Atel Treasury Handbook 2014 by Treasury

Franรงois MASQUELIER

Technical and Financial Challenges of Corporate Treasury Function

ATEL Treasury Handbook First Edition 2014

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Technical and Financial Challenges of Corporate Treasury Function

By François MASQUELIER 2014

Preface When Francois did me the honor of asking me to preface his book I agreed immediately. Him as I and some others have as objective to better understand what a modern corporate treasurer. What exactly does a treasurer business? Must first analyze the financial risks inherent in the business activity of the company for which he works, which is then rests his offer policymakers a policy for managing these risks and must finally implement these strategies and express business requirements in an understandable way by what we call "the market". Finally, it must evaluate the appropriateness of its actions in terms of goals. The profession of corporate treasurer is most often not formally recognized, legally, let alone regulated. It is therefore up to us to establish the ethical rules of operation. We do in our everyday practice, but also by hosting Associations of Corporate Treasurers in both our respective host countries at European and global level: the adoption of best practices by market participants in this respect is an essential element of our approach. The work of Francois is in this context a great tool for all those who are entrusted with a mission treasurer. His contribution is all the more valuable it is the work of a professional whose message is practical, pragmatic, lived. We needed it. Hugues PIROTTE, Professor of Finance, Solvay Brussels School of Business School of Economics and Management (ULB)

Table of Content PART I INTRODUCTION TO THE CORPORATE TREASURY FUNCTION

1.1 1.1.1 1.1.2 1.2 1.2.1 1.2.2 1.2.3 1.2.4 1.2.5 1.2.6 1.3 1.3.1 1.3.2 1.3.3 1.3.4 1.3.5 1.3.6 1.3.7 1.3.8 1.4 1.4.1 1.4.2 1.4.3 1.4.4 1.4.5 1.4.6 1.4.7 1.4.8 1.4.9 1.5 1.5.1 1.5.2 1.5.3 1.5.4 1.5.5 1.5.6 1.5.7 1.5.8 1.5.9 1.6 1.6.1 1.6.2 1.6.3 1.6.4

18 18 19 25 25 25 26 27 28 28 29 29 29 30 31 32 33 34 34 35 35 36 36 37 38 39 40 41 42 46 46 46 47 47 48 49 50 50 51 53 53 53 54 55

INTRODUCTION EVOLUTION OF TREASURY FUNCTION VALUE CREATION IN THE TREASURY FUNCTION ORIGINS OF MODERN CORPORATE TREASURY MANAGEMENT DEFINITION OF THE CONCEPT OF TREASURY MANAGEMENT ORIGINS OF THE TREASURY FUNCTION CORPORATE TREASURER, A CONCEPT WIDELY OVERLOOKED IN MODERN ECONOMIC HISTORY TREASURER ASSOCIATIONS DEFINITION OF THE TREASURY FUNCTION GENERATION “X” EVOLVING ROLE OF THE TREASURER AND NEW CHALLENGES THE EVOLVING JOB OF THE TREASURER HYPER-‐SPECIALISATION OF THE TREASURER CHANGES IN THE ECONOMIC ENVIRONMENT IMPACT OF THE NEW INTERNATIONAL ACCOUNTING STANDARDS TECHNOLOGICAL DEVELOPMENTS TREASURERS, THE PRISONERS OF THEIR OWN SPECIALISATION TREASURY MANAGEMENT, A SEXY JOB THE FUTURE OF TREASURY MANAGEMENT THE TWELVE LABOURS OF HERCULES IN TREASURY CORPORATE TREASURER’S CHALLENGES FOR THE COMING YEARS MODERNISING THE JOB OF THE FINANCE DEPARTMENT PARALLEL BETWEEN THE EVOLUTION OF THE TREASURY MANAGER’S JOB AND THE CFO’S JOB CFO, THE GUARDIAN OF THE TEMPLE THE MODERN CFO’S OLYMPIC ORDEAL FUTURE CFO CHALLENGES AND OBSTACLES ADAPTING TO SURVIVE CFO’S FUTURE CHALLENGES THE ROLE OF THE TREASURER IN CORPORATE & FINANCIAL STRATEGY THE CORPORATE TREASURY’S ROLE IN TROUBLED TIMES FIRST WORLDWIDE CRISIS CONSEQUENCES OF A SYSTEMIC RISK BERMUDA TRIANGLE THE TREASURER’S ROLE IN TROUBLED TIMES “GET THE TREASURER ON THE PHONE, PLEASE!” WHAT HAS CHANGED FOR THE TREASURER THE TREASURY, A KIND OF ROYAL GUARD IT CREATES MORE VALUE TEMPLE GUARDIANS ECONOMIC CRISIS, WHOSE FAULT IS IT? LOOKING FOR THE CULPRIT OF THE CRISIS IASB, DESIGNATED CULPRIT TRANSPARENCY AND DISCIPLINE THANKS TO FAIR VALUE ANGLO-‐SAXON APPROACH TO ACCOUNTING VS. THE EUROPEAN APPROACH

1.6.5 1.7 1.7.1 1.7.2

WHERE IS THE END OF THE TUNNEL? CONSEQUENCES OF THE SUBPRIME CRISIS FOR CORPORATE TREASURERS A SPECIFIC CRISIS AT THE EPICENTER OF AN EARTHQUAKE REPERCUSSIONS FOR TREASURERS

56 57 57 57

2 PART II GENERAL ISSUES IN CORPORATE TREASURY

2.1 2.1.1 2.2 2.2.1 2.2.2 2.2.3 2.2.4 2.3 2.3.1 2.3.2 2.3.3 2.3.4 2.3.5 2.4 2.4.1 2.4.2 2.4.3 2.4.4 2.4.5 2.4.6 2.4.7 2.5 2.5.1 2.5.2 2.5.3 2.5.4 2.5.5 2.5.6 2.5.7 2.6 2.6.1 2.6.2 2.6.3 2.7

62 62 63 65 65 66 66 68 68 69 70 70 72 73 73 73 73 74 77 80 81 82 82 82 83 84 84 85 86 88 88 89 90

2.7.1 2.7.2 2.7.3 2.7.4 2.7.5 2.7.6

SATISFIED OR YOUR MONEY BACK ARE YOU SATISFIED WITH YOUR TREASURER? TRADITIONAL STRUCTURE – TYPES OF TREASURY CUSTOMER SATISFACTION STUDY EXPECTATIONS TRANSFORMED INTO OBJECTIVES WHICH IS PREFERABLE – A BILATERAL DISCUSSION OR A FORMAL SATISFACTION SURVEY? ADDING VALUE BY ENHANCED IN-‐HOUSE SERVICES SATISFACTION SURVEY OF TREASURY ACTIVITIES TREASURY PERFORMANCE INDICATORS THE IDEA OF A SATISFACTION SURVEY PRELIMINARY TO QUALITY SERVICE WHAT QUESTIONS SHOULD BE ASKED? RESULTS TO BE CONSOLIDATED BEST PRACTICES IN TERMS OF TREASURY MANAGEMENT – INSIGHTS AND PERCEPTIONS BEST PRACTICES IN TREASURY HOW TO IMPROVE TREASURY STANDARD PRACTICES? CHARTER OF BEST PRACTICES AND CODE OF ETHICS ISSUED BY IGTA LIST OF MAJOR ETHIC PRINCIPLES RECOMMENDED BY IGTA STRATEGIC ROLE OF TREASURERS THE ROLE OF TREASURY ASSOCIATIONS EVOLUTION OF THE ROLE OF TREASURER CORPORATE-‐BANK RELATIONSHIPS AND BANKING POLICY RELATIONSHIP WITH BANKS THE CHOICE OF A BANK THE CHOICE OF THE NUMBER OF BANKS ASSESSMENT OF THE SERVICES OFFERED THE TRANSFER OF OPERATIONAL FLOWS BY A BANK THE ASSESSMENT OF A COMPANY BY ITS BANKER THE ROLE OF THE TREASURER KNOW YOUR BANKER – “KYB” A SEA CHANGE IN THE FINANCIAL MARKETS REDUCING BANK COUNTERPARTY RISK TECHNOLOGY -‐ LOVE IT OR HATE IT RFPS: HOW BEST TO FORMULATE YOUR NEEDS TO ENSURE YOUR REQUESTS FOR PROPOSALS SUCCEED? DEFINITION OF AN "RFP" WHAT IS AN RFP FOR? COMPOSITION OF AN "RFP" RFI, RFQ AND RFT DO’S AND DON’TS WHEN SELECTING VENDORS/CONTRACTORS CRITERIA OF SELECTION

92 92 93 93 94 95 96

2.8 BEST PRACTICES FOR PARTICIPANTS IN THE CREDIT RATING PROCESSES – ROLE OF INTERNATIONAL GROUP TREASURY ASSOCIATION (IGTA) 2.8.1 CREDIT RATING AGENCIES 2.8.2 WHY DEFINING A CODE OF STANDARD PRACTICES FOR PARTICIPANTS ON THE CREDIT RATING PROCESS? 2.8.3 NECESSITY OF REGULATION 2.8.4 CONTENT OF THE IGTA CODE OF STANDARD PRACTICES 2.8.5 MAIN REQUESTS FROM CORPORATES 2.8.6 IOSCO CODE 2.8.7 GOOD COOPERATION OF TREASURY ASSOCIATIONS 2.9 BANK BALANCE SCORE CARD OR HOW TO RATE YOUR BANKS 2.9.1 QUANTIFY AND QUALIFY BANK RELATIONSHIPS 2.9.2 HOW TO MAP ONE’S BANK RELATIONSHIPS 2.9.3 BEST PRACTICES IN BAM (“BANK ACCOUNT MANAGEMENT”) 2.10 MONITORING PERFORMANCE IN THE TREASURY FUNCTION 2.10.1 PERFORMANCE, A SYNONYM FOR PROFIT? 2.10.2 WHY MEASURE PERFORMANCE? 2.10.3 KPI PROBLEMS 2.10.4 ENVIRONMENT OF INCREASING SUPERVISION 2.10.5 A TRICKY BALANCING ACT 2.10.6 THE IMPACT OF SYSTEMS ON TREASURY MANAGEMENT 2.10.7 MOVING TO VALUE ADDED 2.10.8 TARGETED KPIS TO CHANGE BEHAVIOUR 2.10.9 TREASURY DEPARTMENT PERFORMANCE TABLE 2.10.10 PUTTING THE TREASURY FUNCTION INTO PERSPECTIVE 2.10.11 TREASURERS IN THE LIMELIGHT – AN OPPORTUNITY? 2.11 ARE TREASURERS BECOMING “SUPER FINANCIAL REPORTERS"? 2.11.1 DO YOU LIKE FINANCIAL REPORTING? 2.11.2 GOOD NEWS FOR FINANCIAL REPORTING ADDICTS 2.11.3 SOME MAJOR POST PITTSBURGH G-‐20 REGULATIONS ARE CLOSELY CORRELATED AND INTERCONNECTED 2.11.4 TREASURERS, THE NEW "GREAT REPORTERS" OF FINANCE? 2.12 ETHICS IN EUROPEAN TREASURY AND FINANCIAL AFFAIRS 2.12.1 BACKGROUND AND CURRENT CLIMATE 2.12.2 ETHICS AND TREASURY 2.12.3 CODIFICATION OF ETHICAL PRINCIPLES 2.12.4 RESPECT FOR ETHICAL RULES 2.12.5 CODE OF ETHICS 2.12.6 RULES CODIFICATION 2.13 CHANGES IN THE TMS MARKET – A BROADER RANGE OF PRODUCTS 2.13.1 THE CONSOLIDATION TREND ON THE TMS MARKET 2.13.2 MARKET FRAGMENTATION 2.13.3 CLASH 2.13.4 REMAINING TARGETS 2.13.5 THE BIG DECISION: ERP VERSUS SPECIALIZED PRODUCTS 2.13.6 MINI-‐ERPS 2.13.7 FINANCIAL REPORTING 2.13.8 FINANCIAL NEWS DUOPOLY

98 98 99 100 100 101 101 102 103 103 104 107 108 108 108 109 110 110 111 111 111 112 114 114 115 115 115 116 117 120 120 120 122 123 124 125 127 127 128 129 129 129 130 131 131

2.13.9 2.14 2.14.1 2.14.2 2.14.3 2.14.4 2.15 2.15.1 2.15.2 2.15.3 2.15.4 2.15.5 2.15.6

CONSOLIDATION PHASE AUTOMATED CONFIRMATION MATCHING SETTLEMENT MANUALS PROCESSES AND STP CORPORATES MOTIVATIONS IMPLEMENT THE SOLUTION CONFIRMATION MATCHING SETTLEMENT SOLUTIONS MANAGING MARKET RISKS WITH ACQUISITIONS IN EMERGING COUNTRIES TYPES OF ISSUES ENCOUNTERED PRE-‐ACQUISITION FINANCIAL RISKS POST-‐ACQUISITION FINANCIAL RISKS METHODOLOGY PROPOSED CASH FLOW STATEMENT PROJECTIONS FEW SOUND CONCLUSIONS TO KEEP IN MIND

132 133 133 134 135 135 138 138 139 140 141 142 143

3 PART III CASH MANAGEMENT

145

3.1 3.1.1 3.1.2 3.1.3 3.1.4 3.1.5 3.1.6 3.1.7 3.2 3.2.1 3.2.2 3.2.3 3.2.4 3.2.5 3.2.6 3.2.7 3.3 3.3.1 3.3.2 3.3.3 3.3.4 3.3.5 3.3.6 3.3.7 3.3.8 3.3.9 3.4 3.4.1 3.4.2 3.4.3 3.4.4 3.4.5

146 146 146 147 148 149 150 151 153 153 153 154 155 155 157 157 158 158 158 158 159 159 160 160 160 161 162 162 162 163 164 165

CASH GENERATION CAPACITY BACK TO "TRUE" FINANCIAL VALUES LIQUIDITY RISK COST OF FINANCE ACTUAL LIQUIDITY AND POTENTIAL LIQUIDITY THE POSITION OF THE BANKS SELECTIVITY IN MAKING LOANS KEEPING SUBSIDIARIES' FINANCING REQUIREMENTS UNDER CONTROL THE MAGIC TRIANGLE OF ASSET MANAGEMENT WAR CHEST MAGIC TRIANGLE NO DECISION-‐MAKING TOOLS STP AND ONLINE PLATFORMS A COMBINED APPROACH LIQUIDITY PLANNING REGULATIONS HOW CORPORATES USE OVERABUNDANCE OF CASH? ABUNDANCE, EXCESS OR EFFECTIVE MANAGEMENT OF LIQUIDITIES? THE RISE IN CASH, A MAJOR OBJECTIVE WHERE RATINGS AGENCIES STAND EXCESS OR SURPLUS: MORE THAN JUST LIQUIDITY RESERVES ALTERNATIVE USES OF THE CASH COMMUNICATION WITH THE MARKETS CASH & CASH EQUIVALENTS UNDER IFRS DYNAMIC LIQUIDITY MANAGEMENT OR OPERATIONAL YIELD SHORTENED CYCLES AND LIMITED VISIBILITY HOW TO CREATE VALUE IN BETTER MANAGING SURPLUS OF CASH? CASH SURPLUS RETURN ON CASH SURPLUS SELECTION CRITERIA OF MONEY MARKET FUNDS RETURN OBJECTIVE DYNAMIC MANAGEMENT

3.4.6 3.4.7 3.4.8 3.4.9 3.4.10 3.5 3.5.1 3.5.2 3.5.3 3.5.4 3.5.5 3.5.6 3.6 3.6.1 3.6.2 3.6.3 3.7 3.7.1 3.7.2 3.7.3 3.7.4 3.7.5 3.7.6 3.7.7 3.7.8 3.7.9 3.7.10 3.7.11 3.8 3.8.1 3.8.2 3.8.3 3.8.4 3.8.5 3.8.6 3.8.7 3.8.8 3.8.9 3.8.10 3.8.11 3.9 3.9.1 3.9.2 3.9.3 3.9.4 3.9.5 3.9.6 3.9.7

CHOOSING ONE’S INVESTMENT WHAT IS EQUIVALENT TO CASH? ENVIRONMENT OF LOW OR NEGATIVE INTEREST RATES WHAT SORT OF THINGS ARE EQUIVALENT TO CASH? PREVENTION THROUGH A CLEAR AND TRANSPARENT POLICY CONTROLLING MEANS PLANNING AHEAD! THE TREASURER AS ADVENTURER CREDIT IS MORE EXPENSIVE! WHY EFFECTIVE CFF? PROPER FORECASTING MEANS PROPER COMMUNICATION TECHNICAL BARRIER RELIABLE CASH-‐FLOW FORECAST, HOLLY GRAIL OF TREASURERS CASH-‐FLOW FORECASTING IS KING NEED FOR RELIABLE FORECASTS FORECASTING FOR BETTER MANAGEMENT RULES TO BE FOLLOWED FOR GOOD FORECASTING CAPE ON CASH VISIBILITY ON CASH CASH FLOW FORECASTING A CORPORATE CASE STUDY DEFINITION ISSUE CASH CONVERSION LEARNING BY PRACTICING OPTIMISING WORKING CAPITAL NO SCALES, NO DIET WORKING CAPITAL, THE RIGHT ALCHEMY MAKING A WORKING CAPITAL PROJECT WORK SLIM DOWN YOUR WCN CASH-‐POOLING, MYTHS AND REALITIES CASH POOLING, THE VECTOR OF CENTRALISATION CASH POOLING -‐ DEFINITION OBSTACLES TO PERFECT BALANCE LEVELLING EXISTING CASH POOLING TECHNIQUES CHOICE OF LOCATION SET UP CHOOSING THE TYPE OF CASH POOLING DISADVANTAGES OF NOTIONAL CASH POOLING MULTI-‐BANK APPROACH IS MULTI-‐CURRENCY CASH POOLING EVEN POSSIBLE? THE FUTURE OF CASH POOLING MONEY, A SCARCE COMMODITY MONEY, A COMMODITY LIQUIDITY RISK HOW TO ENSURE LIQUIDITY DIVERSIFYING SOURCES OF FUNDING CHANGING SPREADS AND BENCHMARK RATES FANTASTIC LIVE SCENARIO NOTHING COULD LESS CERTAIN…

166 166 167 168 169 171 171 172 172 173 174 174 175 175 175 176 179 179 179 179 180 182 182 183 184 185 186 189 190 190 190 190 191 193 193 193 194 194 195 195 197 197 197 198 198 200 201 201

3.10 3.10.1 3.10.2 3.10.3 3.10.4 3.10.5 3.11 3.11.1 3.11.2 3.11.3 3.11.4 3.11.5 3.11.6 3.12 3.12.1 3.12.2 3.12.3 3.12.4 3.12.5 3.12.6 3.12.7 3.12.8 3.13 3.13.1 3.13.2 3.13.3 3.13.4 3.13.5 3.13.6 3.13.7 3.14 3.14.1 3.14.2 3.14.3 3.14.4 3.14.5 3.14.6 3.14.7 3.14.8

"INDUSTRIALISING" YOUR PAYMENTS: A LUXURY OR NECESSITY? COSTS AND COMPLIANCE INDUSTRIALISING PAYMENTS COST-‐RETURN OF A PAYMENT FACTORY ADVANTAGES PAYMENT FACTORY, PART OF THE FINANCIAL IT STRATEGY RED 7 … THE WINNING NUMBER FOR MONEY MARKET FUNDS? ACCOUNTING ISSUES QUALIFICATION AS “CASH & CASH EQUIVALENT”(*) HOW TO DEMONSTRATE CRITERIA ARE MET? IFRS 7 DISCLOSURES ISSUE CRITERIA FOR FIRST LEVEL OF THE FAIR VALUE PYRAMID INTERPRETATION FROM IFRIC NEEDED SECURITY IS BEYOND PRICE, BUT PERHAPS TIMES HAVE CHANGED. PRIORITY GIVEN TO COUNTERPARTY SECURITY. SECURITY HAS A PRICE, BUT NOT JUST ANY PRICE POSSIBLE ALTERNATIVE STRATEGIES NOTHING OR LESS THAN NOTHING? THE PARADOX OF THE THRIFTY SQUIRREL “MONEY FOR NOTHING” (DIRE STRAITS) STEP OFF THE BEATEN PATH "MONEY, MONEY, MONEY… IN A RICH MAN’S WORLD" (ABBA) RESPONSE OF CORPORATE TREASURERS TO THE “SUB-‐PRIMES” CRISIS ARE MMFS REAL CONSERVATIVE CASH INVESTMENTS? MMFS HAVE COME OF AGE… SURVIVING THE MARKETS ABSENCE OF SUFFICIENT TRANSPARENCY MAIN CONSEQUENCES AND LESSONS LEARNT CREDIT RATING AGENCIES (CRA) COST OF FUNDING ISSUE AN X-‐RAY OF MONEY MARKET FUND RISKS REDUCING THE INHERENT RISKS IN MONEY MARKET FUNDS METHODOLOGY AND RESULTS MONEY MARKET FUND DOES NOT MEAN NO RISK COLLATERAL, A WORD THAT STRIKES FEAR INTO TREASURERS’ HEARTS! REPO OR NOT REPO? TRI-‐PARTY REPO: AN ALTERNATIVE INVESTMENT DOCUMENTATION PRICELESS PROTECTION

202 202 202 204 205 205 207 207 207 208 209 210 211 212 212 212 213 213 214 214 214 215 216 216 217 217 218 218 219 220 221 221 224 225 226 226 228 229 230

4 PART IV IAS 39 AND IFRS 9, HEDGE ACCOUNTING EXCEPTION

231

4.1 4.1.1 4.1.2 4.1.3 4.1.4 4.1.5

232 232 233 233 234 234

A REVOLUTION IN ACCOUNTING AND MOVING TO "FAIR VALUE" TRANSFORMATION IN ACCOUNTING REFLECTING THE PRESENT AND THE FUTURE AND REFLECTING THEM IN THE ACCOUNTING SYSTEM ORIGINS OF THE TRANSFORMATION IAS 39 AND FAS 133 THE NEW BASIC STANDARD

4.1.6 4.1.7 4.1.8 4.2 4.2.1 4.2.2 4.2.3 4.3 4.3.1 4.3.2 4.3.3 4.3.4 4.4 4.4.1 4.4.2 4.4.3 4.4.4 4.4.5 4.4.6 4.4.7 4.5 4.5.1 4.5.2 4.5.3 4.5.4 4.5.5 4.6 4.6.1 4.6.2 4.6.3 4.6.4 4.6.5 4.7 4.7.1 4.7.2 4.7.3 4.7.4 4.7.5 4.7.6 4.8 4.8.1 4.8.2 4.9 4.9.1 4.9.2 4.9.3 4.9.4 4.9.5

(NEW) IFRS RULES REVOLUTION DOES NOT PLEASE EVERYONE GOALS ACHIEVED 12 YEARS UNDER HEDGE ACCOUNTING AND IAS 39, FOR BETTER OR FOR WORSE? THE GOOD AND BAD SIDES OF IAS 39 "HEDGE ACCOUNTING", A TEMPORARY EXCEPTION FOR BETTER OR FOR WORSE? OVERHAUL OF IAS 39: REVOLUTION OR SIMPLIFICATION? FAIR VALUE IN THE FIRING LINE AFTER FINANCIAL CRISIS NEED FOR IN-‐DEPTH REFORM OF IAS 39 CONVERGENCE OR DIVERGENCE? HEDGE ACCOUNTING THE 39 STEPS IAS 39, CHALLENGE OR OPPORTUNITY? POSITION OF ACT’S KEY DEFICIENCIES IN THE STANDARD HEDGING OF TENDER PORTFOLIOS CONVERGENCE WITH US GAAP EU ENDORSEMENT EVERY CLOUD HAS A SILVER LINING THE THIRD ACT OF IFRS 9: REVOLUTION OR SIMPLE REFORM OF HEDGE ACCOUNTING? THIRD AND FINAL PART OF IFRS 9 STRUGGLE TO UNDERSTAND IAS 39 REPORTING KEY MEASURES PROPOSED BY IASB IN THIRD ED WHAT SHOULD CORPORATE TREASURERS DO? NEXT STEPS THE SON OF IAS 39 CELEBRATION OR FUNERALS? FAIR VALUE IN THE FIRING LINE AFTER FINANCIAL CRISIS NEED FOR IN-‐DEPTH REFORM OF IAS 39 CONVERGENCE OR DIVERGENCE? HEDGE ACCOUNTING IAS 39: EVERY CLOUD HAS SILVER LINING.… IAS 39, THE DISDAINED RULE… PROHIBITION OF NETTING MANAGEMENT OF FOREIGN EXCHANGE RISK, A REAL "GROCERY STORE" TO WHOM IT BENEFITS ... INDIRECT BENEFICIARIES NOT THE END OF THE STORY FAIR VALUE COULD BECOME VERY COMPLICATED TO DETERMINE IN VOLATILE MARKETS. VOLATILE MARKETS THE INTERNATIONAL ACCOUNTING STANDARD BOARD (IASB) WAYS OF FINANCING AND HEDGING INVESTMENTS IN VOLATILE CURRENCIES INTRODUCTION DIFFERENT APPROACHES TYPES OF RISKS IN CASE OF ACQUISITION IN FOREIGN CURRENCY POSSIBLE SOLUTIONS VOLATILITY MITIGATION

