a global mindset.

leadership elements of confidence and career focus which I feel have helped me succeed in a very maledominated and sometimes aggressive environment.

But increasingly I see collaboration, team building and intuition are valued and coming to the fore.

What is clear to me is that a corporate culture that encourages flexibility will be better positioned for the future and enable improved talent management benefitting all – customers, share-holders and employees.

FTA Outlook 2015 | 37

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Finance Education Feature

ELEVATING AUSTRALIA’S FINANCE LEARNING STANDARDS IN HIGHER EDUCATION DEREGULATION OF THE HIGHER EDUCATION SYSTEM IS A TOPIC OF GREAT DEBATE IN THE CURRENT POLITICAL CLIMATE. HIGHER EDUCATION PROVIDERS, THE FINANCE PROFESSION AND OTHER STAKEHOLDERS MUST WORK CLOSELY TOGETHER TO ENSURE THAT FINANCE GRADUATES ARE PREPARED FOR THEIR CHOSEN PROFESSION AND THEIR ROLE IN THE WORKPLACE.

BY ASSOCIATE PROFESSOR KEVIN TANT FFTP, MONASH UNIVERSITY

INTRODUCTION The current deregulation process in higher education has its origins in the Bradley Review of Higher Education, initiated in March 2008 by the federal government “to examine the future direction of the higher education sector, its fitness for purpose in meeting the needs of the Australian community and economy, and the options for ongoing reform”.1

The finance learning standards needed to focus on acceptable minimum outcomes for the diverse range of finance degrees offered by all higher education providers in Australia.”

38 | FTA Outlook 2015

In December 2008 the Bradley Review recommended major reforms to the financing and regulatory frameworks for higher education including targets for participation in higher education, funding certainty, upgrade of infrastructure, reforms to student income support, improved pathways between the higher education sector and vocational education and training, promoting diversity and quality by allocating funding to student demand and the establishment of the Tertiary Education Quality and Standards Agency (TEQSA) (subsequently established under the TEQSA Act 2011)2 to enhance quality and support accreditation. Most of these items are still on the political agenda today!

Beyond the political debate, however, we are all aware of the significant effect education has in

developing graduates who are prepared for the rigours of a continuously changing professional and social landscape. Whilst the current political debate will ultimately have a profound effect on the delivery of higher education, our commitment to the profession and to finance and treasury education should not wait until the political issues are resolved. The world and key challenges facing treasury professionals will continue to evolve as the current higher education debate continues.

One of the primary objectives of higher education is the sustainable development of professional skills, capacity and capability to meet Australia’s future economic and social needs. Higher education has a responsibility to assist graduates develop awareness, knowledge, skills and values. From a professional and societal perspective, however, there is a need and responsibility to also take the educational experience from a theoretical to a practical level to make graduates “work ready”. Corporate finance and treasury professionals have a key leadership role to play in contributing to this transformative change as graduates must develop the business skills, behavioural skills and technical skills required for the future challenges of the profession for sustainable development of the economy.

DEVELOPMENT OF THE FINANCE LEARNING STANDARDS Increasingly over the past two decades one education debate has shifted towards graduates developing non-technical skills encompassed in concepts surrounding employability, generic skills, competency skills and graduate attributes; recognising their importance for workplace employment. Many employers suggest that more emphasis is still required in these areas.

The Australian Qualifications Framework (AQF) provides (generic) summary statements describing the typical learning outcomes a graduate should possess at various levels of educational qualification from certificate1 through to doctoral degree level.

TEQSA regulation requires higher education providers to comply with AQF and also benchmark graduate outcomes against other education providers of similar status. That is, higher education providers must demonstrate that their degree programs explicitly teach and assess the achievement of knowledge and skills specified by the AQF. Since 2010, the Australian Business Deans Council (ABDC)3 has been working progressively towards interpretation of the generic learning outcomes outlined under AFQ4 as discipline-specific learning outcomes for each of the business disciplines through working parties and expert advisory groups. Learning outcomes have been developed and endorsed by the ABDC for the disciplines of accounting (2011), marketing (2012), economics (2013) and finance (November 2014).

A key concern was to focus on “what should be” rather than “what is” to ensure that Bachelor and Coursework Masters graduates are equipped to handle the challenges and demands of the future and to ensure that the high quality of Australian higher education continues into the future.6

From a professional perspective, the Finance and Treasury Association (FTA) contributed significantly through the consultation process via its technical committee and through its Chief Executive Officer who was a member of the Finance Expert Advisory Group that recommended endorsement of the finance learning standards by the ABDC. In this way, the perspective of treasury and corporate financial risk managers was included in the finance learning standards including the clear need to take the educational experience from a theoretical to a practical level to make graduates “work ready” and in providing the definition below that reflected the practice of treasury professionals.7 “Finance is a discipline which describes, measures and optimises the financial relationship between the owners of capital (monetary assets) and the users of capital for the mutual benefit of both parties [while taking into account wider stakeholder interests]…Often the finance professional will ‘own’ the analysis, but management will ‘own’ the decision and will make that call in light of stakeholder interests other than the owners/users of capital (e.g. regulators, governments, communities etc.)”