235 235 236 238 238 240 241 242 242 242 243 244 245 245 245 245 246 246 246 248 250 250 251 251 252 253 254 254 254 255 255 256 257 257 257 258 259 259 259 261 261 262 263 263 263 263 264 264

4.9.6 HEDGING OF BALANCE SHEET TRANSLATION RISK 4.9.7 NO PERFECT SOLUTIONS 4.10 HOW COULD AN ACCOUNTING STANDARD SETTER RESPOND TO A CREDIT CRISIS? 4.10.1 CRYSTAL-‐CLEAR TRANSPARENCY FOR FINANCIAL INSTRUMENTS WITH IFRS 7 4.10.2 IFRS 7, A NEW ACCOUNTING STANDARD FOR FINANCIAL INSTRUMENTS DISCLOSURES 4.10.3 INFORMATION PROVIDED BY THE TREASURY DEPARTMENT 4.10.4 YET ANOTHER MAJOR PROJECT FOR TREASURERS? 4.10.5 FOLLOWING THE TREND OF IMPROVING INTERNAL CONTROLS 4.10.6 HOW TO DELIVER THIS INFORMATION 4.10.7 MISSION ACCOMPLISHED? 4.10.8 FUNDAMENTAL SHIFT IN MENTALITY 4.11 IFRS 7, A NEW NIGHTMARE FOR CORPORATE TREASURERS? 4.11.1 “7, RED, UNEVEN AND LACKING” 4.11.2 NEW NIGHTMARE FOR TREASURERS? 4.11.3 NEW INFORMATION OR DISCLOSURE NOW OBLIGATORY 4.11.4 IFRS IN LINE WITH REGULATIONS ON RISK CONTROL AND MANAGEMENT 4.11.5 OBJECTIVES AND MEASURES STIPULATED BY IFRS 7 4.11.6 INFORMATION PROVIDED BY THE TREASURY 4.11.7 HOW DOES ONE IMPLEMENT IFRS 7? 4.11.8 TOO MUCH IS TOO MUCH! 4.11.9 BANKERS CALL FOR REVIEW OF FINANCIAL RULES 4.11.10 HOW COULD AN ACCOUNTING STANDARD SETTER RESPOND TO A CREDIT CRISIS? 4.11.11 CESR STATEMENT OF THE RECLASSIFICATION OF FINANCIAL INSTRUMENTS 4.11.12 REVIEW OF TOP EUROPEAN COMPANIES 4.12 COMMODITY HEDGING IN EUROPE 4.12.1 COMMODITY BLUES 4.12.2 COMMODITY HEDGING: TOUGH TASK BUT NECESSARY 4.12.3 TRADING AND COVERAGE 4.12.4 COMMON SENSE PRINCIPLES TO BE IMPLEMENTED 4.12.5 DIFFICULTY IN COVERING PROPERLY AND EFFICIENCY TEST ISSUE 4.12.6 COMMUNICATION ON COVERAGE STRATEGIES 4.13 SPECIFIC COMMODITY HEDGERS, THE FORGOTTEN… 4.13.1 SPECIFIC ISSUE OF SOME COMMODITY HEDGERS 4.13.2 REMOVAL OF EFFECTIVENESS CORRIDOR 4.13.3 EACT LOBBYING 4.14 WHAT IS THE TRUE (RE)VALUATION OF A FORWARD CONTRACT? 4.14.1 REVALUATION, DIVERGENCE DEPENDING ON THE COUNTERPARTY CALCULATING IT 4.14.2 METHOD FOR CALCULATING A FORWARD FOREIGN-‐EXCHANGE CONTRACT 4.14.3 RECONCILING THE UN-‐RECONCILABLE 4.14.4 RECOMMENDATIONS 4.15 IFRS 13, OR WHEN COUNTERPARTY RISK HITS YOUR BOTTOM LINE 4.15.1 IFRS 13, THE ONE WE FORGOT? 4.15.2 DEALING IN FINANCIAL INSTRUMENTS 4.15.3 MEASUREMENT AT "FAIR VALUE" 4.15.4 METHODOLOGY TO BE APPLIED 4.15.5 A SUBJECT THAT IS MORE COMPLEX THAN IT SEEMS. 4.15.6 SUGGESTED METHODOLOGY 4.16 ALTERNATIVE FX COVERAGE SOLUTIONS UNDER IAS 39

265 265 266 267 267 267 268 269 270 270 271 272 272 272 273 273 274 275 276 276 276 277 279 280 281 281 281 282 282 283 283 284 284 285 285 287 287 288 291 292 293 293 293 294 295 295 296 299

4.16.1 4.16.2 4.16.3 4.16.4 4.17 4.17.1 4.17.2 4.18 4.18.1 4.18.2 4.18.3 4.18.4 4.18.5 4.18.6 4.18.7 4.19 4.19.1 4.19.2 4.19.3 4.19.4 4.19.5 4.20 4.20.1 4.20.2 4.21 4.21.1 4.21.2 4.21.3 4.21.4 4.21.5 4.21.6 4.22 4.22.1 4.22.2 4.22.3 4.22.4 4.22.5 4.22.6 4.22.7 4.22.8

VOLATILITY CONTROL AND IMPROVED FINANCIAL RESULTS 299 ALTERNATIVE STRATEGIES 299 “FORWARD EXTRA” – ACCOUNTING IMPACT* 300 DYNAMIC MANAGEMENT OF FX RISKS 301 WHAT SERVICES ARE EXPECTED FROM A TRADING FLOOR AND WHAT HAS CHANGED SINCE THE ONSET OF THE FINANCIAL CRISIS? 302 1. SERVICES EXPECTED OF A TRADING FLOOR 302 CHANGES OBSERVED SINCE THE START OF FINANCIAL CRISIS 304 DECIDING TO HEDGE 306 TO HEDGE OR NOT TO HEDGE, THAT'S THE QUESTION 306 ADAPTIVE HEDGING STRATEGY 307 WHAT TO DO AND WHAT NOT TO DO WHEN IT COMES TO HEDGING 308 ADVANTAGE OF USING THE TRADING PLATFORMS AND NEW TECHNOLOGIES 310 KEYS FACTORS IMPACTING HEDGING STRATEGIES 311 ARE WE FACING MORE EXPENSIVE FX PRICING IN THE COMING YEARS? 312 OTC DERIVATIVES REFORM, CHALLENGES 313 TO COLLATERALIZE OR NOT TO COLLATERALIZE THE HEDGING PROCESS, THAT IS THE QUESTION 316 AND WHAT IF YOU USE MARGIN CALLS FOR HEDGING YOUR FX? 316 WHETHER OR NOT TO RESIST THE REQUIREMENT TO POST COLLATERAL 317 QUESTIONS TO ASK YOURSELF 317 POSSIBLE SOLUTIONS 318 SO WHAT WOULD BE ADVISABLE? 320 FINANCIAL INFORMATION PROVIDED BY TREASURY DEPARTMENT 321 INFORMATION PROVIDED BY THE TREASURY 321 HOW DOES ONE IMPLEMENT IFRS 7? 322 FAIRNESS OF FAIR VALUE 325 FAIRNESS OF FAIR MARKET VALUE 325 PRACTICE AND REALITY OF FAIR VALUE 326 SUBJECTIVITY OF THE FAIR VALUE NOTION 327 RELIABILITY OF THE INFORMATION REPORTED 328 CORNELIAN DILEMMA 329 THE BEST IS THE GOOD’S ENEMY 330 THE IAS 39 EFFECTIVENESS TESTING – WHAT IF THE 80-‐125% RANGE WAS ELIMINATED? 331 DOUBLE EFFECTIVENESS TESTING 331 TESTING METHODOLOGY 331 PROSPECTIVE EFFECTIVENESS 332 RETROSPECTIVE EFFECTIVENESS 332 INEFFECTIVE PORTION 333 PRACTICAL ASPECTS OF THE TEST TO CONSIDER 334 TESTING TOOLS 335 PROPOSED SIMPLIFICATION 335

5 PART V REGULATIONS

336

5.1 5.1.1 5.1.2 5.1.3

337 337 337 338

MIGHT TOO MUCH REGULATION KILL OFF REGULATION? THERE IS ONLY SO MUCH THAT YOU CAN ACHIEVE IF YOU WANT MORE RULES, YOU WANT MORE SUPERVISION THE COSTS AND BURGEONING ON COSTS OF THE FREE-‐MARKET PARADOX

5.1.4 5.2 5.2.1 5.2.2 5.2.3 5.2.4 5.2.5 5.2.6 5.2.7 5.3 5.3.1 5.3.2 5.3.3 5.3.4 5.3.5 5.4 5.4.1 5.4.2 5.4.3 5.4.4 5.4.5 5.5 5.5.1 5.5.2 5.5.3 5.5.4 5.5.5 5.6 5.6.1 5.6.2 5.6.3 5.7 5.8 5.8.1 5.8.2 5.8.3 5.8.4 5.8.5 5.9 5.9.1 5.9.2 5.9.3 5.10 5.11 5.11.1 5.11.2 5.11.3 5.11.4

MORE REGULATION OR LESS REGULATION? REGULATE FINANCE THE SAME WAY AS CONTROLLING AIR TRAFFIC TO AVOID CRASHES IN MID-‐AIR THE ECONOMIC VOLCANO THE DILEMMA: INTERNATIONAL REGULATOR OR NO INTERNATIONAL REGULATOR RESPONSIBILITIES AND ALLOCATION OF ROLES MINIMUM SAFETY STANDARDS COMMON LANGUAGE LOCAL CONTROLS AT THE POINT OF DEPARTURE FINANCIAL RADAR REFORMING OTC DERIVATIVES, A NEW CHALLENGE FOR CORPORATE TREASURERS NEW REGULATION FOR OTC DERIVATIVES? DIRECT IMPACT FOR CORPORATE TREASURERS ALTERNATIVE SOLUTIONS RISKS IF APPLIED AS IS COORDINATION OF ALL ACTORS ON STAGE ARE WE FACING MORE EXPENSIVE FX PRICING IN THE COMING YEARS? THE PRICE IS RIGHT CASH COLLATERAL SOLUTION TECHNICAL AND ADMINISTRATION ISSUES CORPORATE ALTERNATIVE SOLUTIONS BRAND NEW WORLD FOR FX DEALING A VICTORY IN A BATTLE CAN OBSCURE THE PROBLEM ALSO SPOTLIGHT ON THE COLLATERAL REQUIREMENT TREASURERS: SHIPSHAPE OR “I SEE NO SHIPS”? REPORT FORMAT USING AN INDEPENDENT INTERMEDIARY OR A TRADE REPOSITORY DIRECTLY? REPORTING CHALLENGE OTC DERIVATIVES, A VICTORY OR A LOST BATTLE? EXEMPTION OF THE OTC DERIVATIVES REFORM NON FULL EXEMPTION COLLATERALIZATION SHALL EVENTUALLY BE IMPOSED BANKS ON BILATERAL BASIS TO GIVE IT, STEAL IT BACK… A NEW DIMENSION TO FX DEALING IS THE PRICE RIGHT? CASH COLLATERAL SOLUTION TECHNICAL AND ADMINISTRATIVE ISSUES CORPORATE ALTERNATIVE SOLUTIONS A BRAND NEW WORLD FOR FX DEALING REPORTING FINANCIAL AND NON-‐FINANCIAL PERFORMANCE IN A SINGLE CONSOLIDATED REPORT AVANT-‐GARDE COMMUNICATION HOW THINGS STAND NOW EMERGENCE OF AVANT-‐GARDE COMPANIES RATING AGENCIES: IN THE SPOTLIGHT ONCE AGAIN! HOW TO FAIRLY MEASURE THE « RATERS »? SUB-‐PRIME SUMMER OLIGOPOLY SITUATION CONFLICT OF INTEREST RATING THE RATING AGENCIES

339 340 340 340 341 341 341 342 342 344 344 344 345 346 347 348 348 348 349 350 350 351 351 351 352 353 354 355 355 355 356 358 361 361 361 362 362 363 364 364 365 365 368 370 370 370 371 371

5.11.5 5.11.6 5.11.7 5.12 5.12.1 5.12.2 5.12.3 5.12.4 5.12.5 5.13 5.13.1 5.13.2 5.13.3 5.13.4 5.13.5 5.14 5.14.1 5.14.2 5.14.3 5.15 5.15.1 5.15.2 5.15.3 5.15.4 5.15.5 5.16 5.16.1 5.16.2 5.16.3 5.16.4 5.16.5 5.16.6 5.16.7 5.16.8 5.17 5.17.1 5.17.2 5.17.3 5.17.4 5.17.5 5.17.6 5.17.7 5.17.8 5.18 5.18.1 5.18.2 5.18.3

STRUCTURED FINANCE ABSENCE OF SIGNALS OR WRONG UNDERSTANDING OF REPORTS ISSUED? CONSEQUENCES CORPORATE CONNECTIVITY TO SWIFT SWIFTNET FROM A BANK MODEL TO A CORPORATE STANDARD TYPES OF CONNECTIVITY MODELS 3SKEY OR PERSONAL DIGITAL SIGNATURE VIRTUOUS CIRCLE NEXT MILESTONES SCORE STANDARDISED CORPORATE ENVIRONMENT SWIFT, A WELL-‐KNOWN NAME FOR A FINANCIAL COMMUNICATION GIANT FROM SWIFTNET TO SCORE SCORE IS AVAILABLE TO LISTED COMPANIES BENEFITS OF USING SWIFT SCORE'S FUTURE BAM OR EBAM ? (ELECTRONIC BANK ACCOUNT MANAGEMENT) BANK DATA ISSUE SOLUTION TREASURERS LOOK FOR REGULATORS WANT FINANCIAL TRANSPARENCY DID YOU SAY “EBAM” OR “BAM”? BANK DATA ISSUE SOLUTION TREASURERS LOOK FOR REGULATORS WANT FINANCIAL TRANSPARENCY AFTER A PAYMENT FACTORY, WHAT ARE THE NEXT STEPS? TECHNOLOGY IS THERE, BUT BANKS ARE NOT READY YET E-‐BAM: A BANKING CONNECTIVITY FANTASY OR A MIRAGE IN THE MIDDLE OF THE FINANCIAL DESERT? E-‐BAM, BANG! MORE THAN JUST A FASHION ITEM THE COMPLEXITY OF MANAGING BANK ACCOUNTS MISMATCH IN SUPPLY AND DEMAND 4 YEARS ON WHO WANTS TO GO FIRST, ANY VOLUNTEERS? THE MERITS OF E-‐BAM FASHION OR A WORTHWHILE PROJECT? EBAM, THE NEXT STEP IN PAPERLESS ACCOUNT MANAGEMENT DID YOU SAY "EBAM"? FROM CONCEPT TO REALITY… BUT WHEN? THE PIGEON, THE POSTMAN, THE FAX… AND EBAM INTERNAL CONTROLS AND THE NEED FOR AUTOMATION DIGITAL SIGNATURE AND IDENTITY MANAGEMENT AUDIT CONFIRMATIONS RUNNING A GREENER TREASURY DEPARTMENT FOR EBAM IT'S ALREADY TOMORROW DOES SEPA REALLY MATTER TO CORPORATES? WHAT IS SEPA? EXPECTATIONS OF TREASURERS “CAN THE PSD PROVIDE WHAT TREASURERS WANT?”

371 372 372 373 373 373 374 375 376 377 377 377 378 379 380 381 381 381 381 383 383 383 384 385 386 387 387 387 388 388 389 389 390 391 392 392 393 394 395 396 396 397 398 399 399 400 400

5.18.4 PROGRESS OF THE SEPA, SATISFACTORY OR NOT? 5.18.5 SEPA, HOPES OR OVER EXPECTATIONS? 5.19 WHAT A WONDERFUL REGULATION WORLD!

402 403 404

6 PART VI ERM AND INTERNAL CONTROLS IN FINANCE

406

6.1 6.2 6.2.1 6.2.2 6.2.3 6.2.4 6.2.5 6.2.6 6.3 6.3.1 6.3.2 6.3.3 6.3.4 6.3.5 6.3.6 6.4 6.4.1 6.4.2 6.4.3 6.4.4 6.4.5 6.4.6 6.5 6.5.1 6.5.2 6.5.3 6.5.4 6.6 6.6.1 6.6.2 6.6.3 6.6.4 6.6.5 6.6.6 6.7 6.7.1 6.7.2 6.7.3 6.7.4 6.7.5 6.7.6

ENTERPRISE RISK MANAGEMENT (ERM) NEXT STEPS TO CONSIDER 407 TREASURY RISK MANAGEMENT: A MODEL FOR ERM? 409 TREASURY, EXAMPLE OF GOOD PRACTICES FOR RISK MANAGEMENT 409 TREASURY MANAGEMENT MODEL 410 HOW TREASURERS DEAL WITH RISK? 411 MITIGATING RISK 412 INTERNAL CONTROLS AND VARIOUS REGULATIONS 412 NEXT STEP IN THE DEVELOPMENT OF THE TREASURER’S JOB 413 RESULTS AND CONCLUSIONS OF A EUROPEAN SURVEY ABOUT CORPORATE TREASURY POSSIBLE ROLE 414 WITHIN THE ERM PROCESS OBJECTIVES OF THE SURVEY 414 ERM, NECESSITY RATHER THAN NICETY 414 POTENTIAL ROLE OF TREASURERS 415 MOTIVATING FACTORS 416 ROLE OF TREASURY ASSOCIATIONS 418 CONCLUSIONS 418 CONTINGENCY PLAN FOR THE TREASURY FUNCTION 420 IT MIGHT BE WORSE 420 TREASURY STRUCTURE FLOWCHART 420 SETTING UP A BCP 421 BCP OBJECTIVES: 422 TEST THE BCP REGULARLY 422 BE PREPARED! 423 ENTERPRISE RISK MANAGEMENT ANALYSIS APPLIED TO CORPORATE RATINGS 424 RATING AGENCIES LOOKING FOR ERM PROCESSES REVIEW 424 CREATION OF MORE SYSTEMATIC FRAMEWORK FOR AN INHERENTLY SUBJECTIVE TOPIC 425 SECTOR DIVERSITY ISSUE 425 RECOMMENDATION: BE PREPARED! 426 THE RISK MATRIX – TOOL FOR THE MANAGEMENT OF RISK 429 MAPPING TREASURY RISK 429 RELATIVITY OF MEASUREMENT 429 THE RISK SCALE 430 A GLOBAL REVUE 430 MAJOR TREASURY RISKS 431 MATRIX OF RISKS 432 RISK APPETITE: ARE YOU HUNGRY FOR RISK? 433 “RISK APPETITE” OR “RISK PROFILE”? 433 AS MANY “RISK APPETITE” CONCEPTS AS THERE ARE COMPANIES 433 KEYS TO SUCCESS 434 STRATEGIC OBJECTIVES: THE BASIS OF THE RISK PROFILE 435 WHAT IS TYPICALLY INCLUDED IN A RISK PROFILE 436 RISK APPETITE PARADOX 437

6.8 ADDING VALUE FOR STAKEHOLDERS THROUGH BETTER ERM PROCESSES 6.8.1 ERM, AN EVOLVING CONCEPT TO BE DEVELOPED 6.8.2 S&P HAS ISSUED A DOCUMENT PRESENTING THE ERM APPROACH ADOPTED FOR NON-‐FINANCIAL COMPANIES 6.8.3 ANALYSIS OF THE ERM PROCESS 6.8.4 BASIS FOR ANALYZING AND SETTING FUTURE OBJECTIVES 6.8.5 CREATING VALUE THROUGH ERM 6.9 ARE YOUR INTERNAL CONTROLS EFFECTIVE AND EFFICIENT? 6.9.1 THE 8TH EUROPEAN DIRECTIVE (2006/43/EC-‐ 17 MAY 2006) 6.9.2 RECOMMENDED APPROACH 6.9.3 MATRIX STRUCTURE – AN EXAMPLE 6.9.4 EVALUATION OBJECTIVES 6.9.5 MATRIX STRUCTURE – AN EXAMPLE 6.9.6 YET ANOTHER REGULATION OFFERING OPPORTUNITIES 6.9.7 QUANTIFICATION OF RESIDUAL RISKS CAUSED BY INTERNAL CONTROL FAILURES 6.9.8 CONSTRAINTS CAN BECOME OPPORTUNITIES 6.10 HOW TO BE READY WITH GOOD INTERNAL CONTROLS IN TREASURY DEPARTMENTS? 6.10.1 INTERNAL CONTROL FOR TREASURY DEPARTMENTS 6.10.2 THE TREASURY MANAGER, A SORT OF MINI CRO 6.10.3 DON’T WAIT UNTIL YOU ARE FORCED TO MAKE PREPARATIONS 6.11 INTERNAL CONTROLS FOR THE TREASURY: THE MISSING PIECE... 6.11.1 INTERNAL CONTROLS 6.11.2 INTEGRATED FRAMEWORK FOR INTERNAL CONTROLS 6.11.3 INTERNAL CONTROL CHECKLIST 6.11.4 AUTOMATION: A SOLUTION TO BOOST INTERNAL CONTROLS 6.11.5 ESTABLISH, DOCUMENT AND MONITOR EFFECTIVELY 6.11.6 COST OF ESTABLISHING COMPLIANCE 6.11.7 VISIBILITY AND TRANSPARENCY ARE KEY 6.12 ENTERPRISE RISK MANAGEMENT ANALYSIS APPLIED TO CORPORATE RATINGS 6.12.1 RATING AGENCIES LOOKING FOR ERM PROCESSES REVIEW 6.12.2 CREATION OF MORE SYSTEMATIC FRAMEWORK FOR AN INHERENTLY SUBJECTIVE TOPIC 6.12.3 SECTOR DIVERSITY ISSUE 6.12.4 RECOMMENDATION: BE PREPARED!

439 440 442 443 444 444 445 446 447 447 451 452 453 454 454 456 458 459 459 460 461 462 463 464 465 466 466 467 467 468

7 GENERAL CONCLUSION

470

8 LIST OF ACRONYMS

471

9 DEFINITIONS:

472

439 439

Part I Introduction to the corporate treasury function

1.1 INTRODUCTION

1.1.1

Evolution of treasury function

There has been a profound evolution in the treasurer's job over the last few years. This evolution can be explained by a number of factors that sparked it: legal, tax, technical, IT, financial, economic and accounting factors. The function has seen real changes, fast and profound. At a time of increasing internationalisation, it would be astonishing if treasurers had escaped this "globalisation". Their role and function has grown to be much broader and much more important. Treasurers have had to come down from their ivory towers and the confinement or isolation to which they had regrettably been restricted. The role of finance is more than ever the focus of concern in corporations in these periods of crisis. Several financial scandals serve to remind us how far corporations that are apparently sound can very quickly be undermined or fall apart. Never have financial considerations had such an impact and such importance within corporations, illustrated by the crucial, even vital, role that they were to play throughout the liquidity crisis. For some people it has suddenly become the most important role. The corporate finance and treasury function is usually concentrated at the highest levels of corporations and multinational groups. Centralisation is widespread. The treasury function, by its nature, offers real opportunities for economies of scale and improved efficiency by becoming more centralised. Techniques and resources now make it possible to concentrate financial activities in order to be more competitive. With the watchword being "profitability", international groups might find it worthwhile and helpful to concentrate their treasury management. The treasurer is a manager of financial risks. Concentrating treasurers' activities has allowed them to hone their skills and develop very specific expertise. As well as becoming generalists in financial management, treasurers have also become very skilled specialists, a sort of mandatory and essential point of reference in corporate management. This book attempts to describe the main changes that the treasury function has had to face, and the main problems that it has encountered in practising its profession. It tackles new and recent themes that corporate treasurers have to deal with, together with the reasons for these changes. Treasurers' concerns are different to what they used to be. The scopes of their jobs and their role in the business have grown enormously. They can contribute real value added to the business. They now take part in "value creation" through better management of

their activities and by reducing the financial risks for which they are responsible. This book is not a treasury officer's manual for use by finance professionals, but rather a look at a job in the process of change, and an explanation of the reasons for that change. It takes a look at some of the questions and themes that all treasurers encounter in their daily work. Nevertheless, it makes no claims to being exhaustive. The treasurer's profession is still little-‐known to the general public. In some languages there still is no translation of the word "treasurer". However, it would seem worthwhile describing the evolution of a profession which is still adapting to its external environment and still developing.

1.1.2

Value creation in the treasury function

1.1.2.1 Value creation Why should treasury be exempt from the concept of "value creation", which is so often hailed as the modern-‐day quest for the Holy Grail? We have to create value in corporations, they keep on telling us. But why can’t the treasury function be a generator of "value-‐added" as well? Value creation is the production or increase in the business' wealth and, consequently, in the wealth of its shareholders. Indirectly, this "created" value also benefits stakeholders, which comprise a broader group of interests than "business partners". Creating value – by which we mean the added-‐value, which results in an increase in the company's resources and, broadly, its equity, weighted for the potential or actual risks that it faces – is no longer just the capacity to generate profit (meaning net profit after tax). The definition presents few difficulties. Measurement, by contrast, is more difficult, even impossible. Financial handbooks describe value creation as being the difference between return on capital invested (operating profit after tax) and the cost of equity (cost of capital calculated on the basis of interest rates and the risk premium applicable to the industry in question). True, stock market reality sometimes distorts the effects in calculations. In estimating the market price of a security or share, there always remains a large element of subjectivity which eludes all attempts at calculating value creation scientifically. Markets may sometimes (over)react to the announcement of restructuring or redundancies for example, without us being able to talk about "value creation". This concept is therefore one additional measure or criterion to take into account in evaluating businesses and their (relative) performances.

1.1.2.2 Financial incentives offered to personnel Many international groups have used and still use financial incentives to create value. They use the all-‐too-‐familiar stock options as incentives for the employees who receive them. The stock-‐market turmoil both at the turn of the millennium and since 2008 has completely wiped out their advantages, except perhaps in the very long term. Employee savings plans have greater impact and are perhaps a greater incentive at this time. They have also taken care to use other tools for measuring employee performance. Many companies use the ideas of value creation and financial ratios for measuring this and evaluating their employees. Bonus awards may depend on the company's overall performance. They want to make employees aware of performance, but no longer only in terms of net profit, a concept that is sometimes transient and artificially distorted. 1.1.2.3 Uncertainty in the measurement of value creation In the past we talked about "wealth creation" or "making a profit". Now, companies seek to create value and performance at all levels of the organisation (finance department, human resources, logistics, production, etc.). Obviously, finance directors will tell you that the PER (Price Earnings Ratio) is still the key factor. This reflects the growth in the company's profits. But any concept of this type is always relative. It depends on the level compared to competitors or to peers. However you try to measure it, the measurement is still uncertain. You need to convince the markets and the shareholders of the company's potential and its ability to generate profit and manage risk better than its rivals. Measurement is possible but sometimes a number of working assumptions need to be made to compare and estimate the situation before and after the treasurer's activities. What is the benefit of a "Commercial Paper" program? We can measure the overall cost paid before and afterwards. Against that, the benefit achieved by having more sources of finance is rather trickier to estimate. We have to combine quantitative (measurable) factors with qualitative (non-‐measurable) factors. 1.1.2.4 Value creation in the treasury function Treasurers do not work at the operational or even industrial levels. Their role seems relatively small, limited to part of the financial function. However, it is an important cog and through its effect on cash management, interest-‐rate risk and liquidity, for example, it can create value. Treasurers are very often service centres set up for all group members. If treasurers produce services, some companies think it right that they should be billed (sometimes for tax reasons). Billing cannot take place unless there is a "service" and unless the customers are satisfied with it.

Treasurers therefore produce output like any other department, even though first and foremost they are there to serve the industrial and production functions. Other businesses recognise that the finance department has a role as a value creation centre, including treasury which is part of it, or one of its cogs. The problem is not knowing whether treasurers create value or not, but rather measuring the value that they create or contribute to the business. We can look at what used to be done and what is done now, and so can make comparisons and compare the gains achieved. This is, however, very difficult to define. Where, for example, the treasurer sets up a monthly multilateral netting arrangement to centralise settlements and to reduce the number of transfers arising from these receivables and payables, he creates value. He can compare the cost based on current data in relation to the reduction in the number of transfers being generated because of the monthly or quarterly multilateral netting arrangement. Savings made on transfer fees, the reduction in the exchange rate risk base and also the reduction in the risk of error are tangible and measurable evidence of this. Furthermore, this saving will be recurrent and in our example will produce long-‐term or even permanent effects. 1.1.2.5 Measuring value added How do we measure the value added by a treasurer who has to apply the new international accounting standard IAS 39 or IFRS 9 on marking all derivatives to market price (in the broadest sense defined by the IASB)? Through qualifying for hedge accounting, he will mitigate the impact on the income statement and at the same time reduce the volatility of net income. Value thus created could be measured by the amount recorded on the capital account which is better known by its abbreviation of O.C.I. (Other Comprehensive Income in US GAAP) or EHR (Equity Hedging Reserve under IFRS 9). The total thus "frozen" into equity is the resulting impact on net income that has been achieved by his actions and by obtaining hedging status. That is what we should call "value creation". We very often ask treasurers to use benchmarks for comparisons. This is very difficult! How do you measure the value of your work when, through your meticulous efforts, you save the business by making sufficient credit facilities available to it to ensure it has enough liquidity and is therefore able to survive? If you set up an efficient reporting system enabling you to predefine the company's future cash flows accurately, what is the value added of that? It exists, but it would seem impossible to define even though it is visible. Many people simply think that where there is "optimisation", there is "value creation". And the fact that the value is difficult to estimate does not mean that it is any the less real or effective. Value is not always about the best price, but about the decision that is

most effective overall. When a treasurer tries to spread his operational transactions impartially, proportionally and judiciously between different banks, without going solely for the lowest price, he is creating value. When he concentrates transactions on banks defined by group bank policy, he is creating value. The lowest price may imply dispersion, which is ultimately damaging for the group. A treasurer is a manager rather than a producer. The problem is that his management work is not always quantifiable in terms of quality. The manager of an open-‐ended or closed-‐ended investment fund who produces the greatest value and whose value grew most is the best fund manager. Treasurers' work cannot be quantified or even compared in such a simple way. But the difficulty should not tempt us to abandon measurement. Value creation and its calculation can be performed within a set of well-‐defined boundaries. Treasurers, through their improvement work, will provide direct or indirect benefits to the whole group through the value thus created. Risk prevention by treasurers is also a form of building value. 1.1.2.6 Creating value by involving other departments In seeking to improve their management methods, they will generate requirements of their counterparties and of the functions they have dealings with. Treasurers will put other departments to some trouble. For example, to apply hedge accounting, they will ask for a major contribution from its subsidiaries although value creation here is just the idea of minimising the volatility of accounting results. Where treasurers try to improve working capital management, they put sales people to some trouble by, for example, imposing rules on them which are different to those they are used to, but which are essential to safeguarding the interests of the group as a whole. When they ask for information to be reported, are treasurers creating value? Some people will immediately think that they are not. However, through better control of the subsidiaries' cash positions, finance department can prevent all sorts of crises and upsets. Here again, the concept of "value creation”, is not wholly incompatible with that of "causing extra work". If you look at treasurers as being administrators, with all the pejorative connotations that that term bears, you belittle the role. There is a widespread idea that a superior job is one that is not (too) administrative. That is a stupid prejudice, if ever there was one. In the current context, a number of tragic economic disasters have occurred, reminding us all how vital the financial function still is. Indeed, we could look at treasury as being one of the operational business lines. It can be distinguished from an industrial type business line by being a different type of business line, more a financial one. The big difference is in the raw materials being used by each. Treasurers use underlying financial information. But this

operational financial management is very closely linked to the other type of management. The one cannot exist without the other. Treasurers create value that is undeniable. They are also part of the value creation process of the business as a whole. For example, where they analyse investment plans by measuring the impact on borrowings, or credit rating, on currency risk, on any increase in working capital requirement (WCR) for example, they are taking part in the value creation process. 1.1.2.7 Changes in the treasurer's role Treasurers have seen their function and the role evolve hugely over the last thirty years. The traditional idea of "treasury" in France was that of a public government paying agency. The term "treasurer" is anyway seldom well defined in dictionaries in any language. People only seem to know the historical and rather outdated definition of this word. The treasurer's job has seen statutory, regulatory, technical and technological and even IT changes. It has seen the volatility of various markets, new ideas on cash pooling, on cash management, Anglo-‐Saxon type management techniques, leveraged derivative products and the deleterious effects of their use, changes in the world of banking and the concentration of financial institutions, then more recently the arrival of international accounting standards. The treasurer function has seen so much evolution – even revolution – that now more than ever; treasurers appear to be key components or cogs in corporate management. The function has become broader through the addition of new responsibilities, particularly in terms of reporting, in terms of controls to be introduced and in terms of involvement at various levels (planned investment, acquisitions, mergers and sales of assets for example). The job has developed, broadened and most of all became much more complex. 1.1.2.8 Agent of change Treasurers play a role in the dynamics of change in their management role. On this score, amongst others, they contribute to creating value. Nevertheless, their value generation role is still underestimated by corporate senior management. Operational departments see them as an evil necessity, like accountants. If the treasurer has hedged payment for supplies in US dollars at 1.4350/1 EUR, and at the time of payment it stands at 1.3848, then he has created value. Currency hedging can create value, or prevent it being destroyed. When it guarantees its subsidiaries an exchange rate for a certain period of time, it makes life easier for them and forms part

of the value creation process. Perhaps the fact that the business has lost an opportunity if at the time of payment the USD is worth 1.4850/1 EUR is not really important. It establishes an exchange rate and safeguards the operating margin. By applying hedge accounting to hedging currency risk on a future purchase (cash flow hedge under IFRS 9), he provides a "bonus" in restricting underlying volatility to a hedging instrument in off-‐balance-‐sheet items. When treasurers forecast their requirements for committed credit facilities very accurately and keep them down to a minimum, they avoid the company having to pay too much in commitment fees. The saving generated by this accurate management style is value creation. Plenty of other examples could be put forward. Building a prior comparator (benchmark) is a simple way of estimating value creation. An interest rate or average budgeted borrowing or exchange rate could serve as a benchmark for the treasurer to achieve or exceed. But in our view, treasurers could achieve a yet greater potential value by streamlining management procedures or speeding up collection of cash or receivables. The more complex the structure and the larger the financial transactions are, the greater the potential for creating enormous value will be. Treasurers can sometimes even create value where top management would have destroyed it by making acquisitions that were too expensive or that could not be integrated operationally. It is easier to integrate financial activities than operational ones. 1.1.2.9 A shared objective: better management Ultimately, value creation is the job of all employees and a shared objective, because they need to find the cash and the resources needed to run the business and ensure that it survives. It is now essential to have a wide range of skills in order to succeed. Selling a lot or producing quality is no longer enough, you have to manage the business as a whole. This is where the treasurer makes a non-‐negligible contribution in terms of value added. Treasurers play a key role in managing currency, interest rate, credit and liquidity risk. Their knowledge of highly technical subjects makes them specialists who are called in to minister to the subsidiaries – a sort of adviser at the service of financial controllers, tasked with achieving a better financial balance in the subsidiaries for which they are responsible. More than ever, they are hyper-‐skilled consultants at the service of their colleagues.

1.2 Origins of modern corporate treasury management “He must study the present in the light of the past for the purpose of the future” (John M. Keynes)

1.2.1

Definition of the concept of treasury management

Defining the "treasurer" concept is a tricky job since dictionary definitions are often obsolete, incomplete or out of touch with the reality of modern corporate finance and economics. Furthermore, it is a word unknown in some languages, which cannot be translated. For once in financial matters, it is of Latin rather than Anglo-‐Saxon origin. The term comes from the Latin regions and southern Europe (Provencal Thezauraria, Spanish, Italian Tesoreria – thesaurye, thresaurie -‐ French trésorerie, "treasure house"). The Académie Française's definition, probably one of the oldest, dates from 1835. A trésorier (treasurer), a masculine noun with a feminine form (trésorerie or treasury), is a person who manages the finances of a company, an association, etc. Synonyms are Chancellor of the Exchequer or quaestor. The "treasury" is also the place where public funds are kept and administered – government funds. It means the resources from which the expenditure of a public or private enterprise is met. We can even find some very ancient quotes in French such as "Sachant bien que par vous ne seront meprisez (mes talens), combien qu’ils soyent provenus d’une bien pauvre thesorerie” [knowing that you will not disdain my talents, especially as they have come from such a scant treasury] (Quotation from the writings of PALISSY). Sadly no dictionary, not even a modern one, gives a full definition of the function of "corporate treasurer" as it has evolved, especially over the last few years. It is regrettable that no major dictionary has been able to adapt to the reality of a function that is now well recognised, even if not (very) well-‐known. Fortunately, Wikipedia gives a fuller definition for those interested in it. Better still, to a certain extent it reflects the evolution of the treasurer’s function.

1.2.2

Origins of the treasury function

If you ask yourself how far back the treasury function goes – and particularly the corporate (non-‐financial) treasurer’s function – you will be hard put to pinpoint a specific moment in time. The origin of the modern treasury function is in the public (state) treasury and the concept of "treasure" (with the implication of "public treasure/funds)". We can find traces of these concepts in ancient Egypt with the "treasurer", or "Imy-‐ro khetenet" in Egyptian (12th dynasty in the reign of Sesostris III,

for those amongst us interested in Egyptology), meaning "Master of the Seal". He was also the highest judge in the land, after the king and his vizier in the ancient Egypt of the Pharaohs. Sadly, this is not, or is no longer, really how things work in modern corporations. This Egyptian treasurer controlled the chamber containing the gold and silver and was Master of the Seal (highly secret duties and appellations in reality). In particular, he controlled all the reserves (that is a concept that we treasurers can recognize) and the stores (another concept our wives would recognize) of products other than food products, which were controlled by the vizier. He was helped by "assistants", by "substitutes" and by "Keepers of the Seal". Here again, there is nothing new. Like us, he needed a team of helpers. The “Iykherneferet" was also a role considered as that of treasurer and "Master of Secrets". This was a function that was at the same time mysterious, important, little-‐known and entrusted to persons of high worth. Here again, surely nothing has changed in modern corporate treasury practice? Nevertheless, this was always essentially a government function linked to the public “treasure" and to the government. We find this concept time and again throughout history. But it is in the middle ages that the concept starts to emerge more clearly. In the 13th century, the office of treasurer was introduced in France. He administered the royal finances. We would hazard a guess that similar functions also existed in England, Spain and Italy. In France, Philip the Fair was to transfer the Templars’ wealth to the Louvre Palace in 1295. Treasurers were also called “Messieurs des Finances" or "Mr. Finances" – a happy expression that can still be used today. The Templars invented a number of things, particularly the traveler’s cheque. They were inventors of genius who understood the importance of having someone in charge of financial and treasury management (in short, their Order's cash). The Templars were the "modern" bankers of their day. They funded several governments and were suppressed because they became too powerful. The Templars were a sort of Central Bank or European Investment Bank before their time, an IMF of the Middle Ages, the ancestor of modern supranational bodies. The Templars contributed to shaping modern finance and banking, and also the treasurer's function. For example, they invented a way of encrypting messages to be sent to their other offices throughout Europe, to avoid thievery on their long voyages. The “traveler’s cheque” was born. The SWIFT message of ancient times originated in that age.

1.2.3

Corporate treasurer, a concept widely overlooked in modern economic history

This function has clearly all too often been overlooked or passed over unsuspected by historians. However, it has evolved enormously. Its evolution is the product of a number of factors, such as professionalism, organizational changes, corporate mergers and the internationalization of trade and industry, technical and legal innovation and, finally, the creativity of the people in charge of treasury management over the centuries. The origin of modern treasury management as we know it today, however, is to be found in

Europe in the 1970s, in the specific economic circumstances of that time, which probably had a big effect. For once, Europe was not lagging behind the USA, which is often in the forefront in financial matters. Some historians assert that thirty years ago most people were unable to give an explanation of what treasury management involved. Sadly, that would still seem to be true today. At that time, it was not even considered as being a separate job in its own right. That has well and truly changed. However, there is no hard and fast, prescribed career or academic path preparing people specifically for the treasury function. Things have been changing of late, but the subject is not well covered by faculties and universities in general. The treasury function has started to grow in professionalism at the speed of light, especially in the last five or six years. Nevertheless, it is a function that has received little recognition in business and economic history. We can certainly find evidence of “treasury functions” in various historical writings, particularly in the USA in the 1900s. For example The New England Textile Company mentioned the “treasurer”; The Baltimore & Ohio and the Mobile & Ohio railroads referred to the “treasurer’s accounts”; the GE company in 1899 reported “treasury, accounting, collection and credit departments” together with a list of treasurers; the US Steel Corporation in 1904 reported “treasurer and secretary” and the Union Typewriter Company referred to a “treasury report”, as did Otis Elevator in 1906. At roughly the same time in Britain we find a “treasurer of the British Municipal Government”. The modern treasury concept and the treasury function proper appear in the 1950s, although they were already in existence in some companies such as BP or ICI twenty years earlier. Later, in the 1970s, the idea of "cash management" appeared. People then talked of "group treasurer". Today, cash management is only a small part of the job, as can be seen from the space accorded to it in treasury textbooks.

1.2.4

Treasurer Associations

It was also in those years that the first treasurer associations appeared. Although recent and young, they have made a big contribution to developing and promoting the treasurer’s job. Let us give them the recognition that they deserve. The oldest of them is AFTE in France, which celebrated 35 years of existence at the end of 2011. The British ACT followed shortly after, along with FTA in Australia, SIT in the USA and OPWZ in Austria. Then other countries also developed their own association structure, such as AFP in the USA (1980), TMAC in Canada (1982), DACT in the Netherlands (1996), ATEL in Luxembourg (1994), ATEB in Belgium (1991), IACT in Ireland (1986), etc. Later still, these banded together under the banner of the IGTA (International Group of Treasury Associations) or more recently in the form of the EACT in Europe. The EACT is also additional proof of internationalization and the need to group together to ensure that the corporate treasurers’ function and their technical and legal resources

move forward. The legislative and tax environment has now become so important and has such a big effect on the treasury function that a real counterweight was needed to safeguard the interests of corporate treasurers in the European Union. EACT is a lobbying body which looks after the treasury management profession, amongst other tasks.

1.2.5

Definition of the treasury function

A more modern definition of the treasurer’s function would involve saying that treasurers in non-‐financial businesses are responsible for monitoring and managing the corporation's cash and near-‐cash to best effect (or its borrowings and other liabilities), for raising new capital if needed, for raising funds through bank loans or via the capital markets and for maintaining excellent relations with its banking partners, stakeholders and other investors. Treasurers have set duties, which depend on defined policies and procedures. They are responsible for the proper management of financial risks (sometimes even for managing all group risks – ERM). These may include interest-‐rate, foreign exchange, credit, counterparty, commodities, equity risk, etc. They may even sometimes include insurance or external pension fund risks.

1.2.6

Generation “X”

It is still a very young and new function. In sociology, we would speak of generation X. This gives us a glimpse of the developments in the years to come – technology, globalization, the advent of new alternative techniques for funding (disintermediation), for payment ("e-‐payment" and "e-‐globalization") and powerful IT tools to improve productivity, efficiency and security. The definition of the treasurer’s function will need to be changed time and time again since it is constantly developing and has not reached maturity. A major objective will be to have this profession achieve greater recognition as being essential in the finance departments of modern multinationals, and to place treasurers closer to CFOs, which is where they should be in view of their role and skills. Market volatility is certainly not going to abate, and we have been thrown in at the deep end of a new era, a new order, a new dimension, where things will never be the same again. New regulations, new technologies, an interconnection and correlation between markets, economies and continents – these will force the treasury function to evolve, making it more essential than ever in the future, and particularly more and more specific. The long crisis that we are going through is perhaps, in this respect, a fantastic opportunity for corporate treasurers.

1.3 Evolving role of the treasurer and new challenges “For more crucial than that we know or do not know is what we do not want to know” (Eric Höffer)

1.3.1

The evolving job of the treasurer

The treasurer's function, like many others, has evolved considerably over the last few years. The main changes derive from changes in technology and progress made by IT and the Internet in particular, from changes in the legislative framework (EUR, central treasury structures, SEPA, MIFID, EMIR, 8th Directive, etc.), and also from changes on the economic front and from globalisation, which have been so much decried over the last few years.

1.3.2

Hyper-‐specialisation of the treasurer

If we compare the job in its present form with the job as it used to exist only a few years ago, we can see how much progress has been made. The economic world has changed enormously. We are now in an era of ultimate professionalism and job hyper-‐ specialisation. A treasury manager is a "specialist" who also needs a "generalist" side. Treasurers have to understand a function which, because of the tools used and the techniques applied, has become a terribly technical job. But they still have to keep a general overview to enable them to manage and introduce products, techniques, solutions and bank software. What characterises the treasurer's job is the wide diversity of skills that it needs. The treasurer's job requires a knowledge of IT, tax, legal, economic, financial, accounting, and more. It is a key job, at the crossroads of all finance departments. Treasurers, who have long since left the ivory towers to which they used to be confined, are now at the heart of the whole finance function. If treasurers still live in towers, it's a different sort of tower – the control tower of finance. All financial transactions have to go through treasury. It is therefore an unavoidable point of contact. These many contacts make the job interesting and exciting, but require a broad range of knowledge.

1.3.3

Changes in the economic environment

The world's economy has evolved. There are no longer borders to stop international economic dealings. The world is now one. Companies become international groups with many business lines, subsidiaries on every continent and, consequently, multi-‐currency transactions. Many treasury departments manage greater funds and more financial transactions than some banks. Some multinationals are in fact true internal group banks. The phenomenon of specialisation and concentration has also led to companies growing to gigantic size. Mergers and acquisitions, absorptions and joint ventures, takeovers and cooperation agreements have been the watchwords over the last two decades, reaching a peak in 2000, the apogee of the new economy. The range of different activities and the size of companies has made appropriate treasury management absolutely essential. We should not imagine that the current crisis and the difficulties arising after the excesses of the euphoric era of the new economy and the bursting of the Internet bubble have reduced the need for strong and efficient treasury management. Quite the contrary, more than ever, companies are looking to make up for operational shortfalls or losses of income through more efficient financial management. Unable to earn more money or to increase sales, companies are seeking to manage their resources or capital requirements better, to reduce their funding costs and to protect their operating margins more effectively in an extremely turbulent and sensitive environment. We should also mention stock markets, capital, currency and interest rate volatility, which all make treasury management more difficult, but more crucial than ever before. Over the last few months we have found real difficulty in obtaining credit at an acceptable cost. The many defaults on bank loans, together with stricter equity requirements, oblige providers of funds to become much more rigorous and sometimes to withdraw from the lending business altogether. This work sets out the reasons for this change. The role of guardian of the business' liquidity has become crucial. At the same time, there has also been an increase in the treasurer's supervisory role. Treasurers have to ensure, as the group's bankers that internal rules on inter-‐company finance are adhered to. They must ensure that the credit limits allowed to subsidiaries are adhered to. Many treasurers have understood the need to set down precise and strict rules to delimit and waymark their function as the supervisors of the group's internal lending. Through balancing accounts out internally, it often happens that they find error or malpractice. It is in fact easy to draw on a cash pooling account, which will not trigger rigorous checks on cash or on transactions by the subsidiary. That is why management of working capital requirements has (again) become a fashionable subject in treasury circles.

Treasurers keep a watch over the finances but more than ever before they have to ensure there have been no excesses by their less scrupulous affiliates. Changes in the treasurer's role

1.3.4

Impact of the new international accounting standards

1.3.4.1 Revaluation to fair value We cannot overlook the arrival of international accounting standards which completely revolutionise the approach to hedging financial risk, both exchange rate and interest rate. The consecration of revaluing to market value – the infernal fair value and mark-‐to-‐ market process – along with complex hedge accounting rules, have contributed to changes in analysis and financial decision-‐making. The paradox of this change is that now treasury decision-‐making is sometimes or often done using criteria or factors that that rely on purely accounting methodology – with the intention as far as possible to mitigate volatility in an income statement undermined by an economy that has been stagnant since 2000, the dates from which IAS 32-‐39 and FAS 133 became effective. Recent economic events and crises have further reinforced the need to resort to market value rather than to historic accounting cost.