Corporate finance and treasury professionals have a key leadership role to play in contributing to this transformative change as graduates must develop the business skills, behavioural skills and technical skills required for the future challenges of the profession for sustainable development of the economy.”

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The finance learning standards were developed through research into world practice, interpretation of the AQF and consultation with higher education providers, finance professionals5 and other stakeholders (including students).

In promoting diversity with higher education providers (for example corporate finance degrees, banking and finance degrees, financial planning degrees) the learning outcomes could not be prescriptive in terms of curriculum content. The finance learning standards needed to focus on acceptable minimum outcomes for the diverse range of finance degrees offered by all higher education providers in Australia (private providers, universities and TAFE). There is an expectation that providers of all finance degrees will produce graduates who perform beyond the minimum learning outcomes.

THE FINANCE LEARNING STANDARDS ENDORSED BY THE ABDC Figure 1 (see next page) reflects the integrated approach of each of the learning domains of the finance learning standards.

FTA Outlook 2015 | 39

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Finance Education Feature

Table 1 provides a summary of the finance learning standards and learning outcomes that graduates should possess by the time they graduate with their Bachelor or Coursework Masters Degree. 8

FUTURE CHALLENGES – NEXT STEPS Close collaboration with the FTA was crucial in the development of the finance learning standards.

It will be just as crucial in the development of a methodology for higher education providers to benchmark their degree; demonstrating outcomes against other providers of degrees with similar knowledge content (e.g. corporate finance, banking and finance, financial planning).

FIGURE 1: GRADUATES MUST USE MULTIPLE LEARNING OUTCOMES FOR ANY FINANCE TASK - FINANCE LEARNING STANDARDS

KNOWLEDGE

The finance learning standards provide guidance, but additional input from the FTA and other stakeholders is required to ensure that the benchmarking process demonstrates the outcomes reflected from both the education regulatory perspective and “work ready” perspective. Thus the continued input from the FTA and its members is sought to ensure that benchmarking is not an educational regulatory outcome, but the reality of preparing graduates for national and international employment.

When the ABDC endorsed the finance learning standards they recognised that the process needed to continue to reflect this reality and provided seed funds to commence a benchmarking process, similar to that undertaken at the time the accounting learning standards were endorsed.

This process will commence in 2015 and we seek your continued support and commitment to ensure that we take the educational experience from a theoretical to a practical level as graduates develop the skills to navigate the world of work, skills to interact with others and skills to get the work done.

ABOUT THE AUTHOR Kevin Tant FFTP, FFin, CPA is a former national councillor of the FTA (formerly the Australian Society of Corporate Treasurers), former editor of its journal The Corporate Treasurer and former Chairman of its education committee. He was Chair of the Finance learning Standards Working Party that developed the finance learning standards.

REFLECTION

APPLICATION REFERENCES AND WEBSITE DIRECTORY

FINANCE LEARNING STANDARDS

Academic Learning Standards for Finance in the Australian Higher Education Context. Available at http://www.abdc.edu.au/ pages/finance-learning-standards.html

Achievement Matters. Available at http://achievementmatters. com.au/

Australian Business Deans Council (ABDC) (2013). Teaching

COMMUNICATION AND TEAMWORK

and Learning Network Updates; Learning and Teaching

JUDGEMENT

Academic Standards Project. Available at http://www.abdc.edu. au/3.74.0.0.1.0.htm

Australian Government (2011), Higher Education Standards Framework (Threshold Standards) – F2012L00003. Available at www.comlaw.gov.au/details/F2012L00003/Html/Text#_

Source: Academic Learning Standards for Finance in the Australian Higher Education Context (2014) 40 | FTA Outlook 2015

Toc311791711

Australian Government Tertiary Education Quality

TABLE 1 - SUMMARY OF FINANCE LEARNING STANDARDS

and Standards Agency (2011). TEQSA Act. Available at http://

LEARNING OUTCOMES

www.teqsa.gov.au/about/legislation

BACHELOR DEGREE

MASTERS DEGREE

Graduates of a Bachelor degree majoring in finance will be able to:

Graduates of a Masters degree majoring in finance will be able to:

KNOWLEDGE

Explain the context and integrate theoretical and technical finance knowledge.

Explain the context and integrate advanced theoretical and technical finance knowledge including research and recent developments.

APPLICATION

Apply theoretical and technical finance knowledge to critically analyse financial data to solve rudimentary financial problems in straightforward contexts.

Apply advanced theoretical and technical finance knowledge to critically analyse financial data to solve sophisticated financial problems in complex contexts.

Prepare and execute a researchbased project, capstone experience or piece of scholarship.

JUDGEMENT

Exercise judgement, under guidance, to apply financial solutions using ethical, social, regulatory, economic, sustainability and global perspectives.

Exercise judgement, under minimal guidance, to apply financial solutions using ethical, social, regulatory, economic, sustainability and global perspectives.

3. ABDC is the authoritative and collective voice of pro vice-

COMMUNICATION

chancellors, executive deans and heads of all business faculties

AND TEAMWORK

Present and justify, orally and in writing, financial information and decisions in straightforward collaborative contexts involving specialist and non-specialist audiences.

Present, justify and defend, orally and in writing, financial information and decisions in complex collaborative contexts involving specialist and nonspecialist audiences.

Reflect on: • the nature and implications of assumptions and value judgements in analysis, • interactions with other disciplines, • historical and contemporary events affecting the finance profession, • responsibilities of their role in both the finance profession and in the broader society.

Reflect on and evaluate: • the nature and implications of assumptions and value judgements in analysis, • interactions with other disciplines, • historical and contemporary events affecting the finance profession, • responsibilities of their role in both the finance profession and in the broader society.

LEARNING Australian Qualifications Framework (AQF) Council (second

DOMAIN

edition) (2013), Australian Qualifications Framework. Adelaide, Australia: Australian Qualifications Framework Council. Available at www.aqf.edu.au

Department of Education, Employment and Workplace Relations (DEEWR) (2009), Transforming Australia’s Higher Education System. Canberra, Australia: Commonwealth of Australia. Available at www.innovation.gov.au/HigherEducation/ Documents/TransformingAusHigherED.pdf

Discipline Scholars Network (2014). Discipline Standards in Australia. Available at http://disciplinestandards.pbworks.com

Review of Australian Higher Education. Available at http://www. industry.gov.au/highereducation/ResourcesAndPublications/ ReviewOfAustralianHigherEducation/Pages/default.aspx

FOOTNOTES 1. See http://www.industry.gov.au/highereducation/ ResourcesAndPublications/ReviewOfAustralianHigherEducation/ Pages/default.aspx 2. TEQSA has a regulatory and quality assurance function with the primary aim of ensuring that students receive high quality education from any Australian higher education provider.

and schools in Australia. Currently over one in three Australian university students graduate from their schools (and three-fifths of all international university students in Australia).

4. Levels 7 (Bachelor Degree) and Level 9 (Coursework Masters Degrees).

5. This included individual finance professionals and the Chief Executive Officers of the FTA, FINSIA and FPA. 6. Education is Australia’s fourth largest export after coal, iron ore

is an element of greater subjectivity in terms of education quality.

7. Barbuio, F (FFTP and FCPA) (2014) - a senior Finance and Treasury professional.

8. The publication Academic Learning Standards for Finance in the Australian Higher Education Context (2014) provides illustrative

REFLECTION

examples to provide context to the finance learning outcomes. See http://www.abdc.edu.au/pages/finance-learning-standards.html

Source: Academic Learning Standards for Finance in the Australian Higher Education Context (2014) FTA Outlook 2015 | 41

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and gold. Quality of the first three exports can be determined; there

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Tax Outlook

GLOBALISATION AND PROFIT ALLOCATION – THE TAX NOOSE TIGHTENS

BY CHRIS KINSELLA, PARTNER AND STEPHEN JONES, SPECIAL COUNSEL, MINTER ELLISON LAWYERS

The integration of the world and digital economies has enabled multinational corporations (MNC's) to arbitrage their global tax exposure to an unprecedented level.

Governments around the world are scrambling to address this erosion to their tax base and Australia's support of the G20/OECD Action Plan on Base Erosion and Profit Shifting (BEPS) demonstrates its resolve to tackle those trends. ” 42 | FTA Outlook 2015

•

Interest Deductions (BEPS Action 4) – limit base erosion via interest deductions and other financial payments. In December 2014 the OECD issued a discussion draft on developing recommendations regarding best practices in the design of rules to prevent base erosion through the use of interest expense, for example through the use of related party and third party debt to achieve excessive interest deductions or to finance the production of exempt or deferred income, and other financial payments that are economically equivalent to interest payments.

•

The Digital Economy (BEPS Action 1) – in September 2014 the OECD issued a paper which highlights the many issues the digital economy presents for taxation, for example whether the current physical nexus tests for residence or the existence of a permanent establishment continue to have relevance in the digital economy. The OECD acknowledged the difficulties in defining a separate digital economy, and has accepted it is not possible to have a separate tax regime to 'ring fence' pure digital enterprises such as Google.

At its simplest it is preferable for such taxpayers to declare their profit in low tax jurisdictions rather than high tax jurisdictions.

But this brings risks to such taxpayers.