Many accounting standards (IAS and IFRS) are now in force. However, the one that is of most interest to treasurers is IFRS 9, of course. This standard provides for financial instruments to be stated at fair value, and for commitments that were hitherto off-‐ balance sheet to be brought onto the balance sheet; the balance sheet total will thus be modified and the income statement threatens to become more volatile because of provisions for changes in market value from one balance sheet date to the next. While nobody doubts the need to produce more consistent financial statements or achieve better comparability and greater transparency in financial information, the practical aspect of applying international accounting standards gives rise to concern. 1.3.4.2 Transition to and application of IFRS 9 The questions that face treasurers are as follows: how to prepare for the transition, how to manage the switch to IFRS (7 and 9 amongst others) with reconciliation controls, certification procedures, etc. How to adopt accounting and financial information systems, using new software applications that are not always either flexible or suitable, and how to meet increased reporting requirements? The new standards have created a huge amount of additional work in treasury departments. Treasurers, who are certainly more familiar with financial products, are the stalwarts when it comes to applying hedge accounting. They have to mitigate technical weaknesses and the accountants' lack of knowledge on how to account for financial instruments. This isolates them even further in a very technical and complex world. Unfortunately it does not make their superiors see them in a sympathetic light – they take a very dim view of the fact that a simple accounting standard should give rise to so many problems. 1.3.4.3 IFRS, a challenge and an opportunity Nevertheless, although the new accounting standards may be a real challenge for treasurers, they also provide opportunities for a complete rethink of the management of interest-‐rate and currency risk hedging. The evolving nature of the standards adds extra difficulty for treasurers who have to fit in with them and adapt to new features that are not necessarily conducive to simplification.

1.3.5

Technological developments

Technology has advanced by leaps and bounds over the last few years. Decision-‐making and cash management software applications have simplified treasurers' lives. They enable them to hedge more companies and more funds. The speed of access to online information, connectivity – another fashionable theme in treasury management – and the Internet have also transformed the function in a positive way. Today, it is even

possible to use AFP type solutions or cloud computing, subcontracting activities, particularly back-‐office, or to hire outsourced services. Of course, the complexity of these products requires specialists be used to implement them or for consultants be involved in designing the products and putting them into production. One major idea is to interface together the various information solutions from logistics to production, from accounting to treasury and from human resources to production. Accountancy and the software underpinning it is the central pivot in the whole company's IT architecture. All roads in the company and its various departments or subsidiaries lead to the accountancy function and to accounts consolidation. This architecture which centres on the accounting software application should, for example, make it possible to set up a payment factory for the whole group.

1.3.6

Treasurers, the prisoners of their own specialisation

The characteristic of the treasury function is this hyper-‐specialisation, which we have tried to explain. Its highly technical nature makes it very interesting. However, this is also the reason for treasurers being isolated. Even though all departments and jobs may be affected by specialisation, it applies most particularly to the treasury function. One of the big problems affecting senior treasurers is finding a career development path that will satisfy them fully. Specialists in any type of job are always to a certain extent the victims of their own specialist knowledge. They cannot easily export their treasurer knowledge and skills to the other group departments for which they work. Some treasurers try to retrain in other more generalist departments which are locally higher ranking, such as becoming the financial director of a subsidiary, for example. A role closer to operations is also very tempting. Unfortunately, the financial director's role in a subsidiary of an international group often boils down to a chief accountant's job, neither more nor less. The freedom of action allowed to a local financial director in a multinational corporation is very limited. This may give rise to a certain frustration for treasurers who need to make a radical change in the type of job they do. Some fear it or fail to cope with it well. It is sometimes a tricky turning point in the careers of treasurers who, although happy with what they have achieved, decide to make a move within an organisation that they know well. By contrast, their wide-‐ranging knowledge and their internal network will be very useful in furthering their careers and carrying out their new jobs. They can also move sideways within the finance department and hold other posts: management accounting, mergers and acquisitions (where ideally they can put their skills and their knowledge of corporate banking to full use). Treasurers are therefore victims of the interesting jobs that they do. It is more difficult to leave treasury management than to get into it. The treasury function might be called a "gilded cage", and that truly is a better description than "ivory tower". They must, if they want to change jobs within the company, be able to get down from it or get out of it one day.

Many treasurers are victims of this specialisation. In terms of promotion, they have to look for similar but better-‐paid posts elsewhere or they need to aim for a wider range of functions and responsibilities. The treasurer's expertise exports easily. This is why they are often wooed by corporations seeking experienced personnel who can become operational immediately. They are true technicians. This is an advantage because companies always need technicians. What they are looking for in treasurers most of all is their experience since this is not a job that you learn at university or in top commercial colleges. Treasurers forge their knowledge on the ground and through practice. Treasurers' versatility is often the key element that employers are looking for.

1.3.7

Treasury management, a sexy job

The treasury function is viewed with fascination, like many things that are not well understood. It is interesting because of the contacts that you may have with the various banks and their various product specialists. Banks like to "woo" treasurers to convince them of the benefits of the services that they are offering. Treasurers are therefore valued, in demand and pampered by their bankers. The world of the financial and capital markets is intense and very exciting. It is a function in which you depend on an external environment over which you have little control. Creativity is a fundamental requirement for this job. The size and nature of the transactions make the treasury manager's job one of the most exciting ones.

1.3.8

The future of treasury management

There is no danger of the job losing its interest or attraction. It will only become more complex and more technical as time goes by. In doing so, to a certain extent it will isolate itself even more by comparison to other finance departments. Treasurers are often obliged to shut themselves up within narrow fields of technical specialisation. The challenges that they have to overcome are many and complex. Amongst other things, we have referred to international accounting standards, IT solutions, improved working capital and cash management, setting up an in-‐house bank, using payment standards such as SWIFTNet or optimal centralisation of cash management. Technical complexity, the daily lot of the treasurers, doesn't seem likely to disappear. They need to display great flexibility and the capacity to adapt to cope with an ever more unsettled environment.

1.4 The twelve labours of Hercules in treasury “There is no education like adversity” (Benjamin Disraeli)

1.4.1

Corporate Treasurer’s challenges for the coming years

If the treasurer were a herald of ancient Greece (note that the modern Greek treasurer is also a sort of herald), he would be a sort of Hercules faced with twelve labours or major undertakings. The tasks, like cleaning the Augean stables, would seem to be huge and, in some respects, herculean. Since plenty of businesses seem to be directly hit by the economic crisis, the pressure on finance departments is not going to fall away or slacken off. Quite the opposite, we will be asked to do more with fewer resources. The regulatory framework will be a second source of pressure, the technical aspect a third and finally there is the control environment. These will all be elements requiring treasurers to adapt continuously. 12 LABOURS OF HERCULEAN TREASURERS I

Treasury (re)-‐positioning

Cash-‐flow forecasting ( WCN

III

Markets volatility (in general)

Qualified & skilled staffing

Technologic upgrades / STP / Roll out of IT System

Internal controls / ERM / Risk reporting

VII

Accounting standards (new amendments)

VIII

Return on assets versus risk

Counterparty credit risk

Markets volatility

Regulations implementation / compliance

XII

Bank relationship management / Rep’s to improve cost of bank services

The fact that the task may be herculean does not mean that the challenge is an impossible one for treasurers. Many of them have already made major changes to prepare for these various challenges. There is nothing new under the sun. Nevertheless, the crisis in which we seem to be stuck does not make the work less hard or the job any simpler. Instead, thanks to or because of (depending on your point of view) these challenges and the current economic environment, the treasurer's job is and will remain one of the most attractive ones for courageous young finance professionals. A job that never evolves can become boring and wearisome in the long run. There is no danger of this happening with the treasurer's job, however. One of the goals has to be ensuring you have a good structure, a modern and efficient organisation to face the challenges, while at the same time sticking to budget limits and keeping capital expenditure within bounds. In times of crisis the cost aspect is, unfortunately, a critical and sensitive aspect. But as the popular saying goes, you catch more flies with honey than with vinegar. The (increasingly) strategic repositioning of treasurers is passing through this preliminary organisational and automation phase. We need to free up time to spend on tasks with higher value-‐added and to spend more time on our subsidiaries. The service and advisory aspect of the job must come back to the forefront. To free up time and to keep down operational risk, you have to invest in time and in systems and procedures/policies. When treasurers reach this threshold, they can then devote more time to the job of giving strategic advice to subsidiaries, to joint ventures and to management. It is a sort of rite of passage for reaching the treasurers' Nirvana. Obviously, every business has its own culture and specific approach, based in particular on its risk appetite. However, no treasurer can live with this and leave things as they are without adapting. In this respect we have often likened the treasurer to a type of chameleon. "The treasurer, a career of the future", we are sure of it.

1.4.2

Modernising the job of the Finance Department

“”What we anticipate seldom occurs; what we least expect generally happens” (Benjamin Disraeli)

1.4.3

Parallel between the evolution of the treasury manager’s job and the CFO’s job

The new CFO has arrived in his most recently updated version. His job has evolved considerably over the last few years because of fundamental changes in the environment in which he operates, just as happened with the treasury manager's job.

After spending a huge amount of time on compliance, he is now being asked to improve the organisation's performance. He is being asked to be transparent, multi-‐skilled, efficient, proactive and a visionary. This is a very wide-‐ranging job description which it is necessary to better describe. It is not only just technical jobs, such as the treasurers, that have evolved greatly over the last few years. The CFO's job has also obviously mutated for a number of reasons. It now requires qualities other than those needed in the past and also new aptitudes to fulfil the growing expectations of the shareholders and the Audit Committee. The CFO now sees his performance measured and evaluated. He can no longer just do his job and produce the financial results; in addition, he has to demonstrate that he has performed. We have now gone into a yet more competitive era. We have to demonstrate that we are achieving fixed, pre-‐set targets effectively. This need to demonstrate that expectations have been fulfilled and the job has been done, from a perspective that is not just backward-‐looking, creates the feeling of increased pressure on CFOs. Onto profit reporting has to be added the method, how we got there and how we will keep on getting there – a new predictive aspect of the job which goes beyond just producing cash flow forecasts and budgets. The management aspect is new because the methods and the control system are going to be of the essence and must be demonstrable. The days of taking people's word for it or judging by past results are well and truly over. The neo-‐CFO in his 2011.0 version has become the multinational market standard.

1.4.4

CFO, the guardian of the temple

The CFO is often vital to strategic decision-‐making. He must protect the company against the commonly occurring and frequent biases arising from taking decisions on emotional or barely rational grounds. Only a few CFOs use the lever that their job gives them to influence decision-‐making. They were often excluded or little involved in the strategic decision making process. CFOs often seemed to be distanced from strategic operations and were seen as "spoilsports". The new CFO must take a full part in the strategic decision-‐making progress and not only from a financial point of view (for example foreign exchange, finance and interest-‐rate risks, etc.). They are often also criticised for having a propensity for excessive and systematic evasiveness. All too often, this role of guardian of the temple and financial orthodoxy has been perceived as being incompatible with the strategic decision-‐making and acquisitions process. He was a supplier of (financial) services rather than a major player in decision-‐making. Things have changed and the CFO is now vested with the role of adviser and joint decision maker, for example in Mergers & Acquisitions activities. Moreover, he has to display great nimbleness and flexibility in taking all the new expectations on board and fulfilling them in due course.

1.4.5

The modern CFO’s Olympic ordeal

As with the Olympic rings, we can distinguish five essential interlocking areas of responsibility that all CFOs are going to have to address (if they have not already done so). These five key areas are: 1. Transforming finances 2. Treasury management 3. Corporate reporting 4. Cost control 5. Measuring performance and risk management in the broadest sense To confront these challenges and tasks, they could develop and expand their staff, subcontract or centralise services into specialist departments (for example Shared Service Centres), by increasing the quality of technical and IT resources, laying down training and monitoring quality standards particularly in terms of change management. The equation looks simple: do more, do it better, do it cheaper. That sums up the whole art of efficiency.

If you ask what the foremost quality of a modern CFO should be, the word "adaptability" is the one that comes up most frequently, with the idea of flexibility and efficiency. To

be efficient, you need to be effective at moderate cost. Additional effort and marginal costs must always be justified and offset by the gains deriving from them (quantitative and qualitative). The CFO must not think only in terms of quantity (cost) but also in terms of quality (improvement in procedures, internal control, STP, etc.).

1.4.6

Future CFO challenges and obstacles

It has been said that "adaptability" is the keyword for the CFO who must learn but also, as the visionary economist Alvin Toffler wrote, must unlearn and then re-‐learn once again. This is a sort of never-‐ending crusade peppered with major technical challenges – technological, financial and regulatory. Like the treasury manager's job, the CFO's job has evolved considerably over the last few years. The CFO has a strategic role in driving operations rather than simply recording them (accounting/consolidation) or facilitating them (finance/management accounting). In the 21st-‐century, the CFO must manage those factors that could affect operational performance, and take a view on and manage risk in the broadest sense. He must furthermore be a source of Business Intelligence (BI1). We are very fortunate that BI techniques have evolved and have now reached maturity. Today they enable the CFO to meet shareholders' demands and requirements. These rising up obstacles come from an external environment, which remains hostile and shifting. The European regulatory framework has been changing fast since the London G20. Modern assets have become more virtual, intangible and sometimes intellectual. We have to draw on the last ounce of the available human resources. Not only has the decision-‐making process been trimmed down but the demands for information have increased, obliging the CFO to equip himself with (more) effective tools (for example IFRS 7 & 9, SOX, etc.). Demands are ever more pressing, the environment is less favourable and the time allowed has been shortened. This is like the soap powder washing whiter challenge – it has to do as much as possible at a very modest price. Another development is the need to invest in technology, something that CFOs did not do or do not like doing. That has certainly changed.

1 BI: Refers to computer-‐based techniques used in identifying, extracting and analysing business data, such as sales revenue, costs and incomes. BI provides historical, current and predictive views of business operations (e.g. reporting, data mining, business performance management, benchmarking, predictive analytics, etc.) and aims to support better business decision making. It is also known as a Decision Support System (DSS).

As in the USA, he has become an effective no.2 who must have excellent communication skills. He must also develop his soft skills. The CFO's cockpit and instrument panel have been improved thanks to developments in BI. However, the aircraft is now supersonic and it needs solid training and different aptitudes to fly it. Finally, he must be a visionary. A jet plane with an inexperienced pilot does not make sense. Similarly, producing reports, assessments and forecasts without a proactive view and without then taking the decisions, makes no sense. If the CFO sees that he is going too fast, he must be able to put on the brakes or change course. It is this ability to anticipate that will give the company its competitive advantage. He must model and explore the future and predict the unforeseeable (even though it may never happen). This is why Financial Performance Management (FPM) is the bridge between finance and operations. This new role may seem daunting, but also exciting and rewarding. Technological knowledge and analytical skills are becoming essential qualities in fulfilling the CFO's wider job functions.

1.4.7

Adapting to survive

The crisis has given CFOs more power. Together with the “financification” of the economy, it is at the root of the growth and expansion of their responsibilities. The need to control and manage the financial component has been sublimated to a certain extent. Under pressure, businesses have enhanced the role of financial managers to maintain their profitability. CFOs have had to take this phenomenal post sub-‐prime financial crisis pressure on-‐board. In record time and with limited resources, they had to rethink their management and control techniques, to adapt them to an environment that is at best flimsy. Managing costs, rationalising expenses, controlling capital expenditure, seeking performance, budgetary orthodoxy, regulatory reporting and so on are all CFO's fields of responsibility, which have increased over the last three years.

1. 2. 3. 4. 5.

Cash is key – focus on cash – “cash culture“ inoculation Automation of reporting and STP of processes To be closer to operations to better understand their needs To digest and compliant with new regulations To know all “companies languages” to better understand corporation functioning 6. To communicate directly and efficiently with stakeholders (e.g. shareholders, banks, suppliers, customers, auditors, investors)  from the shadow to the light – CFO’s should also “sell” the company 7. To proactively manage finance and to measure performances to pilot performances with ad hoc tools and KPIs (B.I.) 8. To proactively manage enterprise risks (including reporting) 9. To become “actor of changes”  leadership in changes 10. To implement, to enhance, to develop internal controls (better controls imply better management and results) 11. To improve customer risk and to actively manage credit 12. To become the co-‐pilot of the company beside the CEO

1.4.8

CFO’s future challenges

Nobody would dispute the challenges and changes in the CFO's job. They have to become better technicians than they were in the past. This interest in things technical and IT (notably Business Intelligence) makes it easier for them to understand their treasury managers when it comes to "selling" a SEPA or Payment Factory project, or again when the treasury manager suggests adopting a new TMS tool fully integrated and interfaced with the ERP. Communications between the treasury manager and the CFO have been improved by the financial liquidity crisis. Today, new regulations (such as OTC Derivatives, IFRS 9 and 7, MiFID, 8th Directive, etc.) have improved communication between the two, which is all for the better. While the CFO may have moved closer to the CEO, the treasury manager has also moved closer to the CFO, producing an upward shift in financial management as a whole. This new and exciting environment presents not only challenges but also wonderful opportunities and fantastic technical possibilities. Just like the treasury manager, the CFO can re-‐invent his job and enrich it, breaking out of its purely financial bounds. The modern CFO must have the qualities and skills of adaption which will make him the true guardian of the temple. His

intellectual curiosity will enable him to flex to these new requirements. The desire to re-‐learn will also be an essential quality for him to succeed and blossom. New CFO’s role means inevitably a new role for treasurers too, with new challenges, more responsibilities, and a larger scope of tasks and, at the end of the day, a more attractive job.

1.4.9

The Role of the Treasurer in Corporate & Financial Strategy

“These heroes of finance are like beads on a string when one slips off, all the rest follow” (Henrik Ibsen) 1.4.9.1 Strategy in treasury What a weird idea to talk about financial "strategy" and about the role of the treasurer in it! But first, what does strategy really mean? Strategy is the art of having an army advance on a theatre of operations or is a set of coordinated actions, of skillful operations to reach a goal. This definition can be extended beyond the art of war. It can even be applied to treasurers. It would thus be the art of coordinating financial means and tools needed for the management of a company or the preparation of its financial defense or even all the decisions taken on the basis of economic and financial assumptions in given business conditions. It is certainly not like this that treasurers would have described their role. Before adopting a strategy, it is be necessary to define a general treasury mission. From this mission he will derive strategies to be adopted. But, more recently, it has been noticed that treasurers are getting involved to a greater extent in general financial strategy. 1.4.9.2 Treasurer takes leadership The stars in finance often come from the M&A or from capital market fields. "Deal makers" win the laurels and the rewards, while the treasurers work behind the scene, their role being rather that of a lamp man making sure that the machine works. But times are changing … Focusing on costs, efficiency of processes and on tighter control of liquidities modifies the circumstances. Other "stars" are needed now; those working backstage are they now stepping out into the limelight? Often discreet, treasurers are not given the honors those working on the center stage of finance usually receive. Nevertheless, their position at the crossroads of all the disciplines of finance and their degree of hyper-‐specialization involve them henceforth in numerous dossiers of which they had been excluded in the past.

During last years he has become, more than ever before, an essential figure in finance management. The battleground of treasurers is a field more than ever before mined with all kinds of pitfalls: IAS, specific (European) legislations, disparate tax measures, declining economies, low interest rates and increased markets volatility. The strategy which is entrusted to him is of key importance and vital; many people have only recently been painfully reminded of this. He is at the center of a series of risks of financial nature that he is best placed to manage and to control. That is why, as in the USA, his role is maybe of even greater importance. He is more and more charged to monitor financial risks namely credit, liquidity, and counterpart or transaction risks, among other things. 1.4.9.3 Strategy, synonymous with … Strategy is synonymous with prevention. Doesn't forewarned mean being forearmed? The strategist's organizational skills enable him to anticipate "setbacks" and to foresee any frustrating difficulties. Access to relevant information and ability to measure factors, criteria or sources of risk are needed in order to eliminate problems before they emerge. The treasurer must be inquisitive and become aware of problems at a very early stage to be able to react on the spot to changing business conditions. A strategist avoids isolation that separates him from reality. He is a "field worker" by definition and adequate strategies require understanding of operational business. Strategy is inevitably based on knowledge allowing to avoiding ambushes and to unquestionably improve performances. Ignorance and excessive confidence are enemies of the strategic treasurer. The strategic treasurer knows that it is necessary to raise the level of financial understanding in the company. This is also synonymous with persuasion. The context finally lends itself to more listening to him than in the past. The absence of pertinent questions by senior management is enlightening as regards the absence of interest, or to be more precise, of understanding. A communication strategy is necessary in order "to sell" one's vision of finance. Strategy can also mean being able to turn one's back on traditions and to act differently by upsetting established ways of thinking and taking new approaches. There can be no strategy without prior (re) organization. The operational parameters have permanently changed without being accompanied by adequate evolution of treasury entities. The treasury function was largely viewed as a sort of unchanging and rigid activity. Conversely, strategy also means the ability to adopt tried and tested models. Benchmarking is very useful and the role of local and international associations of treasurers cannot be denied in this context. Just like a chess player studying the individual games and the possible sequences of moves. The resources available to the treasurer are limited: resources of time, human and sometimes material resources. Strategy also consists in managing in the best possible manner one's resources, which are by definition limited. This is achieved by distinguishing quintessence. But of all the resources, time is the scarcest commodity.

1.4.9.4 Treasurer, a role in full evolution The priorities of treasurer have changed these last few years. His role is closer to that of the CFO. This convergence of functions is proof of his increasingly important role in financial strategy. There are companies that have understood that instead of overstaffing, it would be a good idea to outsource or to pool certain activities in shared service centers to save some of the treasurer's time to enable them to concentrate on strategic tasks creating more value. Thus the treasurer will, for example, be able to make time for (re) discovering the close ties to subsidiaries. This is something he had lost sight of, due to the isolation in his control tower without windows on the outside. He is moving closer to the troops at the frontline of the battlefield. He also claims a consultant's role vis-‐à-‐vis his subsidiaries whereas, paradoxically, he complains about the lack of understanding displayed by them and about the inadequate feedback of relevant information. They strongly feel the urge to evolve into a more strategic role involving more dedication to the execution of deals and to the provision of specialized advice while embracing a wider concept of risk management. 1.4.9.5 Strategic roles of the treasurer The treasurer has a strategic function in series of tasks such as: banking strategy, relationships with ratings agencies, control and utilization of funds by subsidiaries, management of financial risks, assurance of liquidities, mitigation of volatility of earnings generated by the adoption of IAS, M&A operations, structured finance, pension funds and working capital management. The frame of activities is paradoxically getting wider and characterized by increasing regulation thus implying greater skills. He has to be a clever strategist in order to succeed in reconciling respect of rules and financial optimization. And to crown it all, Management makes available fewer and fewer means allowing him to achieve this goal. This is where the real challenge of the treasurer is. In order to ensure strategic management, it is necessary to have adequate control tools, levers to pull, appropriate treasury roadmap and information necessary for decision taking, in order to be able to navigate by sight. Otherwise management policy would have to be characterized as improvised, remedial, from day to day and reactive. The treasurer needs to receive more information. The requirements of IAS 39 for hedge accounting, the need to establish more precise cash flow forecasts, centralized management of the group's debt oblige him to rely on his internal communication networks. This should lead him to get out of his 'den'. As smart strategist, he has to allocate resources adequately to reach his objectives while minimizing risks and avoiding to adversely affecting results through excessive volatility. It is also necessary to allocate treasurers to the most technical tasks generating the highest added value. Proliferation of statutory constraints Treasury management is a sort of orchestration that requires great dexterity on behalf of a maestro because the score becomes increasingly complex. Indeed, a proliferation of

European measures, accounting standards as well as of technical, technological, local and fiscal constraints is being observed. Excellence is needed to be able to orchestrate all these matters with respect of rules while at the same time guaranteeing financial efficiency. All these measures are emerging virtually all at the same time, from different sources, and the treasurer has to find his path in this jungle of texts. But all measures are aimed at strengthening internal control and risk management systems. 1.4.9.6 Larger scope of activities for treasurers Treasurer is increasingly involved in activities outside his ordinary scope of action. In order to gauge the extent of this change, it is necessary to compare the function, as it is today with what it is forecast to be. In the future, he will be less bogged down by the execution of routine tasks and transactions. The function will become increasingly sophisticated with greater emphasis on strategy, consulting and risk control (not only related to finance). The treasurer is a strategist. He has to tackle important challenges: of technical, technological, legal or statutory nature. These challenges and the pressures are such that he needs good organization and control of a maximum of elements. He has to be somewhat of a visionary person, able to anticipate in order being a skillful strategist. Technology is certainly one of the most interesting axes of development which will give the treasurer the means to reach some of his objectives, though not directly, but through the spare time that will be left for tasks with stronger added value. He has to avoid "heavy artillery" to reach minor targets and should rather focus his efforts on major objectives, a kind of art in which he will inevitably have to excel. The strategist adapts to his environment and becomes immersed in it. He has to awaken the chameleon side hidden within him and go somewhat beyond his usual nature. He has to federate specialized internal forces (tax, consolidation…) and operational internal forces. The role of the treasurer, according to Darwinian logic, will inevitably continue to evolve and to mutate with the development of his scope of action.