Governments around the world are scrambling to address this erosion to their tax base and Australia's support of the G20/OECD Action Plan on Base Erosion and Profit Shifting (BEPS) demonstrates its resolve to tackle those trends.

In July 2013 the OECD listed 15 action points requiring further work. Some of those action points are particularly relevant to finance and treasury operations including: •

Hybrid mismatches (BEPS Action 2) – neutralising hybrid mismatch arrangements. In September 2014 the OECD issued its hybrid recommendations which are aimed at neutralising tax mismatches in respect of cross-border arrangements between two or more jurisdictions where the arrangement is characterised differently in each jurisdiction for tax purposes.

Mark Konza, Deputy Commissioner – International, Public Groups and International at

the ATO is the person tasked with implementing the BEPS initiatives on behalf of the Australian Government. In 2014 he announced the ATO are currently investigating 86 multinational companies over their tax planning arrangements, and in particular, tax concerns over: •

migration of intangibles;

•

offshore marketing and procurement hubs;

•

debt pushdown/excessive interest arrangements;

•

tax arbitrage by hybrid entities; and

•

transfer pricing outcomes which are inconsistent with arm's length outcomes.

On 19 December 2014, the OECD released a discussion draft of proposed revisions to the OECD Transfer Pricing Guidelines (the Guidelines). These revisions are important as Australia's domestic transfer pricing rules (now contained primarily in Division 815-B of the Income Tax Assessment Act 1997) requires that the arm's length conditions identified in the domestic legislation should be interpreted so as to be consistent with the Guidelines.

A key focus of Division 815-B in working out whether an Australian member of a MNC gets a transfer pricing benefit, is to identify with specificity, the actual conditions operating between members of the MNC, then using one or more of the OECD recognised transfer pricing methods, identify the arm's length conditions, and to then price the transaction on the basis that arm's length conditions applied.

The substitution of arm's length conditions for the actual conditions is colloquially known as reconstruction.

In contrast, the new discussion guidelines include an entirely new section which provides not only for reconstruction of an arrangement between related parties of an MNC if the conditions operating would not have been entered into by independent entities dealing with each other at arm's length, but calls for the complete nonrecognition of the transactions for transfer pricing purposes if the transaction possesses fundamental economic attributes which would not be undertaken by independent parties acting in their own self interest.

The draft guidelines also propose special measures to address the BEPS initiatives for: (i) Rules to prevent BEPS by transferring risks among, or allocating excessive capital to, group members. This will involve adopting transfer pricing rules or special measures to ensure that inappropriate returns will not accrue to an entity solely because it has contractually assumed risks or has provided capital. The rules to be developed will also require alignment of returns with value creation. (ii) Rules to prevent BEPS by engaging in transactions which would not, or would only very rarely, occur between third parties. This will involve adopting transfer pricing rules or special measures to clarify the circumstances in which transactions can be recharacterised. (iii) Transfer pricing rules or special measures for transfers of hard-to-value intangibles.

It is now more important than ever for MNC's to carefully assess their transfer pricing positions and to ensure they have robust documentation which demonstrates the conditions operating within the MNC are arm's length, or if not arm's length, then appropriate adjustments have been made to ensure an arm's length outcome which complies with the new transfer pricing regime now in operation.

It is now more important than ever for MNC's to carefully assess their transfer pricing positions and to ensure they have robust documentation which demonstrates the conditions operating within the MNC are arm's length, or if not arm's length, then appropriate adjustments have been made to ensure an arm's length outcome which complies with the new transfer pricing regime now in operation. ” FTA Outlook 2015 | 43

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Under the transfer pricing rules that applied prior to the 2014 income tax year, the legislation did not specifically provide for 'reconstruction', and the relevant text in the Guidelines was that generally, tax administrations would not reconstruct the actual transaction unless the economic substance of the transaction differed from its form, or the arrangements viewed in

their totality differed from those which might have been adopted by independent enterprises and the tax structure adopted practically impeded the tax administration from determining an arm's length price.

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Cash Management Outlook

THE EVOLVING ROLE OF CASH AND LIQUIDITY MANAGEMENT

BY MICHAEL LEIGHTON AND NELS MORTENSEN CFTP, FIRST TREASURY

Following the GFC of 2008, the business environment for corporate treasurers was characterised by liquidity shortage, high volatility in exchange and interest rates and a widespread credit crunch. Suddenly no financial institutions, outside Australia at least, were “too-big-to-fail”.

The regulatory follow-ons (Basel III, Dodd-Franck etc.) have affected the way banks operate, further impacting corporates. Today, 6 years on, this has led to an increased importance in - and increased responsibilities for - Treasury in regards to the disciplines of cash and liquidity risk management. At the same time, Treasury faces increased pressure from their banks, regulatory authorities, rating agencies, management and board.

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

44 | FTA Outlook 2015

In this article we will look at the changing role of Treasury focusing on the disciplines of cash and liquidity management, as well as some bestpractise approaches, and by taking a more global look we will give a prediction of what may be coming next for Australian corporates.

Cash management was previously primarily viewed as a secondary task to Treasury, and the main purpose was “to know how much cash is in our bank accounts today” (or more likely “yesterday” or “last week”). Today, it is one the most important disciplines and has an impact on nearly all areas of the treasury. Cash management today entails the following areas:

• • • • • • • •

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

Especially the last item, working capital management (WCM), may be unexplored territory for most treasuries, but as more and more treasuries have optimised their other areas of cash management, the focus has shifted to WCM, which traditionally has been the responsibility of the financial controllers.

Due to the increasing responsibilities of Treasury throughout the company, treasury departments are at the same time becoming more centralised.

The main pillar of Treasury, the Finance Policy, is no longer a policy just for Treasury, but for the whole company. Key performance indicators (KPIs) are set up to ensure the entities and subsidiaries satisfy the demands of Treasury, so they can make the best use of cash and liquidity.

At the same time, centralisation of standard systems ensures automation, with incorruptible reporting and solid audit trails.

Historically cash management functions were decentralised in the company. The positive side of this is that local people could deal with local

issues and relationships were with local banks.

It could be said that with the move by many companies to do business with the developing countries that these positives are still there.

However, the requirements of Treasury today require centralisation.

Cash visibility is at the heart of cash management. Having control over the company’s cash gives a number of quantitative and qualitative benefits and often provides its own business case: • Fewer bank accounts reduce bank fees, reduce risk in their maintenance, and leave less idle cash • Control of the present cash in bank is a necessary starting point for cash flow forecasting • Control of the cash balance means less likelihood to need to draw on overdraft facilities • Control of the currency balances helps in the FX management • Control of cash can help to attain better ratings (and therefore cheaper funding) Companies should therefore keep banks and bank accounts to a minimum and keep account balances continuously updated in their systems.

Even a small improvement can facilitate huge savings for the company, and the business cases in this area are often compelling.

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

Finally, the forecast can also be useful to the CFO, strategy department, tax department and is also an integral part of a public rating process.

Rating agencies do not look at P&L or balance sheet items, their focus is liquidity.

Good cash visibility is an essential foundation to a good cash flow forecast.

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

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

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

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

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

Unfortunately, this is not an uncommon scenario.

A cash flow forecasting solution was set up with the ERP system providing the system support.

Bank balances and short term business flows FTA Outlook 2015 | 45

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Cash Management Outlook

came from the ERP and known and forecasted treasury flows were imported from the TMS. Longer term flows came from manual forecasts from 15 business units.

The cash float was immediately reduced by 2/3, and as the forecast could be drilled-down to currency, individual currency forecasts were used to find optimal terms for FX forward hedging. Short-term investments and loans were optimised and the forecasts could also be drilled-down to entity level, the subsidiaries could use the individual forecasts for their own purposes.

Initially manual forecasts were not optimal, but version-to-version and version-to-actual reporting was used to set up a “league table” of forecasting accuracy. This league table was 46 | FTA Outlook 2015

sent to the business units each month and within 6 months manual forecasting accuracy had improved enormously.

Liquidity management takes cash flow forecasting a step further. Liquidity not only includes cash, but also short-term investments, which can be easily converted to cash, and unutilised bank facilities.

The main goal in managing liquidity is to avoid financial stress (the inability to fund the daily business). The risk of financial stress is usually managed by means of the calculation of a liquidity ratio, i.e. the ratio of available liquidity to the company’s outgoings over a particular horizon. The ratio used and the horizon of the outgoings is dependent on the business and the company’s risk appetite.

Another benefit of proper liquidity management is that it can be used as a driver to improve the company’s ratings and therefore funding costs.

Good cash flow forecasting is an essential foundation of good liquidity management.

Other tools that can improve cash management, which we won’t go into too much detail on, are Internal Banks and Payment Factories.

These are rarely seen at a larger scale among Australian companies, but are widely used in Europe and the US.

and the systematic management around the sending of invoices, collections of payments due and in the management of disputed payments.

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

WHERE DO WE GO FROM HERE? When done right, setting up an Internal Bank can help optimise cash synergies across the business. An internal bank should be thought of as a real bank – it just happens to be internal and managed within the Group by Treasury. It should involve the design of new business structures, processes, organisational setup as well as a system to support the transactions being handled and executed via the internal bank.

Payment factories allow a company to optimise straight-through processing of their payment solutions via centralisation and automation of the payment process. It is most commonly channelled through a system in order to optimise automation. Payment factories might be in the perimeter of a traditional treasury area of responsibility, but it is imperative that Treasury is involved in the project of setting up the factory, and their skills can be extremely useful in the process.