1.5 The corporate treasury’s role in troubled times

1.5.1

First Worldwide Crisis

For a few months, we have been in a situation that none of us has experienced before and hopefully never will again. For the first time in human history, the economic crisis is worldwide. Economic historians will be sure to tell us in the coming years what happened and why it happened. Is it a butterfly effect or a more global problem? Is it a confidence crisis or are there real financial problems? Are these the limits and excess of capitalism or a normal side effect, exacerbated into a serious economic crisis? Who can say exactly? It does not matter, pragmatics will say. Let us not worry about why. The G20 in London took care of that, as well as all the world’s regulators. Let us not worry about the causes, but let us deal with the consequences, as all the very pragmatic European treasurers say to each other. It seems useful at this stage to ask ourselves what has changed or will change for treasurers and to think about the treasurer’s role in these troubled times.

1.5.2

Consequences of a Systemic Risk

The real problems started with the failure of the investment bank Lehman Brothers, which exposed the vulnerability of the world’s economy to systemic risk. Can the bankruptcy of a financial institution shake the entire financial system, and as a result impact the treasurer’s daily work? Evidently, it can. We can only be pleased with the first drafts of measures taken in London by the leading nations of the world, especially the decisions to reform the calculation rules for bank capital adequacy and to extend prudential supervision to include speculative funds and financial derivatives markets. In addition, reinforcing the role of the Financial Stability Forum, as partner of the IMF (International Monetary Fund) in the fine-‐tuning of indicators that could detect the emergence of major macroeconomic and financial risks is also a sound idea. However, none of them will admit that the many challenges still lie ahead to finally establish an effective defense system against systemic risk. Such complete, exhaustive mapping of the financial system will take time. We will need to identify and include within the scope of the new rules those markets that had previously been exempt. Moreover, we have to revise monetary policies to avoid creating new financial bubbles, as it is these bubbles that feed the systemic risk.

1.5.3

Bermuda Triangle

Some say that the banks are crossing the “Bermuda Triangle,” stuck between the will to simultaneously fight to ensure the stability of the banking system, to maintain private stock ownership of publicly traded banks (to avoid other nationalizations) and to apply the “fair value” principle to increase the value of banking assets. Unfortunately, these three objectives seem somewhat contradictory and paradoxical according to experts. This does not mean that we have to fight to repeal the IFRS, which have led to more virtue and have also indirectly revealed the latent risks associated with certain hazardous, toxic and badly managed products.

1.5.4

The Treasurer’s Role in Troubled Times

This crisis has had and continues to have a profound impact on the role of the treasurer on a daily basis, as their responsibilities have increased. MAIN IMPACT IDENTIFIED: Banking relations – complete overhaul and return to fundamental principles in order to make them sustainable. Increased volatility of financial markets and a greater amplitude of movements (notably FX, IR, commodities and equity) Credit risk impacts everyone, even companies with no major risk Major increase in credit spreads and the cost of guarantees Less banking product dumping (loss of opportunities and cost surge for the treasurer) Internal verifications reinforced or to be reinforced / segregation of duties Reinforcement of policies and internal procedures Use of sensitivity analysis tools (prevention) and stress testing Increased focus on ERM (Enterprise Risk Management) Major liquidity risk, affecting everyone Bank counterparty risk to be considered (new) Pervasive nervousness and gloom affecting all transactions in general / pervasive stress and tensions Greater correlation between financial factors and increased globalization Risk of increased banking controls imposed by regulators (with a direct impact on clients) Fundamentals called into question (e.g. reliable charts analysis), irrationality of behaviors on markets and of the markets themselves

Reinforcement of IFRS rules (notably IFRS 7 and IFRIC 16 & 18, possibly IAS 39) Restructuring the fiscal debt and impact to be managed (waivers) More reliability of cash-‐flow forecasts, required by Boards of Directors Returning to a banker (end of the American ‘single global bank worldwide’ approach, which has become too risky) Increased role in M&A transactions and portfolio restructuring We will attempt to develop these points and explain what has changed in the treasurer’s role, what has impacted it and why it was again placed in the spotlight. Companies have had to resign themselves to going back to the fundamental principles of finance and to their finance manuals. The Bristol & Meyers was checked out of the libraries of CFOs. What seemed unthinkable a few months ago has unfortunately become a sad reality for every company. We sometimes need a ‘good crisis’ to make people aware and bring financiers (as it turned out, mostly bankers and insurers) back to this sad reality. The verifications existed, but were not applied at all or not enough. The goal here is not to look for who is responsible for this crisis. They are many parties responsible, and the conjunction and combination of different factors has plunged the economic world into a deep state of helplessness. As always, the economic world will recover, but it will be very difficult this time.

1.5.5

“Get the Treasurer on the Phone, Please!”

Boards of Directors, Audit Committees and other shareholders were so worried that the treasurer returned to center stage. However, other stakeholders have also requested their input (i.e. ratings agencies worried about ratings, despairing bankers, investors, credit insurance companies and suppliers). Management requested the help of their treasurer to comfort them. One of the consequences for treasurers was surely being placed at the center of discussions, but also inheriting an obvious additional workload. The movement that had begun five years ago was restarted by this crisis, a second chance or more precisely a new opportunity to further strengthen the role of treasurers within the entire financial organization. They have become indispensable in modern finance, as they master and control the financial risks that have become critical. The role of the treasurer has not changed, but has become more important in these troubled times. Its sphere of responsibility has become extremely critical and even vital sometimes. For example, when the cost of financing increases to the point of penalizing debt service or when bank loans default, the company is in danger. Bank counterparty risks, which were once theoretical, have now become real.

1.5.6

What Has Changed for the Treasurer

The treasurer now has even more power, no doubt about it. As mentioned above, treasurers must manage new or increased risks. They have had to adapt their management and be more vigilant about hedging and exposure to financial risks (i.e. sensitivity analyses and increased stress scenarios, and quantitative management tools). However, market volatility and greater variations in the value of underlying securities has made it more important than ever to ensure ad hoc hedging instruments. These major changes have also cast doubt on hedging policies and strategy. For instance, oil commodity hedgers have been burned and do not know where to go for help. However, it is not in the middle of a crisis that we must question everything as an excuse to adapt. Even discussing hedging management has become a sensitive issue. Everyone ends up not wanting to divulge their approach to hedging or they remain as laconic as possible. We have seen a simplification of the products used and a general increase in quantities covered, which implies a much heavier workload. Access to credit has become a sensitive issue for treasurers. They assess the importance of a monitored, quality banking relationship. Some banks are getting out of the corporate loans market, but those that remain have reduced the number of loans granted by two or four. Businesses are lining up to work with loan syndications in order to obtain the amounts they need. It has become necessary to manage a larger number of banks than in the past, with all the additional work this entails. A glimmer of light has become visible at the end of the tunnel, and loans are being granted, but the prices have skyrocketed. The pendulum has not yet swung back to center. Clients realize that the durability and robustness of a banker is an advantage that comes at a price, such as broader margins. The era of deadlines and rock-‐bottom prices is indeed behind us. Bankers must now make their margins on products and not rely on hypothetical gains in dealing rooms. The banking relationship has changed considerably, as we cannot snub a bank these days. Every Euro loaned is welcome. The credit factor is now an integral part of exchange operations prices, which also increase the purchase price. There will probably be margin call systems to cover the risk of non-‐delivery that we have always believed to be very theoretical. The world is quite different today. The low quality of one’s credit risk has a price that we have to accept. It is even more difficult, as the spreads were very tight. For example, a BBB+ company must pay 500 basis points on a five-‐year loan. These heavy spreads force clients to fix their interest rates out of fear of a sharp rise in prices that would then make the cost unaffordable.

1.5.7

The Treasury, a Kind of Royal Guard

If cash is king, then treasurers are necessarily the royal guard. The treasurer is the bodyguard of that which is the dearest and most precious today: liquidities. Short or long, they must protect company solvency at all costs. They keep an eye on its supply. These past months, this task has become more complicated. Treasurers also have to further anticipate the cash flow and net situation of the company in the future. They monitor the cash conversion (i.e. free-‐cash-‐flow) of EBITA and track variances, all while hunting down explanation of these deviations from forecasts. Counterparty and liquidity risks are not new, but they were often relatively theoretical. The treasurer must now mitigate them and diversify the sources of financing (some of which have been completely exhausted) and investment On the pyramid of treasurers’ roles, treasurers have again progressed forward, towards the top. The crisis has modified their role by significantly increasing the analytical aspects, as well as the strategic aspects of the job. The crisis has helped treasurers to cut themselves out of administrative problems to rise towards strategic management and general management. It could even be said that if anyone deserves to have their bonus reappraised, it is the company treasurers, whose role has clearly grown as a result of the crisis and who generate even more value than before the crisis. Their management of fundamental matters has become vital. However, the base of the treasury’s functional pyramid is in no way lacking. The amount of reports and their content are inversely proportional to the rate of inflation. The frequency, details, explanations (i.e. strengthening in 2009 with amended IFRS 7) and the number of recipients of their financial reports have increased significantly. The pressure exerted by management on the treasurer has again increased considerably. The treasurer also produces 15 to 18% of the financial information contained in the annual report (excluding reports related to ERM). The treasurer must remain cool-‐headed in such changing times. Stress and anxiety are pervasive, and they must be sure not to give in to this stress, which is so often a result of a heavier workload.

1.5.8

IT Creates More Value

To generate more value with the same means (owed to cutting costs), operational processes must be computerized. IT tools need to be more powerful and more integrated (Straight Through Processing – STP) to centralize and generate financial information in real time (i.e. TMS solutions such as SaaS or ASP; payment factory tools,

revaluation, sensitivity tests; quantitative analysis and other high-‐quality financial information). This includes a complete modernization in order to improve internal verifications and segregate operational tasks that are risky and time-‐consuming. The treasurer will also inevitably be subject to regulatory reporting requirements that the European Union and other regulatory agencies will impose locally (i.e. LME in France) or internationally (8th Directive and its national implementation), as a technical response to this crisis. Today, these management tools offer an entire arsenal that is completely integrated or can be integrated. These IT products are precious tools for decision-‐ making. They help to make financial risk management and ad hoc reporting more sophisticated and professional. Business Intelligence (BI) has made modernization easier thanks to things such as decision tables borrowed from treasury tools. General management teams now demand reliability, real-‐time information, and complete reports and financial statements. The role of the treasury has become more preventive. It must anticipate and analyze hedging strategies, particularly commodities, which have experienced very high levels and then very low ones. This requires time and intellectual resources, and the talent hunt has begun. Top treasurers are not affected by the crisis. Now more than ever, CFOs are looking for high-‐quality, highly experienced treasurers. However, due to the recession, they must also be experts in financial communication, as this could be fatal. We must also not forget ERM (Enterprise Risk Management), which at the very least requires strong input from the treasurer, the internal expert on financial risk. It is necessary to provide proof of identifying and managing these risks, which in many cases have become major again, such as in heavily indebted companies and/or companies exposed to foreign currencies or raw materials, for example.

1.5.9

Temple Guardians

The world will never be the same as it was before. We have experienced a kind of financial pandemic. The treasurer’s job description has radically changed; the roles and attitudes of partners have changed. Securities and their scale have profoundly been modified. Can we still speak of “credit establishments” or of banks? Should we not say “financial institutions”? Do they still lend money that in many cases they no longer even have? Moreover, cost cutting hinders any attempt at investing and improving productivity, which are often synonymous with new IT systems. We must be able to show the added value of any investment. KPIs and other Key Activity Indicators are absolutely necessary in order to better manage one’s treasury in times of scarcity. Yet, it is in these troubled times that investments in terms of increased productivity would be most welcome. The preservation of capital has become a leitmotiv. In this extremely difficult environment, one must finally reduce debt (“deleveraging”), as the growth risk could be affected for quite some time. Ratios and other financial covenants have obviously been altered and consequently increase the cost of financing by lowering the credit ratings given by rating agencies or by a failure to maintain financial ratios. The

treasurer is therefore faced with many challenges in these difficult times. It is indeed a great opportunity to become indispensable and respectable in the eyes of the general management. The treasurer must develop their soft skills, notably in matters of communication and negotiation. The prices are no longer and will never be the same in terms of financial products and services. It is the end of a frenzied dumping period and financial product superstores. Treasurers’ have taken on more responsibilities and must be remunerated accordingly. Often, a threat and a crisis are excellent opportunities to review the role and operation of a financial position. The art of pro-‐active treasurers is having known how to be able to take advantage of this crisis to reassert their roles, tasks and responsibilities within their companies’ financial management structure. Treasurers have become a kind of financial celebrity at their companies and will no longer be regarded in the same way. We owe them respect as the temple guardians they have become once again. Good for them if they can benefit from this well-‐ deserved ephemeral glory. "Man only accepts change in times of need and only feels the need when there is a crisis." -‐ Jean Monnet

1.6 Economic crisis, whose fault is it? “Anyone can hold the helm when the sea is calm” (Publicius Syrus)

1.6.1

Looking for the culprit of the crisis

Some people seem to be looking for a culprit for the deep economic crisis we are going through. They believe the international accounting standards and the application of fair value accounting are the perfect culprits. But are they really the cause of all the problems? When a problem occurs, normal people try to find the cause, especially those responsible. The financial cataclysm arrived in a brutal manner, and some consequences were sudden and followed on, one after the other. However, the financial community was deaf to the precursor signs of this depression. We were all far from imagining the scope of what has happened. The economy has become a huge grid where everything interlaces and intersects. What we have indeed concealed is the correlation between the different markets and their stakeholders. The interconnection of the economic and financial world is such that we had to fear a domino effect. Among the different designated culprits, some will agree that the usual suspects are mainly the sorcerer’s apprentices of Wall Street: the American mortgage market with its ‘ninja’ credits (“No Income No Job (and no) Assets”) and their excessive granting; the non-‐stop securitisation of financial assets, with its opacity and derivatives; the rating agencies for their lack of responsiveness; the regulators and control authorities for their absence and laxity or even the international accounting standards for imposing the recourse to fair value. So, whose fault it is? Maybe we could agree on a collective and shared responsibility.

1.6.2

IASB, designated culprit

A number of financiers, notably bankers, would like to benefit from the current crisis to set about the international accounting standards. They advocate dropping the fair value principle in favour of the historical cost method to it. According to Sir David Tweedie, Chairman of the International Accounting Standards Board (IASB), international accounting rules are not the cause of the current credit crisis. It is important that market stakeholders are able to trust the information presented in corporate accounts and financial reports”. This is why the IASB has followed up and analysed the performances of the IFRS rules. It decided to address the problems highlighted by this credit crisis one by one and treat them adequately. On the contrary, Sir David believes

that by accelerating the merging of the IFRS accounting rules with the American rules (US GAAP), this will help the capital market. By defining a single set of high quality accounting standards for global use, the two organisations will reduce the possibility of arbitrary accounting. Moreover, the IASB wants to meet the objectives stated in the report established by the Financial Stability Forum as soon as possible. In the US, the FAS 157 has been in use for a few months. Its goal is to establish guidelines on how to apply and calculate the fair value of assets. FAS 157 is a principle-‐ based standard type, which then allows for more flexibility in interpretation for preparers. It is being blamed for the chaos on the market. It would have forced many banks to make mark-‐to-‐market of their positions in a market that has become inactive and where the fair value no longer represents the true value of an asset. In September, the IASB also published a document on the fair value in a market that is no longer liquid in order to help companies apply this evaluation. The standard setters have reiterated the underlying principles and reminded us that it is possible to use cash flow models in situations where there was little or no noticeable market. In this type of situation one must simply support the hypotheses in the documentation in order to convince its auditors. Perhaps we could exceptionally accept, under certain conditions, transferring portfolio assets trading to held-‐to-‐maturity with amortization (historical cost)? This would take away the volatility component. It also seems obvious that more than any other method, we need instructions on how to apply fair value during an extreme period. It is a unique opportunity to test the model and explain it in more detail. The crisis must not be a poor excuse to get rid of the IAS 39 philosophy and fair value principle. The substance over form principle must resist waves of protests and the banking lobby. Let us avoid simplistic approaches consisting in looking for culprits where they are none. The best would have been to not touch toxic or too complex products as they are real time bombs. Moreover, as a response to the crisis, the IASB published an Exposure Draft (ED) entitled “Improving Disclosures about Financial Instruments” (15/10/08). The ED introduced a three-‐level hierarchy of the measurement of fair value. Therefore, it seems apparent that a standard cannot be held responsible for such a disaster. As well, it would be foolish to blame the blood analysis of being responsible for the illness. It would be better to look for the cause of the illness and how to treat it, all while protecting itself from a possible relapse.

1.6.3

Transparency and discipline thanks to fair value

Contrary to what others have said, it is the fair value of a trading portfolio of a bank that guarantees the transparency and a certain discipline. An interesting idea was evoked

with a sort of “crisis discount”, which reduces the result. One should mention it to third parties, but not incorporate it into banking results. This way the pro-‐cyclical effects of the evaluation of fair value can be avoided. Some also suggest an upgraded fair value. In hazardous periods, we would apply the mark-‐to-‐model and avoid crisis discount, all while limiting the pro-‐cyclical impact. To a large extent, the blame surely lies in the unbridled creativity of mathematicians of the City. “Forgive them, Lord, for they know not what they do!” However, by regulating the uses of certain products, we could avoid a number of problems. We should also appoint an effective and more efficient ‘officer’ who could control the markets better. The role of the Chief Risk Officer at a bank will be put under even more pressure. But in the long-‐term, they will be valued and appreciated properly. It is without a doubt the start of the end or the beginning of a new, more transparent era. Taking the bad with the good, most optimists would say.

1.6.4

Anglo-‐Saxon approach to accounting vs. the European approach

Contesting fair value comes down to questioning the Anglo-‐Saxon approach to accounting. It is the classic opposition between the accounting based on the historical cost (continental European accounting approach) and one based on current value, more prospective (Anglo-‐Saxon accounting approach). People who contest the IFRS approach (as compared to a national approach, French GAAP, for example) can find arguments to criticise the alleged quirks of international accounting standards. However, what shareholder would dare say that they do not want more transparency in annual financial statements? Ask bank shareholders what they think of it. Giving a false image of the value of a financial asset is comparable to misinforming (or improperly informing) the shareholder. One should not pick the wrong battle or the wrong culprit. Accounting rules have therefore not aggravated the current situation; they have just simply updated it in a more obvious and immediate way. On the contrary, the IFRS mirror is less deforming that the previous accounting mirror (local GAAP). We can even claim that the IFRS has allowed and will allow resorting to fair value to prevent these kinds of mistakes made by the banks and insurances companies. It seems obvious that the IFRS rules did not generate or aggravate the huge losses of banks, but on the contrary, that they uncovered them, therefore preventing much more painful wake-‐up calls. What we could criticise is not resorting to fair value, but the calculation method in the case of inactive markets. But is this not the basis of the market of supply and demand? Without demand, financial assets, much like material goods, lose their value. It is the absence of buyers that kills the fixed value, not the evaluation. The IASB, just like its American counterpart before it, published in October 2008 an explanatory document to help preparers measure fair value more precisely. It is perhaps still insufficiently detailed.

1.6.5

Where is the end of the tunnel?

According to economists, the financial crisis is far from over. But some more objective people already claim that there is more than one party to blame for this. Alan Greenspan or his successor, rating agencies, banks, legislators, regulators, supervisors and the governments, control organisms, media, investors and finally, accounting standard setters. They all followed the crowd without hesitation. An accumulation of joint factors and a unique historical crisis have gotten the best of American-‐style capitalism and investment banks. Do we need to find a single guilty body to this crisis? Should we not be finding a way out and then how to avoid the same misadventure in the future? More than the accounting interpretation of an operation, it is the transaction itself that we must question as well as the people who initiated it. Let us not point to the wrong culprits, but rather improve the rules that measure fair value, especially when markets become inactive.

1.7 Consequences of the Subprime Crisis for Corporate Treasurers “It’s fine to be honest, but it is also very important to be right” (Winston Churchill)

1.7.1

A Specific Crisis at the Epicenter of an Earthquake

Undeniably, the subprime crisis has changed treasurers’ approach to liquidity management. In addition, it has significant, lasting consequences on the markets and the behaviors of the people doing business in them. Let’s hope for more virtuous behavior and more transparency for investors in the future. The subprime crisis is not just the epicenter of an earthquake that occurred in the U.S., it is a crisis from which the aftershock, like a tsunami, quickly reached the shores of the European markets, and particularly the monetary fund markets, which had been considered to be risk free and stable. More than just the single-‐handed cause of this crisis, we can think of subprime as only the tip of a gigantic iceberg. The impact may be tremendous on a global level, including financial difficulties for certain credit institutions (such as Northern Rock, IKB and Sachsen), as well as doubt cast on an entire weakened sector, a lack of confidence in the interbank loan market, a rise in the cost of credit, and increased credit spreads even with a risk of credit crunch. Paradoxically, all of these consequences have occurred despite an extremely liquid environment, with companies that have never been so financially healthy. One big question still remains about these products. Who owns what? It is this lack of clarity that is causing problems. Did we really know what we were investing in? We can’t be too sure.

1.7.2

Repercussions for Treasurers

1.7.2.1 Shortage and Higher Cost of Credit Treasurers have had to work twice as hard in these somewhat troubled times. Yet, the golden rule of cash management should be applied at all times, particularly when the storm is raging. You must always have a financial “safety net” to ensure the survival of operations. The best prepared treasurers had committed facilities and backup lines to ensure liquidity and compensate for the failings of the commercial paper (CP) market. They did not suffer too greatly from the increase in credit margins and the credit shortage. The treasurers who had to borrow during this period without previously signing an underwriting agreement saw their financing costs rise and the issue of their

credit sometimes delayed. We can assume that the cost of this underwriting service will worsen in the coming months. Some bankers, particularly the Americans, have suffered from delays in setting up syndicated loans. Fortunately, many treasurers have reaped the benefits of the financial health of their respective companies over the past few years. Many of them are sheltered because they have little or no debt. 1.7.2.2 Less Expensive Assets and Return to the “Equity” Currency The good news is that stocks are once again becoming an exchange currency worth considering. Likewise, asset valuation multiples have decreased. This will make assets more affordable to purchase. In addition, the refinancing difficulties encountered by venture capitalists and other private equity funds will ease the inflation in M&A prices that we have seen over the past few years. No one will complain. 1.7.2.3 Favoring Quality over Yield Treasurers have decided to fly to quality and the purest possible monetary funds. Triple A-‐rated American funds are popular for the stability of their yield, even in this crisis, and for the rating quality offered. This flight to quality will be good for the most stable issuers, particularly the corporate ones. 1.7.2.4 Less Dynamic Management European management has become less active and less aggressive. Investments in funds considered to be “dynamic” have declined sharply, in favor of purely monetary funds, as the term is defined in IFRS 7. Yield is now a lesser consideration than risk, where often, in recent years, the opposite was true. What we were seeing was a race to the highest yield (for example EONIA +15-‐20 bp “all in”). As a result, people resorted to products invested in CDO structures backed by subprime risk, in particular. 1.7.2.5 Direct Management Some treasurers now prefer to directly invest all or part of their assets in order to avoid this risk and lack of clarity and to have better control over the investments they make. The simple bank account deposit has regained its appeal. Once the commercial paper market turns around, some will invest in it directly. Consequently, now more than ever, diversification is on the agenda for liquidity portfolio management.