Optimisation of collections and dispute management is the improvement of processes

The pressure for change can seem a little incomprehensible with today's strained budgets, ever changing regulatory and market environments, all the while trying to manage your day jobs at the same time.

Overall it is important that a coherent approach is deployed. It is often seen that companies focus on one problem at a time, potentially “burning bridges” in the process. As the potential benefits can be huge from optimising your processes, a good starting point is that Treasury formulates a Treasury Roadmap which should be based on a clear understanding of the overall financial objectives of the company as a whole.

As part of this, Treasury should be prioritising which initiatives (i.e. improve cash management and forecasting, bank account management, payment factory etc.) should be the focus for the coming years. Technology is becoming a more integral part of all aspects of the business, and this is ever true for treasury. It should be included as an integral part of the roadmap vision. This could include streamlining bank connectivity (i.e. SWIFT), closely integrating data sources (ERP integration), and implementing treasury, cash and working capital management solutions.

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Working capital management is another area which traditionally may not lie within Treasury.

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

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

The pressure for change can seem a little incomprehensible with today's strained budgets, ever changing regulatory and market environments, all the while trying to manage your day jobs at the same time."

FTA Outlook 2015 | 47

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Regulatory Outlook

REGULATORY REFORM: 2015 AND BEYOND

BY PIETER BIERKENS, EXECUTIVE DIRECTOR, RATES REGULATORY STRATEGY, CBA

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

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

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

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

48 | FTA Outlook 2015

As 2014 drew to a close, Australia’s Department of the Treasury announced a central clearing mandate for interest rate derivatives transactions denominated in A$ or ‘G4’ (Euro, Yen, British Pound, and US$) currencies, to apply to transactions between ‘the major domestic and foreign banks’.

Treasury also provided relief from trade reporting for financial services organisations that undertake small amounts of OTC derivatives activity, by allowing ‘single sided reporting’ to such ‘Phase 3B’ entities.

End-users such as non-financial corporations will be permanently excluded from the regulatory framework applying to OTC derivatives, given that ‘research indicates they don’t play a systemically significant role in the Australian OTC derivatives market’, where the eight largest dealers traditionally account for approximately 90 percent of the A$ interest rate derivatives market (AFMA). The immediate impact of the clearing mandate will be limited, as most inter-

Illustrating the concentration of derivatives activity among dealers, is a ‘non-dealer’ survey published last year by the Council of Financial Regulators (APRA, ASIC, RBA). Although larger non-dealers were over-represented in the sample, the respondents’ median outstanding notional of around A$10bn is a small fraction of the A$1.2tr average outstanding for a dealer in the Australian market (see Figure 1).

The survey further showed that a small number of non-dealers currently have client clearing arrangements in place.

In addition, a significant number of respondents reported they were at least considering central clearing, even in the absence of an actual clearing mandate. In so doing, they may seek access to optimal pricing and liquidity, even if this may not yet be reflected in current market conditions.

Similarly, price differentials between collateralised and uncollateralised transactions have prompted a number of financial institutions to start posting variation margin.

As for any clearing requirement applying to nondealers in the future, regulators will ‘continue to monitor the availability of client clearing for OTC interest rate derivatives and the incentives-led migration to central clearing, particularly by nondealers with access to sufficient liquidity’. They do acknowledge, however, that ‘for some non-dealers it is unclear if [the benefits of clearing] will ever be sufficient to offset the costs’ (Report on the Australian OTC Derivatives Market, 2014).

Barring a non-dealer clearing mandate taking effect, any end-user decision to clear, or post collateral when trading bilaterally, involves a careful weighing of among other things, liquidity costs, operational costs, and capital costs charged by the bank counter party. Generally speaking, only standardised and liquid derivatives transactions are clearable. Costs, risks, and operational aspects of setting up a clearing account will be weighed against any pricing and liquidity advantages to end-users that trade actively in those clearable derivatives.

The posting of collateral affects pricing on bilateral derivatives transactions. This dynamic changes as bank capital requirements, and approaches for measuring counter party credit risk change. Bank capital requirements may be impacted by recommendations of the Murray Financial System Inquiry.

Managing collateral presents its own operational challenges and risks, but some end-users will have the collateral decision made for them, by the Basel framework for margining of uncleared swaps.

THE MARGINING OF UNCLEARED SWAPS

Notional principal outstanding, September 2013

$b

$b Average

40

40

30

30

20

20

Median

10

10

0

0 All nondealers

Government Investment agencies managers

Smaller ADIs

Insurance Noncompanies financial corporations and super funds

Source: Regulators’ survey

Importantly for Australia, fx forwards, and the fixed physically settled fx transactions associated with the exchange of principal of crosscurrency swaps are exempt from initial margin requirements.

How the framework will take shape in Australia is not exactly known as yet, but any implementation is to be consistent with overseas regulations. Suggested collateral requirements may require some modifications to Australia’s legal framework, providing a challenge to the intended implementation date.

Besides the timing, the framework presents a number of other challenges to the covered entities. These include the daily posting of collateral, CSA agreements, limits on the reuse of collateral, the posting of initial margin on a gross basis, the modelling of initial margin requirements, and cross-border harmonization of rules, to name a few. ISDA has requested a delay in the global implementation schedule.

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In September of 2013, BCBS-IOSCO published its ‘Margin Requirements for Non-Centrally Cleared Derivatives’. They are to take effect from December of this year, for transactions between ‘financial firms and systemically important nonfinancial entities’: so-called ‘covered entities’.

Such transactions are subject to variation margin from December, and depending on the size of the entity’s derivatives book, initial margin as well.

Initial margin requirements are to be implemented incrementally, according to the nearby schedule.

FIGURE 1. AUSTRALIAN NON-DEALER RESPONDENTS’ OTC DERIVATIVES

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Regulatory Outlook

FIGURE 2.

Dec 2015

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

Dec 2016

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

Dec 2017

Dec 2018

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

Initial margin requirements are to be implemented as above, subject to a ¤50 m Euro threshold.

Importantly, the calculation of ‘outstanding OTC derivatives’ does include fx forwards and crosscurrency swaps, although these transactions are exempt from actual initial margin requirements.

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

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

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

One of the key planks of the global regulatory agenda, is addressing the issue of banks being

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

Dec 2019

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

‘too big to fail’. An important ingredient of this is an effective resolution regime, which should prevent a run by the firm’s creditors and counter parties.

In the absence of a cross-border regulatory framework of resolution of systemically important financial institutions, the Financial Stability Board (FSB) coordinated with ISDA the development of a Resolution Stay Protocol, signed late last year by eighteen major international banks.

The signatories agree on a stay of resolution in the close-out of derivatives contracts, deemed critical for the orderly resolution of the signatory banks. The FSB expects any adoption of the protocol, or more broadly, of the necessary contractual language on stays in resolution, to become more widespread, through marketbased regulation or market conduct regulation, in the near future.

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

Estimates suggest, however, that incremental collateral demand resulting from global regulatory reform is around $4tr (BIS), arguably a manageable number in light of the more than $50tr in outstanding high quality assets, or the annual $1tr net available issuance of AA and AAA rated government securities (IMF). In Australia itself, the supply of high quality assets ‘would appear sufficient to support current demand for collateral’ (RBA).

Notwithstanding a sanguine outlook for global collateral availability, market participants increasingly prioritize the optimal use of collateral. ISDA data suggest that one-third of market participants now see this as a front office function.

Increased regulatory scrutiny is also being directed to the global allocation to higher yielding, less liquid asset classes, by investors searching for yield in today’s low rate environment. An example is US mutual funds’ appetite for bank loans, an asset class whose net inflows in 2013 exceeded those of the entire decade prior.

This asset allocation coincides with a substantial drop in market making activity across many asset classes, including markets for corporate bonds. This raises concern for market pricing and liquidity, in the event of a sudden reversal of this investor demand.

‘The exits can get jammed unexpectedly and rapidly’, as RBA’s Guy Debelle put it late last year.

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

ACTIVE IN AUSTRALIAN MARKETS

Per cent

AUD bn

60

20

40

10

20

0

-10

0 2006

2008

2010

2012

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

four-quarter rolling averages

3

Australian banks’ net holdings

To some extent, the decline in dealer liquidity is a consequence of regulatory change.

The upcoming Volcker rule curtails banks’ ability to take proprietary risk, limiting dealer inventory to what is needed to service ‘reasonably expected near-term customer demand’.”

Source: BIS, 2014

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

FIGURE 3. AUSTRALIAN AND FOREIGN BANKS

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

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Treasury Outlook

ALIGNING THE TREASURY VALUE ADD FROM BACK OFFICE TO BOARD

BY ALISTAIR MCLEAN FFTP, GROUP TREASURER, METCASH LIMITED

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

Errors happen in Treasury, it is part of the job. Treasury disasters often begin with someone hiding simple errors which later become major problems.�

52 | FTA Outlook 2015

The philosophy for my Treasury team is quite simple: a well-functioning Treasury should never be noticed. At first this might seem a strange statement to make. However where all the risks within a Treasury have been managed appropriately, funding for the future is in place then Treasury is enabling the organisation to focus on what it does best which usually is to make money.

Throughout my career I have noticed the same thing about the best Treasury teams: they are generally highly regarded and visible (even if they are not noticed), they empower their people to manage risks and there is a real collective integrity to that team. A good treasury team will make risk management easily understood by the business without making things too technical.