1.7.2.6 Opportunity to Revise the Internal Rules of Procedure That “hot” summer was also an opportunity to review every aspect of the various internal rules of procedure and policies on operations and investments. CFOs began to exert better control over liquidity surplus management. 1.7.2.7 Seeking Information and Dialogue with Managers Treasurers seek more information from their banking counterparts. What are the underlying securities in which they are invested? What risks are they incurring? Now more than ever, benchmarks are essential. How are they performing compared to other funds? And finally, what are other treasurers doing? (simply for validation of their choices) Sensitivity tests such as V@R could also be used for MMFs. In the future, managers will have greater information obligations with respect to their clients, the current MiFID context notwithstanding. 1.7.2.8 Fewer Buyback Transactions Buyback transactions could decline, as has already been observed in the U.S. since this crisis began. This marked decrease is indicative of a real fear on the part of companies of a prolonged shortage of access to credit and an economic slowdown, which has resulted in fewer buyback transactions. This decrease reflected the cautious approach adopted by American companies in dealing with possible pressure on access to credit. Some companies took advantage of these low interest rates to finance buybacks with debt. This had an impact on earnings per share (buybacks accounted for 1/5 of the growth in the S&P 500). Corporates wanted to ensure that they had sufficient liquidity reserves so that they were prepared for a turnaround in the economic trend that many predicted. 1.7.2.9 The Role of Associations Associations such as the IMMFA had and have a major role to play, particularly to encourage this transparency. Treasurers associations have an obligation to inform their members. Yet this issue has been the topic of many heated debates for many of them since the crisis began. The perverse effect is the suspicion created, causing us all to mistrust one another and the products offered. Banks, associations, managers, rating agencies and regulators must work together to restore this waning confidence. 1.7.2.10 Doubt Cast on Rating Agencies They were criticized for their slowness and unresponsiveness. They are sometimes known to act suddenly, but late, according to investors and governments such as the

European Union. In fact, the stock market had penalized the agencies or their shareholders (Moody’s -‐40%, McGraw-‐Hill, which owns S&P -‐35%, and FIMALAC -‐40%). We may even see some agencies sued by investors who got burned. They go right to the source for their money. Let’s not forget that in 1994, Orange County was reimbursed 140,000 USD for its ratings fees. The State of Connecticut unsuccessfully attempted a similar lawsuit in 2001 as a result of the Enron ordeal. The rating agencies have revised their procedures for rating complex financial instruments and providing investors with information. Moody’s had also reformed its procedures for complex instruments as a result. They also addressed liquidity and market value risks, which indicate an instrument’s risk of default, in response to criticism and requests from regulators and governments. 1.7.2.11 Consolidation in the Banking Sector Bank mergers found a catalyst for the next phase of consolidation in the sector. Treasurers also found that they had fewer partners than before, but these partners were also more stable. The cream of the banking sector certainly rose to the top. As with any crisis, “every cloud has its silver lining,” as the saying goes. We can hope to see an improvement in practices and in the market. Since then, not a day goes by without announcements of significant losses or problems at every level. 1.7.2.12 Monetary Funds: Not So Monetary The positive aspect of this crisis was that certain practices of certain monetary funds had come to light (we mustn’t generalize). Yet, they were considered to offer low risk on principal invested and yield approaching that of a rate index (such as the EONIA overnight index). This crisis has had an impact on many managers. For example, in France, the total amount invested in this type of fund lost nearly 20 billion. This was a massive loss. When we took a closer look, we can see that they may not be as monetary as we thought. There is more than just bond risk and short-‐term floating rates. There are also asset backed securities (ABS). Many other institutional investors, pension funds and other hedge funds were, themselves, heavily invested in these monetary funds. Treasurers have sometimes had blind trust in these funds, which they wrongly thought were almost risk free, and when it came to more “dynamic” funds, they believed that there were no major risks. The siren song of high yield seduced them into a state of complacent euphoria. The month of August of 2007 gave them a rude awakening. This crisis was more than just a tornado that simply comes and goes. Market participants, and treasurers most of all, understood that it will undoubtedly last a few months. If there is one thing we could be sure of, it is that it took and will take some time to heal.

2 Part II General Issues in Corporate Treasury

2.1 Satisfied or your money back “I can’t get no satisfaction”… (Mick Jagger)

2.1.1

Are you satisfied with your treasurer?

Often the treasurer is viewed as a technician providing a service to the financial department. S/he is considered as a kind of specialist serving the company, at a central level, by performing specific, well-‐defined tasks. Yet within multinational groups the treasury is becoming increasingly centralised, and structured as a service centre. Today, the majority of groups consider that the treasury should be a centre of expertise, providing a service both to other departments within the finance group and to its subsidiaries. Increasingly companies employ a hyper specialist technician, who must, however, serve the entire group, offering financial advice and proposing appropriate financial products, along with the relevant accounting procedures. When we speak of service, we cannot escape its quality aspect, or the level of satisfaction of the customers receiving this service. Here the clientele is in-‐house: in the “corporate centre” or at group affiliate level. Why shouldn’t we take an interest in the satisfaction of customers being served by the treasury? It is this concept the current article seeks to address. If a subsidiary pays a fee to the Group Treasury (GT) for a financial service provided, it is quite normal to seek to determine its level of satisfaction. And what if the affiliate customer is not satisfied? Should we not review and reflect from time to time what the other party expects from us in order to improve the service and advice we give them?

2.2 Traditional structure – types of treasury We must consider the most common forms of structuring the treasury department (see table below). Most major groups organise the structure of their treasury department in this way. The current trend is for fully centralised GTs (although some of them are regionalised). They operate as an advanced form of “in-‐house bank”. Lastly, they operate a service centre approach and often invoice their services, mainly for tax purposes.

Feature :

Types :

ROLE

Advisory

Agency

In-House bank

Cost centre

Cost saving centre Service Center

Profit centre

AUTHORITY

Decentralized

Centralized

Balanced

STRUCTURE

Elementary

Intermediate

Advanced

RISK RESPONSE

= trends in modern treasury

Sample questions taken from a questionnaire measuring the satisfaction of in-‐house customers: How many entities are you responsible for?

General Appreciation According to you

Neither agree nor disagree

Strongly Agree

Agree

Disagree

Yes

Comments

Enough

Not Enough

Comments

Strongly disagree

Comments

is Treasury value for its money? is Treasury a facilitator of best practices? is Treasury generally fast to react? does Treasury communicate efficiently? are the Treasury instructions, requested reporting and deadlines clear? are the Treasury instructions, requested reporting and deadlines useful ? do you have enough tools to answer to Treasury requests? is the Annual Treasury Working Group efficient? Treasury is an ivory tower I don't know what they do! issuing instructions Processing of all financial transactions Helping me to add value None of the above According to you, the level of centralisation in the following areas is Payment Bank Relationship IR - FX - Commodity Management Credit Risk and Insurance Cash Flow Forecast process Working Capital analysis General financial documentation

Section 1

Is this Services used? Payment and Bank relationship

Yes (go to table below)

No (go to section 2)

Pro-active and Effective

Reactive but effective

Should Treasury do more?

In House Bank (payments made on behalf of - shared service centre functionality) Payment Factory (execution of the payment done by Treasury) Set-up and management of cash pooling Bank Relationship - Fees and credit facilities Inter Company Finance Management (ICFM) for loans and deposits Issuance of guarantees / letter of comfort You would qualify the treasury services as follow : Payment and Bank relationship

Pro-active but not effective

Not effective

Other, please precise

(extract from satisfaction questionnaire developed by Eurofinance) It would be impossible to include all the questions asked. The table above is only an illustration of the types of responses we should be looking to obtain. In addition to closed questions, open questions may be utilised, giving free rein to ideas and identifying essential requirements. By mapping expectations we can ensure that requests are not made in isolation and that our range of services may be adjusted where necessary to match these specific expectations.

2.2.1

Customer satisfaction study

The main objectives of this type of study are to: 1. better define the clientele 2. measure overall customer satisfaction with the various services provided 3. compare past and present customer satisfaction (benchmark) 4. define the expectations of a clientele and prioritise their importance in order to better determine what needs to be delivered The quality of services to be evaluated and expectations to be defined relate to: “Deliverables” Advice dispensed Compliance with agreements signed Assistance offered (before, during and after provision of a service) Handling of complaints Welcome, information and communications Responses to requests and consideration given to them Subcontracting of treasury and finance services Feedback from reporting and analyses. Effective marketing recommends that customer satisfaction studies should be carried out as part of ISO 9001 quality procedures. Why should the treasurer be exempt from this type of study?

2.2.2

Expectations transformed into objectives

Ideally in such a type of survey, the customer expectations identified must be transformed into qualitative and/or quantitative objectives to be achieved. These general objectives, or KPIs (key Performance Indicators), may become annual personal performance objectives for the group treasurer and his/her whole team members. The aim is to develop customer loyalty (even if we know that often they cannot seek the same services elsewhere – from a competitor or subcontractor). To secure our customers’ loyalty (even if our clientele is relatively passive and or range of services not very flexible), we need to be sure that our subsidiaries are happy with the services we provide. The company often places the customer within its strategy for implementing ISO 9000. It is therefore natural to adopt a similar approach in-‐house. It is also a way of fulfilling the KPI approach, setting bonuses for employees in the treasury department, their performance targets and above all future objectives to be achieved.

Moreover, where affiliates are consulted and their responses taken into account, their motivation levels increase and they feel more involved in financial operations. When this type of analysis is undertaken, and particularly during the analysis and debriefing process, subsidiaries are able to feel valued and motivated by the interest shown in their point of view. Treasurers sometimes create “score cards” for various purposes (in particular management of bank relationships or when analysing tenders) to draw up a refined form of classification. In this particular case it might provide an interesting insight into the GT / subsidiaries relationship.

2.2.3

Which is preferable – a bilateral discussion or a formal satisfaction survey?

Of course, some would claim that a good two-‐way discussion is sufficient to ensure the customer’s satisfaction. This is a possibility! But the idea of a formal written or electronic survey (even if anonymous) offers the advantage of comparing responses, ensuring their relevance and objectivity, and setting objectives for the treasury department. Satisfaction and the degree of satisfaction may therefore become a precise and quantifiable objective or KPI for use by management. The advantage this brings is to standardise the exercise, incorporating it into a wider process and into other multinational groups. We believe it will enable us to establish an interesting and useful benchmark. It will enable the treasurer and his CFO not only to position themselves within the group in terms of services rendered, but also in relation to their peers and other international groups. Is this not a continual search for the comfort of knowing that what we have done has been done well and is in line with market practices?

2.2.4

Adding value by enhanced in-‐house services

Even though everyone agrees that comparison proves nothing, it is good practice to expose ourselves to positive criticism and to take on board comments to help improve the service we provide. If by some good fortune, this service is perfect and adequate, so much the better for treasurers! We note that treasurers who play a proactive leading role always like to be fully informed about best practice in the sector and do not fear comparison. Quite the reverse, by coming into contact with others, we are able to improve and this, in the final analysis, is the main focus and object of the exercise.

Whatever the level of service we deliver to our affiliates, it can always be improved. To achieve this, we must accept the need to question what we do, which is not a gift shared by all. Even though sometimes we will not find any errors, where we do, we should use these as means of enhancing mutual understanding and improving our performance. Where it simply a questions of providing our customer with something extra or different, it is useful to formalise this. The idea is to work together in the interests of the group. Better in-‐house service also creates value for shareholders. Motivation within subsidiaries can only increase if you involve them in your vision of the service to be offered and advice to be given. This exercise may even be undertaken by a treasury working group which many companies organise with their subsidiaries once a year. But the structure of the exercise or its frequency are not important; it is its actual implementation that is to be welcomed, demonstrating as it does, a desire to want to do better. This is the main point of the exercise.

2.3 Satisfaction Survey of Treasury Activities “It is always the best policy to speak the truth – unless, of course, you are an exceptionally good liar” (Jérôme K. Jérôme)

2.3.1

Treasury performance indicators

Most group treasurers act as a sort of service centre with the idea of creating value (Service Centre with Added-‐Value). What an agenda! But how are we to measure this "service" quality effectively when it is provided to customers which are the subsidiaries of a group, or finance or other departments? For several years now, the most active treasurers have had metrics and criteria for measuring their performance in place. The well-‐known "KPIs" ("Key Performance Indicators"), as they are usually called, give a measure of treasury department relative or absolute performance. Clearly, here as in many other places, the difficulty is in drawing the comparison. How can you satisfactorily compare yourself to others by means of a generally accepted benchmark? That is indeed the difficulty that some people have tried to address by means of surveys such as the JPMorgan Cash Management Survey or the PwC Benelux Treasury Survey: by means of forums such as HSBC's Strategic Visionary Forum or S.L.G. Consulting; or by means of conferences such as EuroFinance or even through studies made by treasurer associations or consultants. There is no shortage of sources, but they are often of limited relevance or do not go back far enough, so it is hard to truly measure yourself against others. So why not measure against yourself? People often talk about KPIs, but we prefer the term "Key Activity Indicators" (KAIs), which are more generalist and less based on the concept of performance, which might be seen as a contradiction in terms compared to the "Service Centre" concept described above. It is up to everyone to work out their own methods and define their own benchmarks. Be that as it may, they can always make the comparison with themselves, and set their own targets. In this article we do not cover the full list of KPIs available to everybody. This has been covered by other people in their publications. However, as a reminder, we have in mind the treasury staff turnover ratio compared to the staff turnover ratio in finance or in the company in general; treasury staff over total staff; figures for the split of deals and transactions between banks; the number of wrongly routed payments; the ratio of operating costs over rebilled treasury fees; the number of banks; the number of financial transactions over revenues; the relative movements in net exchange income or expense, which can be measured as a function of

the number of hedge relationships in place; the (out)performance in net interest income/expense compared to the group's benchmark (EONIA, EURIBOR, etc.). There are others, but the list would be too long and this is not the subject we wish to cover.

2.3.2

The idea of a Satisfaction Survey

It is a simple enough idea to use an in-‐house survey on your customers (i.e. subsidiaries and other finance departments in the group's coordination centre). Treasury department could use this survey which, ideally, should be annual, as the basis for its internal strategy and to ensure that it delivers quality of service to its "customers", since that is what they must be called. Without quality of service, it would seem hard to achieve value and harder still to justify the expenses and other items rebilled to the customers. But the customers are obviously only group subsidiaries. All central finance departments are also powerful "customers". Customers of Treasury al ern Int udit A

Ex te Au rnal dit

CFO

• Tax • Controlling • M&A • Strategy

• Consolidation • Accounting

ices Serv

Services Fees

Services

Services Fees

Se rvi

ce s

Treasury & Corporate Finance Department

Affiliates all over the Group

Treasurers should ask their customers a series of questions. These come in two types: customer-‐subsidiaries (all group affiliates that use treasury services – vertical approach) or the other finance departments (horizontal approach) This is an efficient, anonymous and direct way of measuring the impact of services on customers.

Virtuous Circle Good Services delivered to Affiliates

Acknowledgement across dpt./group of Treasury Dpt  Higher value generated, motivation and revenue

Satisfaction of affiliates + faith

• More efficiency • Better cooperation & integration • More response vis à vis HQ • Good satisfaction rating

2.3.3

Preliminary to quality service

One of the most frequently encountered problems is that of definitions. It is therefore helpful to have detailed procedures, precise policies and glossaries to ensure everyone uses the same terms and account names. By way of example, how do you define net debt or decide whether it is a "cash & cash equivalent" account within the meaning of IFRS 7? What does "working capital", or some financial ratio or other, include? Which "cash flow" concept are we talking about? The first thing to do is to prepare special documentation for each type of activity. The terminology should ideally match that of consolidation using international accounting standards. The second step is to standardise procedures to give consistency, shorten reporting times, and give comparability over time or also comparability with group benchmarks.

2.3.4

What questions should be asked?

The survey, like any questionnaire, should ideally be short, easy to fill in (to make it easier to process afterwards), prefer open questions or multiple choice questions, and allow for anonymity. This will guarantee freedom of expression, objectivity and relevance. The aim is to determine the level of satisfaction, for example on a 1 to 5 star scale The questionnaire should also be used as an opportunity for collecting ideas, for identifying specific requests to be met or transactions to be processed as part of centralised treasury and financial management operations.

Examples of questions: (this list is indicative only) 1. SATISFACTION: General level of satisfaction? (1 to 5 stars) Treasury response time? (slow-‐ medium-‐ fast) (1 to 5 stars) Quality of feedback from treasury? (1 to 5 stars) Value added for the subsidiary? (yes – no) Level of prices on offer? (excellent – good – medium – poor – mediocre) Satisfaction compared to the price paid in terms of treasury fees (value for money)? (excellent – good – medium – poor – mediocre) How do you see treasury department? (as a support, a partner, a supervisor or compliance unit, a "necessary evil", other) IMPROVEMENT: What could be improved in terms of services? (open question) What could be improved in terms of advice? (open question) What could be improved at the level of the "Treasury Working Group" or treasury meetings with subsidiaries (structure/items covered/frequency, etc.)? (open question) How would you see treasury ideally? (list of 5 points for free description) TO BE CREATED – TO BE DONE: What new additional services should be covered and provided? (open question) IDEAS PUT FORWARD FOR OPINIONS: "Payment factory” (yes – no) Alternative hedging products – with or without hedge accounting treatment (yes – no) Review of bank terms, etc. Obviously this list of suggested questions is far from being comprehensive. It is up to everybody to include what is appropriate to them. But you need to keep the survey relatively short to ensure that the affiliates fill it in correctly. Depending on specific circumstances and needs, other questions could be put.

2.3.5

Results to be consolidated

The processing of the data should be discussed with the subsidiaries at a meeting attended by everybody. It is helpful to prepare a chart of the results, with the score on the vertical axis and the cost on the horizontal axis. This will give a graphical overview of the group average. At this presentation, it will be helpful to use a number of KAIs that describe the function and what it does (treasury staff/total staff, number of transfers per year, number of hedges, hedging relationships, etc.). It is important to place the treasury function in its context and to ensure its customers understand what it does and what resources are used. The survey may reveal that the team needs strengthening to provide the desired service. From these results, treasury department can set targets for the year or for the coming years. The CFO can use the document for the treasurer's annual review and for setting his bonus. The target to be achieved becomes qualitative. But this survey does not have to be only vertical and can also be horizontal by questioning the other finance departments, although in a different way. It may be seen as hard graft and a thankless task, but the result can lead to better overall treasury management. Surveys of this type have anyway become best practice in treasury centres of the "value added service centre" type. This is one of the reasons why treasurers need better communication skills than in the past.

2.4 Best Practices in terms of treasury management – insights and perceptions “You will go most safely by the middle way” (Ovid)

2.4.1

Best Practices in Treasury

Nobody could dare to say it is not essential for corporate treasurers to apply the best practices in their profession and company. Nevertheless, it is important for Corporate Treasurers Associations to encourage their members to apply these Best Practices and standards of ethics. IGTA (International Group Treasury Associations – regrouping more than 30 major Associations of Corporate Treasurers around the world) has defined a Code of Ethics, which is regularly up dated. You can consult it on IGTA web site (www.igta.org)

2.4.2

How to improve treasury standard practices?

IGTA has been created in 1996 in order to help NTAs (National Associations of corporate Treasurers) to define best practices in terms of treasury and risk management. The objectives of IGTA are the following: Encourage the highest standards of professional ethics and best practices among treasury professionals world-‐wide Raise the profile of the treasury profession Explore the development of reciprocal membership benefits Encourage the exchange of information, business practices, and details of various local regulations By applying and recommending these major principles, all treasury associations tend to improve and harmonize standard treasury practices.

2.4.3

Charter of Best Practices and Code of Ethics issued by IGTA

IGTA also defined a Charter of Best Practices in Treasury Management. These principles are recommended by all NTAs to their own local corporate treasurers’ members.

The Members Associations of IGTA support the following general principles: Members shall exemplify the skills of the profession and act at all times with integrity, care and diligence Members shall seek to maintain and improve their professional knowledge, skills and competence Members shall observe legislation and regulation that governs their respective activities, as well as the spirit of the law and contemporary market practice Members shall consider the effect of their actions on all relevant stakeholders and declare to those parties an conflict of interest Members shall exercise a duty of care such that their activities are capable of close public scrutiny The idea is for all NTAs, all over the world, to promote and encourage these base principles adoption by their treasurers members. This Charter consists of 40 major principles covering the risk management strategy, function, reporting, control, operations and systems.

2.4.4

List of major ethic principles recommended by IGTA

(list is not exhaustive – for more details please visit IGTA web site: www.igta.org/policy/charter.cfm) 2.4.4.1 Organization The Board of Directors is responsible for understanding the risks run by the company, and ensuring that they are appropriately managed. It must approve risk management strategies, but will delegate authority for day-‐to-‐day decisions to an Executive or Treasury Committee so that risk can be effectively managed in the company. This committee should be responsible for defining the company’s risk management policies and ensuring that the risk strategy is implemented through the development of appropriate procedures and investment in skills and systems. The risk management group should prepare, review and get approved, on a regular basis, by the Executive Committee, which turn must submit them to the Board of Directors for adoption. The risk management group should be provided with adequate resources and systems to enable them to implement these policies effectively. The group organization structure should have clear reporting lines and responsibilities to enable the Executive Committee to monitor and control the activities.

2.4.4.2 Risk Management The risk manager should be independent and should have clearly defined responsibilities, reporting directly to the risk management group. He should ensure the day-‐to-‐day measurement, monitoring and evaluation of risks across the company. He should only assume the management of risk, using risk management instruments and techniques, with which it has proven ability to independently identify, qualify and re-‐ value the risk of instruments on an ongoing basis, trade the component parts of the risk management instruments efficiently and report the results comprehensively. The risk management function should in its dealing with banks and other counter parties adhere to ethical standards determined by Codes of Conduct like the French code adopted by IGTA. All positions should be independently valued at fair value using approved policies and procedures at least daily or weekly. Market risk components inherent in any product should be identified to provide a basis for ensuring that market risk measurement is accurate. The Executive Committee should be responsible for the evaluation of customer and counterparty creditworthiness and the setting of individual credit limits. Short-‐term projected cash flows for each currency should be measured and monitored in order to anticipate future funding requirements. Alternative strategies to meet liquidity needs arising from either a loss of market liquidity or market access should be incorporated into the company’s contingency liquidity planning process. Assuring the liquidity of the company by whatever means available should be the first priority of treasury. However in the event where a liquidity crisis becomes likely it is the duty of the treasurer immediately to notify the Board officially of the situation. 2.4.4.3 Controls and Approvals Management should set clear levels of authority for committing the company to different types of transactions. Controls need to be in place to ensure the completeness, accuracy and timeliness of trade data captured. Formally approved and documented policies and procedures should be used for the revaluation of positions. Valuations should be based on appropriate bid or offer level obtained from a recognized provider of market data. This should be in compliance with internationally accepted accounting standards (e.g. IFRS). 2.4.4.4 Prices and Rates Prices and rates used for revaluation should be taken from independent sources. Where in-‐house prices are used, independent review procedures should be in place, including independent models. Approved transactions should be processed in timely manner, with audit trail that links the transaction to the initiator. All transactions should be confirmed independently of trading function with the trading counterparty within defined time constraints. All cash and security movements should be properly

authorized by senior staff and be executed by staff independent of the trading trade processing and reconciliation functions. 2.4.4.5 Staffing The company should ensure that all treasury management, trading, operations, risk management and auditing activities are undertaken by professionals in sufficient number and with appropriate experience, skills levels and degree of specialization. The requisite skills, training and experience for each level of treasury resource should be aligned to the output expected from an employee on that level. IGTA has defined a process to approve education programs proposed by its member NTAs. Compensation levels should reflect the skills required in each area of the business: compensation policies should not encourage behavior that is consistent with the company’s goals. 2.4.4.6 IT, Databases and Audit An internal audit function should be set up by the Board to examine, evaluate and report on accounting and other controls over operations. Internal audit should be specifically charged with assessing, for each area it examines, the adequacy or otherwise of the IT and other systems in operation, in relation to the risk management strategy adopted. Relationships with all custodians, brokers, trading counterparties and customers should be determined and appropriate legal documentation should be in place before any business commences. The Board should also ensure that adequate and comprehensive business continuation plans have been established and tested to address any disruption to normal business operations. The data architecture should define the data storage requirements of the company, including structure, level of detail and location. The technical architecture should define the level of sophistication required for treasury management, including the appropriate use of emerging technologies and package solutions. The technical architecture should define the required levels of security, to ensure integrity and confidentiality of the company’s information, systems and models. But it should also define adequate back-‐up and recovery procedures to ensure the company can withstand failures of hardware, software or telecoms with acceptable level of disruption. Full contingency plans should be in place in the event of failure.