So what can a Treasury team do to never be noticed? From my experience of working in Treasury teams over the last 15 years, I would give the following advice:

Add intellectual capital to everything which crosses your desk. Whether in person or by e-mail, I encourage everyone to question every interaction they have with others and try to ensure that they add something to the process.

Ask yourself whether that task is important: if yes always contribute something to further the process, if not ensure that the process does not need to be repeated.

Always put your hand up if a mistake is made.

Errors happen in Treasury, it is part of the job.

Treasury disasters often begin with someone hiding simple errors which later become major problems. Let someone more senior know immediately about any error and then together take the necessary steps to fix the problem.

Finally put a control in place to ensure the same error never happens again.

Make sure people understand what is important to you. Everyone you work with has something different which motivates them. Integrity is an important value to me, but many people in Treasury share this same value. In my dealings with others I try to ensure that they understand the importance of this value. I have always found it useful to be mentored by someone else whether that is done formally or informally.

When I find myself in a tricky situation I ask myself two questions: what would my Mentor do in this situation and how do I differentiate my

solution from that of my Mentor to ensure that solution I propose aligns with my values?

Never be frightened to put forward an idea.

Great ideas always come up in conversation and the key is to pick these ideas up and take them forward. Simply talking to both internal and external parties will often give you those ideas.

However, particularly when dealing with banks, if someone comes up with a truly proprietary idea then make sure that they are rewarded for this, rather than shopping that idea around.

Always speak up if you are not comfortable.

In any work environment it is important to understand what you are doing and why. If you don’t feel comfortable, try and establish the reasons and motivations behind that request.

Treasury disasters often arise where one person is able to manipulate another. I try to create an environment where my team feel that they can speak up, but at the same time know that there is someone else outside Treasury who they can talk to if they still feel something is wrong.

People are the key to long term sustainable relationships. One party cannot lay off risk without another party being willing to take it on. I believe that you need strong personal relationships with those in the market so that you can create a win-win situation for both parties. To this end it is important to know all the people who you deal with and to have regular face to face contact with them. Whatever you do, don’t hide behind long e-mail trails.

Don’t bypass controls. The older and wiser me knows that controls are there for a good reason. Almost every mistake in a Treasury can be traced back to a failure in control. By all means challenge them and then improve them or remove them if necessary, but whatever you do always follow controls.

So where is the value from the Operations team to the Board? A treasury department makes the average Board very nervous as it manages some very significant risks. A Board has no choice but to trust its treasury team. I often say that it is easier for a Treasury to deal billion dollar derivatives than order a box of pens, as long as it is done in line with policy.

A Board doesn’t want to see a treasury team who has significant control failures in their day to day operations. Every time an internal audit report picks up simple control failures a Board is less inclined to trust that Treasury team when it comes to managing the significant risks within the organisation. By following the advice above a Treasury operations team will gain the trust of their Treasurer, their Organisation and their Board thereby making themselves an invaluable asset to their organisation.

Become an expert.

This is one of the easiest ways to move your treasury career forward. Treasury is an environment which is constantly changing, therefore there is always the opportunity to personally learn and develop.”

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

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Become an expert. This is one of the easiest ways to move your treasury career forward.

Treasury is an environment which is constantly changing, therefore there is always the opportunity to personally learn and develop (and occasionally the opportunity for advancement and reward).

Be consistent. Treasury is about managing risks for the long term sustainability of an organisation. Whilst people may not always agree with your opinion, you will be respected for that clear and consistent message. Often you will find that consistency turns disagreement into agreement.

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

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

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

Phone | +61 2 9270 8115

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

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

Founded in 1999, Reval is headquartered in New York with regional centers across North America, EMEA and Asia Pacific.

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SWIFT Contact | Kees Middendorp, Commerical Director – Oceania Phone | +61 2 9225 8104 Email | kees.middendorp@swift.com Website | www.swift.com SWIFT is a member-owned cooperative that provides the communications platform, products and services to connect more than 10,500 banking organisations, securities institutions and corporate customers in 215 countries and territories.

SWIFT enables users to exchange automated, standardised financial information securely and reliably, thereby lowering costs, reducing operational risk and eliminating operational inefficiencies. SWIFT brings the financial community together to work collaboratively to shape market practice, define standards and debate issues of mutual interest. SWIFT is delighted to have been selected as the vendor for Australia’s New Payments Platform. With NPP, we will take a new journey with the Australian community.

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

Veda Corporate Ratings Contact | Brad Walters, Head of Rating Services Phone | +61 2 9278 7925 Email | brad.walters@veda.com.au

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

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

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

FTA Outlook 2015 | 55

Join a powerful network with knowledge gateways for treasury and financial risk professionals.

Finance and Treasury Association members are at the forefront of the key trends faced by the treasury and finance functions of major corporations.

Advance your career today with respected professional development and credentials, and apply for a certified membership.

Membership enquiries to

03 8534 5003

membership@fta.asn.au

www. finance-treasury.com

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