2.4.5

Strategic Role of Treasurers

The role of the corporate treasurer is expanding. It moves beyond its core and “traditional” responsibilities. Nowadays, treasurers have to focus more on tax and pension issues, real estate, Merger & Acquisitions, investor relation, balance sheet planning, ERM (Enterprise Risk Management), working capital, involvement in Business Units, rating agencies relationship and accounting for financial instruments. The current top 5 concerns in treasury appear to be: (1) Liquidity management; (2) Cash Flow Forecasting; (3) Investment management; (4) Risk Management; (5) Compliance with regulation including international accounting standards The technology and systems are also key-‐concerns for treasurers to be able to comply with several new regulations and disclosure requirements. They also manage more and more risks (i.e. foreign exchange exposures, interest rates, insurances or operating risks including their own department, commodities and equity risks). They are more and more responsible for risk associated with transactions and investments. As companies develop gradually their ERM (Enterprise Risk Management) approaches, the treasurers are naturally requested to play a key-‐role in related management and reporting. Aren’t they “financial risk” specialists? At the end of the day, aren’t “risks” a simple financial translation of a potential impact for the corporation? But one of the major challenges for treasurers is the limited staff. The structures are lean. They need highly skilled or well-‐trained treasurers, which remains a real issue. The role of treasurer is changing profoundly from a “guardian” of assets to a value creator. It should be viewed from the outside-‐in rather than from the inside-‐out. It also generates resources, which could be essential for the business. Treasurers must prepare “Business Continuity Planning” (BCP), as well as operating units do. Financial disasters are seldom foreseen although often avoidable with a minimum contingency approach and planning. Best treasuries should have BCP, try to do more with less by ensuring staff excellence and skills (including soft skills), by leveraging non-‐ treasury resources and staff, by establishing standard policies and procedures to

measure successes and failures, to centralize and optimize effectiveness, to automate as far as possible with real STP as final target. They should enable more complex analytical tools, ensure easier audits. They also should provide with information sharing for better decision-‐ making. The excellence in execution and increased visibility and controls should be their credo. In smaller or mid-‐ size companies, the treasurer’s role is even more essential as he could be a coordinator for lots of operations and tasks nobody else is prepared or trained (e.g. ERM, financial accounting, investor relationships, working capital management, insurances, mergers and acquisitions). The treasurer should try to better understand company’s needs. He should establish his role as a team player. He must be “pro-‐active” rather than reactive. He must commit to broaden his function beyond the traditional “treasury” role he played for years.

Treasurers tend to move up the organizational pyramid of finance. The treasury function has become more strategically oriented. For couple of years, the treasurer has come to play a role closer to that of the Chief Financial Officer (CFO) than this was the case before. He is at the heart of the financial strategy owing, more particularly, to his capacity to manage financial risks, a field in which he is a specialist, owing to his knowledge of the new international accounting standards on financial instruments (IAS/IFRS), of TMS technology (Treasury Management Systems), ASP solutions, modes of payment, on-‐line confirmation or trading systems, etc.. He can, if he seizes the opportunity, really leave his "mark" on the financial strategy, on the "financial brand" of the company and its reputation of being a reliable partner in the financial world, which is of vital importance today. He will have to be the guardian of this strategy and not leave its management to others. Through this task, he will naturally cooperate closer with the CFO and the Board of Directors. The treasurer is also called upon, to an increasing extent, to participate in the operational management of the company owing to this evolution and these new requirements. He must participate more in creating value for the corporation. In numerous organizations, he is developing the service center role of treasury function, servicing the other head-‐quarters departments and the affiliates of the group.

2.4.6

The Role of Treasury Associations

Treasurers' associations indisputably have to assume a role of permanent training and information to ensure or maintain a sufficient level of skills for each of their members. This is an important subject for numerous associations as well as for the world association which defined a common policy and an IGTA approval attesting to the quality and the comprehensiveness of the local training national associations provide. They have to arouse the curiosity of their members and react to it appropriately. The Anglo-‐Saxon model proposed by the English ACT is exemplary, in this respect. It offers comprehensive and high-‐level trainings. But associations are also wondering about the additional role they should play to help treasurers up-‐grade their knowledge and skills to better cope with new market requirements. Associations also offer the opportunity of networking, very useful for comparing one's activity to that of fellow colleagues or for weaving a network of knowledge which could turn out to be highly helpful when changing jobs or when searching for new employment or challenges.

2.4.7

Evolution of the role of treasurer

The role of the treasurer has gone through a real evolution and a profound mutation during these last few years owing to technological, legal, economic or even accounting reasons. To be successful, it is essential to apply best practices in terms of treasury management and to respect basic ethical principles. In order to be able to face these technical challenges, the treasurer, more than ever before, must be ready to embrace change and enroll for specialist training. Very often, the absorbing every day work life makes him forgets this aspect of questioning, nevertheless highly essential in the short-‐ term. It is of vital importance to reach this level of knowledge in order to be able to carry out one's tasks and even extend one's scope of activity. Every treasurer has to aim at the centre of the target by acquiring this basic core knowledge which allows him to keep his job or even to take advantage of the extension of his role. The recommendation not to rest on one's laurels is certainly applicable to everyone, but maybe even more so to treasurers, some of whom sometimes forget to cope with change. To take advantage of these opportunities offered by the treasury function, the applicants will have to demonstrate high-‐level technical skills. To make a success of his career, and, sometimes, of his occupational redeployment, of his progress outside the finance business, the applicant will have to look for relevant information, embrace learning opportunities and acquire the necessary specialized knowledge. It is a good thing to sometimes remind oneself of evidences that are so often overlooked. As Baron Pierre de Coubertin put it, "Every difficulty is an opportunity for further progress." The treasurers are facing new challenges but shouldn't this be seen as a real opportunity?

2.5 Corporate-‐bank relationships and banking policy “I believe that banking institutions are more dangerous to our liberties than standing armies” (Thomas Jefferson)

2.5.1

Relationship with banks

The relationships of corporates with their bankers are far from being a matter of improvisation. Many corporates have historic banking relationships in place. For some of these relationships, there has not even been any economic or technical foundation. On the other hand, there are relationships which have sprung from one-‐off operations or irregular transactions and still others have developed from frequent business. More than ever it seems useful, not to say necessary, for a company to lay out its banking policy in detail as well as the elements which will determine the relationship with a given credit institution rather than with another one. Recent events have demonstrated at great length how much the support of a banker could be necessary or even vital when the winds of change start to blow. The relationship with one’s banker must be adequately cultivated so as to keep it durable and solid. Just like a couple, the banker and the company must be ready to face the storms and to survive the squalls without ever breaking up. It is for that purpose that a minimum dose of confidence has to be established between them and which must be nurtured so that it will resist the storms that may develop anytime.

2.5.2

The choice of a bank

Prior to choosing a bank, it seems essential to define criteria relating to geographic locations, size, network, nationality, services and expertise which one wishes to privilege. This choice will naturally be conditioned by the size of the company, its sector of activity and its territorial clout. There does not seem to be any necessity to look for size as the main criterion. Big size, in fact, can sometimes be a real handicap and generate too many administrative intricacies or entail a total absence of flexibility. It does not seem advisable for an SME of average size operating on its domestic market to resort exclusively to a "global" American bank for example. Proximity will doubtless be of essential importance for such a company. Solvency, more especially in the context of Basel II, will become an extremely important criterion, which will influence a company’s choice of bankers. The practiced margin will thus become a criterion of choice. Not all banks will thus be subject to the same constraints or requirements under the Mc Donough ratios as from 2006 and Basel III afterwards.

2.5.3

The choice of the number of banks

This is really a subtle question because there is no standard answer. What elements must be privileged? A too small number of banks in a company's pool of banks present a risk. Indeed, the last few years have shown that the number of bankers may decrease drastically following a merger or acquisition. There are treasurers who were working with banks that had been folded into a single entity after a series of acquisitions or mergers. Other institutions gave up certain activities or have withdrawn from the credit business. Fortunately, bankruptcies of banks have remained the exception. We must not forget that as far as bank mergers are concerned, the sum of one and one is not equal to two in terms of the credit amount granted. The total amount of credit lines may thus be reduced overnight for reasons extrinsic to the company and its debtor's quality. On the other hand, working with too many bankers may generate a certain degree of dissatisfaction on behalf of these banks and could imply a loss of effort and time for the treasurer. When it comes to choosing between a single or multibank relationship, there does not seem to be any reason for advocating the first rather than the second. As is often the case, the truth is somewhere in-‐between these two extreme positions. Having only one single banker would thus be just as irrational an option as having a plethora of banking relationships. But it is quite obvious that the more banks and accounts a company has, the higher will be the number of transactions to be effected as well as the number of accounts to be balanced. The treasurer has to make sure to have guaranteed the supply of funds to his company. It would be unwise of him to have only one single banker even if the company has only low capital requirements or shows a recurring situation over a substantial period of time. The bank will have to meet the specific needs of the company. On the other hand, the latter will have to try to distribute its streams of activities on the basis of the appropriate specificities of its banks, while making sure to get the best price. The treasurer will nevertheless put the financial institutions in competition in order to optimize the conditions granted to him. The consultants of "Greenwich Associates" conduct surveys on a regular basis to demonstrate the tendencies and the statistics in banking relations. It appears from the latest analyses that companies of big size and international groups still rely on a large (not to say, too large a) number of banks. The number of banks and the selection of these must also be made in close cooperation with one’s reference shareholder(s). It may not be useless to repeat this principle –

however obvious it may appear – but which is quite essential if we want to be more effective and avoid any losses.

2.5.4

Assessment of the services offered

Fortunately, the services have been widely "standardized" during the last few years. This does not facilitate the choice by the treasurer but it has the merit to increase the offer and to allow increased competition with regard to prices. To choose a given bank rather than another is certainly not an easy task. There are numerous parameters which the treasurer has to take into account. Quality is to some extent a subjective criterion and difficult to measure as along as it has not been subjected to appropriate experiments and tests. The originality in the offered packages, the creativity of the proposed services or the advanced solutions and the pro-‐activity provided are a series of factors to be favored. The price must of course remain the decisive factor and the main criterion in the choice of the financial intermediary but it must neither be an exclusive criterion nor the only objective of selection. The customer also has to make sure of the respect for the merits of every banker and more especially of those who grant credit facilities to the company. Aren’t credit facilities the very soul of business? Human contact is an important criterion but which can only be measured on the basis of the frequency and quality of interpersonal interaction. One should not forget that the relationship with the person in charge or "account officer" is a very personal one. Loyalty, respect, confidence and many other qualities are necessary for establishing a solid and durable relationship. These criteria are more difficult to quantify and remain precarious. Thus one usually gets to know quite a number of people in charge of the relationship because many leave the bank or are assigned to other departments. It certainly does not facilitate the durability of the relationship.

2.5.5

The transfer of operational flows by a bank

Regrettably, the choice of banking relationships is very often historic, and alas, hardly rational. Meetings, personal relationships with the one or the other employee or recommendations provided on a specific issue, for example, can be at the basis of banking relationships. Many corporates do not even know any more why they maintain a relationship with such or such bank. The persons with whom the relationship originated may have left the company. It is thus very useful for corporates to regularly question their policy of banking relationships. A more pertinent choice may thus enable a company to achieve substantial savings.

Still, the central criterion must remain the granting of credit. Preference is to be given to banks which still deserve the name of "banks" rather than to those confining themselves in their market niche(s). It is necessary to respect the strengths and the weaknesses of each bank and not to look for the best price at any cost. Fair play implies that the treasurer does entrust his “crème de la crème” streams or operations to a banker who, on his part, is not willing to grant credit facilities to him. A tendency to resistance has recently been observed. Thus it seems rather obvious to us that the treasurer intends to maintain durable relationships with the institutions which provide finance to his company. We also consider it useful to establish a "score card” or a table which allows the treasurer to very accurately determine the global strategy which he intends to implement. The use of a statistical tool for surveying activity has proved very helpful. Certainly, this statistical schedule of the streams of operations entrusted to a bank is very relative because of the real difficulty of comparing products in terms of margin or in terms of added value for the bank. But it remains nonetheless an efficient means of measuring fair distribution of operational streams. It is a very subtle undertaking for the banker to compare the value of a "knock-‐down" option that comes with a rebate ("KI option with rebate") for example, with a swap or a short term draw-‐down. "Trading on-‐ line" tools such as "FX All" or even "Currenex" offer the possibility to easily draw up reports, which the treasurer can use for his a posteriori analysis. The bankers are more than ever sensitive to fair sharing (at least, not to their disadvantage) of the "cake", which they will anyway find to be far too small. It is therefore important for corporates to take care not to have an oversized pool of banks so as not to expose themselves to perpetual dissatisfaction of credit institutions. A frustrated banker constitutes a risk that must not be overlooked. Apart from the withdrawal of a dossier, imposed by his Committee of Credit, for example, he might try to "look for compensation” on other operations and increase conditions relating to such or such other product.

2.5.6

The assessment of a company by its banker

Banks do not lend funds on the sole basis of their shareholders' equity. They mainly engage the money of others. Consequently, following the Basel I Accord ("Cooke ratios"), Basel II ("McDonough ratios") and soon Basel III imposed by the BIS, banks have undertaken to maintain a minimum of capital and shareholders' equity. The recent economic context and the numerous cases of non-‐repayment of credit do not at all stimulate the granting of credit by banks to corporates. A banker is no longer willing to lend funds unless he can be sure of sufficient profitability on the operation, on the accounts, on the streams of activity at the same time he’s providing

credit facilities. He also expects an excellent global profitability on the business done with his customer. Besides, he will also take care that adequate security guarantees are in place to assure him of the solvency of the debtor and protect him against the risk of bankruptcy. One of the important phenomena which we witness today is the disappearance of a series of establishments brought about by mergers or acquisitions and the withdrawal from various geographic territories for strategic reasons. Others, although they have a presence on the territory, refocus on other, more profitable activities than merely making available credit lines. Thus it is getting increasingly difficult to obtain credit facilities at reasonable conditions. A whole class of companies of medium or small size is thus being excluded from the market of corporate credit granting. We think that for medium-‐sized companies there is a real risk of not being able any longer to have access to this market in the years to come. Everywhere, the market sector of medium-‐sized companies forms the backbone of the domestic economy. However, in countries, such as Germany, where small firms are considered to have a poor quality of credit risk, the situation could be disastrous. We should not exclude that certain countries – maybe in violation of Community law – will have to offset this deficiency and guarantee in one way or another the risk taken by the banker.

2.5.7

The role of the treasurer

The treasurer has to take the measure of the current evolution. Banks, just like any other company, are subject to accountability to their shareholders and must look for a certain minimum level of profitability, even if they continue to be engaged in a price war. The treasurer, generally, does not like "shopping around" or fostering competition between bankers with regard to such or such foreign exchange products. This is laborious and unproductive work. Furthermore, it profoundly annoys the banker. The use of on-‐line negotiation platforms allows the treasurer to go directly to the best price without having to face the regrets of bankers disappointed not to have secured the deal. These on-‐line tools also allow corporates to compare the proposed prices historically and to demonstrate to their banks, with evidence in support of their arguments, that their prices had not been competitive. Nevertheless, to be able to do one’s bank shopping remains a luxury that certain companies can no longer afford to offer to themselves, a sort of privilege reserved for the "rich". The treasurer will also have to take into account the deregulation of financial markets and banking disintermediation, which is a very real trend. From "all taxable", we have gone to "all negotiable" or "all free". The duration of banking relationship is essentially based on a balanced relationship between the parties involved. It is not by dumping 90 % of the products they offer and by selling at adequate prices the remaining 10 % that the bankers will improve their global profitability. A better balance between the prices of the various products available would allow bankers to avoid having to fight for being

able to offer products with strong added value (arrangement of bond issues, for example, or of syndicated credits). The bank becomes a sort of "supermarket" where products positioned at the gondola head and promotional goods occupy more space than more appropriately priced products arranged in their shelves. Some products are supposed to offset the losses or the absence of profit on others that are literally dumped. This is paradoxical! More recently the tendency has rather been to "tighten" prices and to take care to keep them at a more judicious level. Regrettably, in Europe, by contrast to the United States of America, there is neither harmonization nor any coordination as to the pricing of banking products. A typical example is that of cross border transfer of funds. Distortion in the costs of bank transfers is such – even though a European Directive was issued in 2001 in order to put an end to such differences – that there’s still competition and that domestic banks have been able to preserve part of their local hegemony. Banks try to make profitable as best as they can the substantial investments they have made in data processing equipment during the last few years. They had to overcome numerous hurdles, one of which having been the advent of the EURO, which was harmful in terms of earnings derived from foreign exchange products. More than ever, the treasurer will have to design and implement a coherent banking strategy which will allow the company to guarantee the liquidity necessary for its further development. This policy of banking relationships is incompatible with the endeavor to earn even the smallest profit through pricing. The treasurer must – and in the future even to an increasing extent – take into account the satisfaction of his banker. This can be achieved by appropriately fixing market prices and by transferring a portion of the operational "business" to the bank, in the amount of the commitment by the bank to provide credit facilities.

2.6 Know Your Banker – “KYB” “The business of a bank is to lend money; which amounts, nowadays, to lending credit” (John Buchanan Robinson)

2.6.1

A sea change in the financial markets

Bankers know all about us, but we do we truly know about them? We have, probably wrongly, neglected to check up on our bank counterparties. So much the worse for us. The banking relationship and liquidity risk are back at the top of the list of priorities. What was taken for granted in the past, such as "a bank cannot fail" or "you can always find credit", is now obsolete. We need to learn how to monitor and check up on our bankers better. The major changes that have occurred over the last two years in the world of finance have aroused renewed interest in transparency and the assessment of risks incurred. Treasury managers have been forced to (re)-‐consider the approach to counterparty risk, especially with their bankers. If you speak to a treasury manager, you will often be surprised by how shaky, unsophisticated and basic the assessment of bank counterparty risk still is. Most of the time, it boils down to a periodic review of bank credit ratings (sometimes changes in Market Cap or bank CDSs are also tracked as indicators). We have to admit this is a "very light" type of in-‐house check. Under regulatory pressure and management insistence, many businesses have tried to define their bank policy better and to strengthen the criteria for selecting their bankers. Before 2008, who would have thought that a major bank could fail and go bankrupt? Very few of us, we have to admit. Today, the impossible has become possible. A bank, however big it may be, can fail. Some people say that this could of course be envisaged but after the bailouts and other rescue packages, surely disasters like Lehman Brothers are most improbable. However "black swans" exist according to zoologists and risk managers. So we need to act. Why not designing a sort of "Know Your Banker" assessment-‐questionnaire, a new type of evaluation called "KYB"? The concept is simple. All you have to do is to draw up a list of selection criteria, check them at the outset then on a regular basis, and summarise the lot in a report similar to a "Bank Balance Score Card" (BBSC). We refer the reader to an article published recently on this suggested approach for monitoring the banking relationship. It is a fair bet that the current volatility in the markets, the rallies and other conspiracies against the weakest or well-‐targeted prey (such as the "PIIGS" debt, Greek or Irish banks, the EUR, the GBP, etc.) will do nothing to diminish counterparty risk. This bank

risk is all the greater since liquidity may depend on it and a defaulting bank would also have consequences for investment portfolios, interest rates, FX, commodities, etc.

2.6.2

Reducing bank counterparty risk

To reduce your risk, you must first identify it by consolidating the whole position (all products together) with this or that banking partner. The TMS ("Treasury Management System"), the online dealing platform or any other IT application could help calculate the consolidated risk. Consolidation is vital because sometimes it enables you to offset certain risks. A long-‐ term view is also fundamental to detecting where risks are building up over time, and the time horizon involved. The longer the exposure with distant maturities and instalments, the higher the credit risk will be. Some banks deal with this risk by increasing the spread (the number of pips) required in long-‐term currency forward swap contracts, but it can be mitigated by signing a CSA type agreement. The idea is essentially to provide collateral (the bank or the company, depending on whether the Mark-‐to-‐Market/M-‐t-‐M position is positive or negative). With such a CSA agreement, the Treasury manager admittedly reduces risks, but he has on the other hand to raise and "monopolise" funds as collateral. However, in the opposite case, (with M-‐t-‐M in his favour), he will have the assurance of protection against the risk of default on closeout of the swap contract. The dilemma facing treasury managers is simple: pay more for credit risk over time or collateralise the change in market value ("change in Fair Value"). The market is looking to identify and measure this risk. In a way, the well-‐known reform of Over-‐The-‐Counter (O.T.C.) derivatives illustrates this wish on the part of the authorities and other regulators to regulate dealings in financial products in the broadest sense through use of margin calls ("Collateralization"), including central counterparty clearing houses (CCPs) in the process. From a practical point of view, we have to hope that this last proposed reform will allow exceptions for corporate "end-‐users" -‐ the treasury managers of non-‐financial organisations. It all works towards protecting the treasury manager, even if, in this instance, liquidity risk (for financing margin calls) is substituted for counterparty risk. It is also high advisable to equip oneself with efficient IT valuation applications (for example REVAL2) in order to measure risks correctly, consolidate them and correlate them. The credit standing of a bank has therefore become fundamental for its clients, as some have recently discovered to their cost. 2 www.reval.com

Clients can also use the method of diversifying counterparties to reduce their residual exposure in respect of banks, although the geographical diversification of counterparties involves more banks and potentially more administration. That's the price you have to pay. Furthermore, it should be noted that in recent European cash management surveys particularly that carried out by JPMorgan3 in conjunction with the ACT4, the number of banks used by international companies is gradually increasing. The need for credit and the jitteriness over lending only partly explains this increase in the average number of banks used. Furthermore, people tend to forget, as happened with Lehman Brothers, that a bank failure (unlike a corporate failure) can bring with it serious systemic risk, as at the end of 2008. There does not seem to be any good reason for using sophisticated tools to measure, for example "Expected Positive Exposure" -‐ EPE; "Maximum Peak Exposure" -‐ MPE or "Potential Future Exposure" -‐ PFE, which incorporate V@R (Value at Risk) concepts, Monte Carlo type simulations, "Credit Value Adjustment" -‐ CVA or percentage confidence levels. In terms of portfolio valuation, the IASB, with the new "Fair Value Measurement" rules and the FASB, with FAS 157, have also contributed to clarifying the methods to be used for revaluing financial instruments, even if these standards are still somewhat lacking or too evasive in certain respects. To reduce risk, use may be made of committed lines of credit (ideally in consortium form) which also provide liquidity which could be lacking in the event of failure of a bank partner. A regular, methodical and mathematical/financial check on counterparties is necessary. Simple credit rating, we have to admit, is only an expert's professional opinion, but unfortunately it is not a guarantee, as often seems to be forgotten.

2.6.3

Technology -‐ love it or hate it

Technology is still a sort of panacea if it is integrated, automated and secure. It can help to identify risks better, particularly counterparty risk, and consequently to mitigate them. Furthermore, this is what banks too are gradually beginning to understand, and they are equipping themselves more appropriately with powerful IT products (e.g. ALGORITHMICS5). 3 www.jpmorgan.com

www.treasurers.org

www.algorithmics.com

"Black-‐box solutions" need to be avoided and transparent, reliable and secure applications favoured instead. We can only encourage banks to become more sophisticated and advanced in terms of risk management and banking counterparties. Indeed, as explained above, a bank’s failure would adversely affect everybody, including its banking peers. Government borrowing, which is at alarming levels, gives rise to fears that the smallest and weakest will not always be able to support their banks. As with the textbook case of Iceland, doesn’t the risk centre on small countries that are weak and isolated? Don’t put too much trust in your banker Don't put too much trust in your banker! Learn to better understand and control the risk he represents for you. This is certainly not straightforward, but it is vital. Certain market practices and further regulation will perhaps help to make the market a healthier place. The new Basel III regulations have just been put forward. We hope that they will be adhered to and applied by everyone, including US banks. However legislating is not the cure-‐all. There is only so much it can achieve. Sometimes, very populist politicians try to demonstrate that regulation, without exception, is the key to averting all systemic risk. We should be very sceptical about that! Will the Basel III regulations be our saviours? Perhaps… but that doesn't stop caution still being a good idea. Despite the best practice consisting in focusing on core international banks, corporates need to diversify their partners to mitigate their financial exposure. So let’s learn to understand our banking partners better and put in place appropriate monitoring mechanisms to improve control of the risk that they represent and which has all too often been neglected or completely forgotten about in the past.

2.7 RFPs: how best to formulate your needs to ensure your requests for proposals succeed? “Some people don’t like competition because it makes them work harder” (Drew Carey)

2.7.1

Definition of an "RFP"

RFP is an acronym standing for "Request for Proposal". During the procurement process, it is the first stage in which suppliers are invited to submit proposals matching specifications that are drawn up with as much precision as possible. The response to the request for proposals puts the corporation and the treasurer in the best position to make a fair selection of the company or companies to be used (depending on whether there is to be a second round and whether a shortlist is to be prepared). Simply responding to the request establishes the supplier’s interest in the request from an early date. Requests are therefore sometimes rejected. It is the means of clearly demonstrating the intention of embarking upon a competitive process and seeking the best combination of quality and price – and it is the combination of both that needs to be evaluated. Obviously an RFP is not issued when opening a bank account or buying some low-‐value service or a low-‐cost piece of software that is easy to install. Typically, RFPs are used for purchasing treasury management systems software, major consultancy jobs, setting up "payment factories", putting "cross-‐border cash pooling" in place at the European level, etc. Through the RFP document, potential suppliers are asked to commit to making their best possible effort to achieve the intended objective. It is also a preventative measure to avoid either side wasting time through misunderstanding or over/underestimating the customer's needs and expectations. It is therefore much more than a simple price bid that is expected. The treasurer is expecting commitments, detailed information, a competitive price, details of implementation and the resources to be provided, completion time limits, any points not covered or outside the scope, etc. It should demonstrate the treasurer's impartiality in choosing the supplier. There are certainly "false RFPs" and pseudo-‐RFPs. Their purpose is to beat down the existing supplier's price at the time the request is put out. Many companies use them for this purpose, without adhering to the rules of fairness which would involve selecting the best supplier and not the existing supplier, even if it drops its price. Bogus requests for proposals should be avoided, since they damage the reputation of those issuing them. That is the price of credibility. When the supplier realizes that the treasurer is prepared to dispense with the current service or

product for another one if it is better and/or cheaper, that supplier then tries much harder, and competition becomes effective.

2.7.2

What is an RFP for?

In treasury management, it is good practice to make use of Requests for Proposals. RFPs are the best way of respecting your partners, giving them the opportunity to put in a proposal and a price for a service or product, to adhere to certain professional ethics and finally to provide assurance of necessary and fair competition between suppliers. At a time when ethics are more than ever in the spotlight, requesting proposals is sound and good practice. It is also the surest way of guaranteeing that the service to which the seller has committed will be performed in accordance with the treasurer's expectations. Defining your needs properly is the way to guarantee that the proposal will match the request. It will also avoid misunderstandings between the seller and the buyer. In short, it is a sort of list of specifications. You would usually ask for a quote for the smallest jobs that tradesmen would do on your house, but for major purchases for your department this is often not done on the pretext of having identified the product or service required. RFPs often show who has the motivation and capacity to do the job required. Buying treasury software is not like buying a dishwasher. The product often requires associated services and human and technical skills. Product life and the firm's soundness are also essential to the project's success over time. It is also often required as a precautionary measure, for internal control purposes, to avoid fraud, cronyism and other risks of misappropriation of corporate assets. If we look at the Bribery Act (www.legislation.gov.uk/ukpga/2010/23/contents) in the UK and at this focus on the fraud and ethics aspect in companies, we realize that RFPs are not only sound practice but also essential to forearm ourselves against subsequent criticism of the selection made. But the question then arises of how best to draft an RFP. Plenty of people talk about it, all too few put it into practice, some ignore it or even worse subcontract it to consultants, and far too many overlook its merits and the reasons for its existence.

2.7.3

Composition of an "RFP"

In general, an RFP must contain a series of pieces of information. It must be neither too short, nor too long. However, for purchasing a TMS for example, there is very often far from adequate precision, and omissions, inaccuracies or loopholes will cost dear over the project’s lifetime.

Alongside this traditional structure, it is advisable to add everything that the treasurer considers to be appropriate and necessary to the success of the project. Obtaining an absolute obligation (preferably) and/or a best efforts obligation are also important in preventing any subsequent disputes. Precision therefore acts to prevent disputes and misunderstandings. It is when the going gets tough that the treasurer will be glad he was comprehensive and precise in drawing up his RFP.

2.7.4

RFI, RFQ and RFT

As well as RFPs, there are also Requests for Information, Requests for Qualifications and Requests for Tenders. Here, the objective is to obtain additional information. They are not binding on any of the parties. An RFI does not necessarily lead to an RFP. It is also the route to a better understanding of the pricing mechanism implemented by a bank, for example for comparing the terms applied by different organizations to all of one’s subsidiaries. An RFQ is often a preliminary stage for compiling a shortlist of potential prospective suppliers who meet enough of the conditions to deliver the treasurer's expectations. An RFQ is also often confused with a Request for Quotation, where the expectation is solely about price and where the treasurer knows that all the candidates approached are able to deliver the required product or service.

Finally, the Request for Tender is used most by public or government bodies. It doesn't matter what the request is called, the important thing is to be certain that you get what you want. For completeness, we should mention the Best and Final Offer (BAFO) which is a sort of second and final round, or even the Best and Revised Final Offer (BARFO). (X)

2.7.5

Do’s and Don’ts When Selecting Vendors/Contractors

DO’s Do: gather information about vendors and be prepared Do: qualify potential vendors (minimum pre-‐studies and researches necessary) Do: develop RFP to be long and comprehensive enough Do: distribute the RFP 8 or 10 weeks before deadline Do: try to answer questions to determine what you expect Do: five « P’s » principle is applicable. Be prepared! Do: pre-‐RFP short list is necessary and key to limit scope of RFP participants Do: talk to peers before to get a piece of advice Do: have a scoring matrix pre-‐defined (with weighting factors) and be transparent with RFP participants. They should know key criteria for selection Do: give feed-‐back/debriefing during and after process Do: define format for answer to ease the flaying Do: whatever the format, use a “classical” OFFICE one easy to use for respondents Do: require respondents to specify resources allocated to the project (with commitment and names of persons involved) Do: always document the process and your decisions to avoid any critics if any Do: award quality and comprehensive answers and presentations, timing respect, smart ideas and initiatives, lowest bids

DON’TS Don’t: delay process or postpone deadline. Be on time is also a positive element for participants Don’t: select more than 5-‐6 participants. Infinite list of potential suppliers can only generate more work, confusion and frustration both sides Don’t: use “one-‐fits-‐all” templates for RFP Don’t: limit the exercise to box ticking Don’t: neglect existing (bank) relationships Don’t: forget you are the best placed to know what you want… Don’t: forget an executive summary

2.7.6

Don’t: think everybody must/can easily understand what you are doing. Explain in order not to be disappointed Don’t: make 5 pages or 300 pages of RFP. Try to find the appropriate size in order not to frighten respondents Don’t: give opportunities to bidders to pretend items were not covered or included in your RFP Don’t: launch a project if you don’t know what you want and if you don’t have resources to treat it on time and properly Don’t: underestimate the process workload and intenral resources to dedicate to the project

Criteria of selection

An RFP must be meticulously and conscientiously prepared to be useful and to achieve the set objective. There are solutions offering RFP templates. Although cheap and helpful, they are not absolutely necessary. Everyone has their own method and approach. Stamp your own style on your RFP. It should have your stamp, your mark and your personal touch. Respect for the participants and fair and transparent treatment is absolutely crucial. Losers also learn about the other participants. Losing with dignity and respect is not always easy. A "good loser" should be respected and will always be well perceived at subsequent requests. If an RFP is issued, it should be genuine and honest. The best applicant must always win, and it should always be based on objective criteria. There is a real dilemma between being complete and comprehensive, and therefore producing a long and laborious document, and "making it (too) short", with the risk of the treasurer not getting what he wants. Grey areas, or areas that have not been covered, are always pretexts for reviewing prices and claiming that the point was thought to be outside the scope. Always ask for a (detailed) breakdown of prices so that you can calculate the cost of each of the solutions on the basis of reasonable assumptions. Prices are sometimes set out in a complex manner, which makes them difficult to compare. In this case a plausible simulation must be run to make an effective comparison between proposals. The quality and presentation of the responses is, to my mind, also a criterion to be taken into account. A company that cannot respond concisely and professionally disadvantages itself from the outset. A premium for the quality of the response should be awarded in the scoring matrix (a scoring matrix in Excel format, in general with a pre-‐set rating for key points). There is little useful and comprehensive literature available to help treasurers on the subject of RFPs. In time, through practice, they will end up finding a style and a template that they can keep on improving with each RFP/RFI. Even though requesting proposals imposes constraints, it is nevertheless good practice and beneficial for the issuer. Prepare yourselves well with a full and precise list of

specifications so that you get back satisfactory responses that enable you to make an informed selection. A project is already an adventure full of pitfalls. Don't make it any worse by any half measures when preparing it.

2.8 Best Practices for Participants in the Credit Rating Processes – Role of International Group treasury Association (IGTA) “I know reform is never easy. But I know reform is right” (Julia Gillard)

2.8.1

Credit Rating Agencies

Credit Rating Agencies (CRA) are bodies nobody could ignore. They are essential to tap the capital market. It is a sort of viaticum for these markets. It is really difficult nowadays to raise funds on capital markets without, at least, one credit rating from a well-‐established institution. These small and select group of organizations that pronounce upon creditworthiness of corporations, banks and sovereigns play a key-‐role in capital market functioning. Some people even argue that this role is dominant. CRA are very limited number of rather small institutions nobody could really bypass. This gave rise to a certain level of resentment among the corporate community. A credit rating agency is a commercial organization paid by borrowers for issuing “rating” or fair valuation of their creditworthiness. These ratings will be mainly used by users, investors, banks and funds. The sort of paradox comes from the principle of the users do not pay for the specific information they needs. A customer, borrowing funds on the financial markets, has to pay for being rated. From this initial principle derived some of the requests raised by borrowers and corporate issuers in particular. There are suspiciously few of these agencies. The three dominating actors are based in the USA (Standard & Poor’s; Moody’s and Fitch) It leads to concern that rating process is not always as open, transparent and fair as it might be in an efficient market. A larger competition among CRAs would be much better than the current oligopoly situation. We can doubt on effective potential of welcoming new agencies able to really compete with the three leading agencies. Their longstanding reputation and history create a solid foundation that perpetuates their dominant position. The role of the agencies came under the spotlights as regulators turned their attention to their specific, lucrative and monopolistic activities. In the USA, the SEC has been considering for years whether CRAs need to be put under tighter controls to avoid and prevent risks of financial disasters as those faced in the year 2000. Then, in 2003, some Corporate Treasury Associations (i.e. ACT in UK; AFTE in France and AFP in USA) called for improved regulation, improved internal controls and a corporate code of practice for

the companies and groups involved in rating processes. These National Treasury Associations (NTAs), all members of IGTA (International Group Treasury Association) were mandated to share views and issue a common guide of best practices to be used with rating agencies.

2.8.2

Why defining a Code of Standard Practices for Participants on the Credit Rating Process?

The three NTAs decided to join efforts to set up a sort of code of practice governing the business relationships with agencies and processes to be respected by both partners. A Code of Standard Practices for Participants in the Credit Rating Process” has been issued by IGTA in 2004 (cf. IGTA web site: www.igta.org) The goals of IGTA were to improve the quality of relationships between rating agencies and companies/issuers, to improve when possible the quality of information and ratings promulgated but also to restore investor confidence in global capital markets. The ideas on how best achieve the common goals were divergent. The decision was to adopt the “codification” route. This code was supposed to serve as indication, guidelines, reference for defining relationships with agencies and expectations from bond issuers vis-‐à-‐vis their CRAs. Behind the idea of a code, IGTA and the three NTAs wanted to stimulate regulators who might attempt to regulate the rating agencies and an internationally recognized standard for those who don’t. AFP recommended that SEC (Security & Exchange Commission) in the USA periodically review each rating agency it recognizes in order to ensure that they continue to be issuers of credible, reliable and fair ratings and have in place efficient internal controls. ACT believed that a robust code of conduct to which issuers, investors and CRAs can provide input would serve to underpin regulation, to minimize the need for regulation and help to avoid fragmentation arising from differences in national and regional regulatory regimes. It is in the nature of regulator to be concerned about the activities of any unregulated sector, but the central role rating agencies play in the working of the international capital markets makes them an obvious target of all attentions but also some critics. In principle, the rating process is fine, but terms of its execution could differ. Corporate treasurers want to ensure that there is enough competition in areas like price, service and choice of CRAs. The transparency of processes is also a great concern for treasurers. The costs related to the rating and the contracts signed with agencies are two other concerns for corporations.

2.8.3

Necessity of Regulation

The role ratings are playing is increasingly important in the regulatory process and capital markets. The CRAs have an increasing power and role while nobody is controlling them. Rating agencies have come under fire for failing to warn investors on time of the dangers and ultimately disastrous collapses of large companies. The famous events frequently reminded have led to some questions whether CRAs are meeting the needs of market participants. Another major influence, which really showed itself after the process started, was the position of the International Organization of Securities Commissions (IOSCO), which said it wanted to revisit the whole concept of looking at regulation. It was in favor of a light touch regulation approach. IOSCO issued a code which is in line, in its general principles, with IGTA principles listed in the Code of Standard Practices issued in 2004. A too tough regulation could drive to interferences with the necessary independence and objectiveness of the established rating agencies. The idea of IGTA and its three members (AFP; ACT and AFTE) was to develop a code of conduct for rating agencies to improve the quality and service they provide and prone more open competition. The attempted to play an active role in the process to insure concerns of corporate treasurers are taken into account. Unfortunately, by crating the Nationally Recognized Statistical Rating Organization (NRSRO) designation, the SEC granted a significant competitive advantage that has led to near-‐monopoly conditions that exist in the credit ratings market today. Issuers have no economic leverage to ensure that agency reports deal fairly with their situation. These circumstances are exacerbated by the fact that, where there are only a minute number of practically useable rating agencies, anti-‐competitive collaboration between agencies are not necessary to prevent competition. IGTA recommended that unnecessary barriers to entry to new agencies should be avoided. The idea was also that the adherence to the industry code of standard practices could be a recital in rating agency contracts with issuers, precedent to the contracts.

2.8.4

Content of the IGTA Code of Standard Practices

Regulatory recommendations Rating agency code of standard practices Issuer code of standard practices The code is intended to serve as a complement to government regulation, when existing, rather than a substitute.

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For credit agencies, the code includes recommendations to improve the transparency in the rating process, protect non-‐public information provided to CRAs, protect against conflicts of interest, address the issue of unsolicited ratings, and improve communication with issuers and other market participants, agency recognition process and improving ongoing regulatory oversight of approved rating agencies. It also includes obligations in the credit rating process, intending to improve the quality of the information available to the CRAs during the initial rating process and on an ongoing basis, and to ensure that issuers respond appropriately in communications with CRAs. The credibility and reliability of CRAs is heavily dependent on issuers providing accurate and adequate information.

2.8.5

Main requests from corporates

2.8.6

No need for regulation prescribing methodology or driving harmonization of approaches across different agencies IGTA is strongly supportive of moves to require ratings providers to publish detailed methodologies and to establish systems which would ensure that they are understood and followed Strong believe that any particular published methodology should procure comparable ratings regardless of the country in which related work is carried out A common basic scale for ratings amongst various providers would facilitate comparability particularly if number of agencies increase in future Nevertheless it does not prevent agencies to refine further their ratings by additional grids and rating categories if necessary Greater regulation of rating agencies in relation to their handling of confidential issuer information is necessary

IOSCO Code

The IOSCO has issued a code on rating agencies on 23rd December 2004. It contains 52 measures. It adopted the contractual way rather than the regulatory way, what was much preferable. Among their recommendations are that the agencies publish their ratings methodologies, document how they are addressing potential conflicts of interest and reveal their non-‐disclosure policies about confidential data. S&P said in its response to IOSCO that its own code of practices and procedures shares the major principles and themes articulated in its own code. But, at the end of the day, the market itself will be the best regulator of CRAs even if it is assisted by these different codes and recommendations. Corporate Treasurers Associations have welcomed this IOSCO code of fundamentals, which should play a major role in improving CRAs practices in terms of rating processes.

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The next step will be to observe the way the code is applied in practice and respected by agencies. IGTA decided in San Francisco, in November 2005, to launch a consultation amongst its corporate members to check whether the processes have been improved or provisions more respected since the publication of these codes of conduct or best practices. Nevertheless we could expect we need another couple of years before being allowed to see how that works in practice before any consideration of regulation is made. NTAs will urge additions to code of practice by agencies on a voluntary basis and may suggest a limited number of amendments to the existing IOSCO code, where and when necessary.

2.8.7

Good cooperation of treasury Associations

Corporate treasurers could be satisfied by their association’s initiatives, which somehow drove to an international reference codification. Now, IGTA decided at its last meeting in San Francisco to consult its corporate members, through a survey, to check whether or not improvements have been noticed. In future, it would even been useful to keep checking the relationship between issuers and CRAs. IGTA would be pleased if that relationship could be significantly and generally improved. The corporate treasurers also do their home works and insure a better transparency of the financial and business information communicated to CRAs. A mutual respect is an essential factor in this particular type of relationships and should, at the end, drive to restore market faith. This example of corporate initiative clearly demonstrates how NTAs and international associations could serve their members and generate Best market practices, whatever the routes or ways undertaken.

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2.9 Bank Balance Score Card or How to Rate your Banks “Happiness: a good bank account, a good cook and a good digestion” (Jean-‐Jacques Rousseau)

2.9.1

Quantify and Qualify Bank Relationships

Treasurers often do not bother to quantify or qualify their bank relationships. One solution, the “Bank Balance Score Card” (BBSC), involves issuing a regular, formal report listing the status and level of one’s bank relationships, in the form of a rating assigned to each one, based on the type and quality of that relationship. This type of report provides a summary tool that can be used to adopt and consistently apply an appropriate strategy for managing relations with the group’s banking institutions. Bank relationship management is certainly one of the most important issues to return to the limelight since the onset of the financial crisis. It will be essential to foster loyalty in these relationships in order to weather the storm and the liquidity crisis in these times of economic difficulty. The idea may seem odd or like a waste of time, yet since the beginning of the financial crisis and its disastrous consequences on the liquidity offered by the markets and banks, maintaining the quality of one’s bank relationships has become an essential task for many treasurers. Bank relationships must be maintained, and fostering a good relationship takes effort. There is work to be done on both sides (both for the bank and the treasurer). However, the treasurer must know how and be able to judge and categorise these relationships as objectively as possible. In practice, this is no easy task. Such a tool, when implemented and regularly updated, becomes a useful instrument for managing bank relationships and offers a way to provide relevant reporting to the upper management. This information is often also part of treasury reports and KPIs. Generally, CFOs consider the successful management of bank relationships and the proper distribution of business among banks to be key objectives for their treasurers. All banks are not created equal. Not all banks are global or as stable and reliable as they many seem. The financial crisis has been a stark reminder of this sad fact. The relationship cannot be addressed in a decentralised, uncoordinated manner, as the “side business” portion has become significant for banks and the “pie” they must share is getting smaller and smaller. Consequently it is now even more important to allocate your business to each bank in proportion to its particular merits and efforts.

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2.9.2

How to Map One’s Bank Relationships

Ten-‐Step Approach to the “Bank Relationship Balance Score Card” 1. Map the banking groups with which you work throughout the world to create a “family portrait” that is as complete as possible. There should be different tiers (one, two or even three tiers, as your company does not have the same level relationship with every bank). 2. Combine the banks into groups (e.g. Société Générale – Geniki – Splitska Banca belong to the same group, BNP Paribas, TEB and BGL are in yet another). 3. Add up all the credit lines, separating “committed” lines from “uncommitted” lines. 4. List the types of criteria used to assign a “score” (e.g. price; efficiency and quick execution; total credit lines compared to the total or average per bank; the bank’s rating (S&P/Moody’s); number of years the relationship has lasted; flexibility; comprehensiveness of products and services; information quality; inventiveness / creativity / structure / dynamism; IT services offered (e.g. SEPA, e-‐invoicing, swift, EBS); and others. 5. Alongside the report, define a system to weight the various criteria chosen (e.g. the total credit line is more important, or reasonable transaction fees or flexibility and quick responsiveness, or the number of errors made during transfers, for example). 6. Attribute a score to each one (this is partially subjective and determined at the treasurer’s discretion– generally in the form of stars or figures like 1 to 5, to keep things simple) and consolidate the results of the scoring. 7. Keep activity statistics up-‐to-‐date (e.g. number of transactions made and percentage compared to the business distribution objective that was set, aggregated processed totals, market share entrusted to the bank, and others). These activity objectives must be in line with the level of the attributed score. The results obtained during requests for proposals (RFPs) and the attributed scores must appear in the report and the database of historic values. 8. Determine the top five banks (top-‐down ranking) 9. Determine the frequency and level of the reporting to be sent to the management

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10. Ensure that the policy and the banking strategy defined with the CFO are followed. These can be included in the treasury KPIs.

It is important to point out that this ranking must reflect the “Bank Policy” defining the bank selection criteria and the tiered list of these banks. Priority should always be given to the tier-‐one “group” banks, the parent company’s banks (generally the policies are aligned with those of the parent company) when requesting a transaction or financing. A typical summary table should present a readable, consolidated summary, such as the one suggested in the example below.

BANK SCORE CARD Summary / dashboard Banks: Type of activities: Name # Narrative

Total credit facilities in €m Starting date: Rating Comments Amount # (incl. uncommitted) Month / Year # stars #

Bank A Funding, cash -pooling

250

01/12/1995

Bank B Financing GT + local funding of sub's

180

25/04/1990

Bank C FX / IR dealing

400

…

Bank D FX dealing / guarantee issuance / ECP program

350

…

Bank E Local cash-pooling + arrangement of capital market transactions

200

…

Bank F Centralisation of GT payment + FX dealing

150

…

Bank G Financing + ABS structures

…

Bank H Tax structures / FX dealing + equity brokerage

05/06/1976

Bank I Credit cards + e-invoicing + funding at group and local level

…

… …..

…. …..

Top down ranking of 5 first relationships:

narrative narrative narrative … … … … …. … …

actions to be taken (if any): ACTIONS reduce transactions with bank I favour bank E for FX dealing include bank F in next RFP for cross border cash-pooling etc….

1 Bank A 2 Bank E 3 Bank F 4 Bank H 5 Bank B

No Standard Solution

**** *** * *** **** *** * *** ** …..

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There is no standard solution applicable to each and every company. As every treasury is unique, it is the treasurer’s responsibility to define the most relevant criteria for his or her situation, as well as the proper weighting for each criterion. The more quantifiable the criteria, the easier the exercise will be. Nevertheless, it seems impossible not to include at least a few more qualitative criteria that are subject to opinion. In these cases a brief comment will suffice to explain the proposed score and justify it. One of the more difficult aspects of this approach will be to collect, condense and aggregate the information at the group level. The monthly group treasury report is one tool that will provide a large amount of information. Other sources may also be used (e.g. the TMS; the “payment factory” or EBS tool; online trading platforms such as 360T, FX All, ICD or STN with activity statistics; the liquidity report/credit lines and their use; various reports that are often in the form of worksheets; and others). The differing nature and various sources of the information that must be collected make the exercise complicated. However, without a predefined strategy and without preliminary scoring, it will not be possible to allocate percentages to specific activities, operations and transactions. You must determine the necessary criteria for opening a relationship and the criteria for tendering procedures when making requests for proposals, in order to remain impartial, improve offers from the tenderers, and distribute your business in the most reasonable manner possible. Generally speaking, a bank is never satisfied with the number of activities or transactions you entrust to it. Be sure to do this as impartially as possible while seeking the best price. This is far from easy. It is important to be respectful and express your desire to give the bank your business. When you try to look at the business allocated to each one, clearly it is difficult to compare, since the products and their margins vary. Despite all of this, it is necessary to pursue allocation. Some people will assert that it is difficult to compare deposit accounts and money market funds, or forward exchanges and options, or exchange swaps or structured products and “strips,” “floors” or “caps,” or even short-‐term and long-‐term loans. However, establishing a list of the operations entrusted to banks will help the treasurer at his or her annual review with the bank. This list will inform the treasurer as to what was allocated where, and how much with respect to the others. The scorecard must be adapted very regularly to reflect these operations. Nothing is fixed or written in stone. It is a changing document that must be continually adjusted and updated. It must remain simple and readable, and thus brief (even if supporting worksheets are attached). It is not helpful to consider developing BSC models such as Kaplan/Norton or Six Sigma. When it comes to financial reports, it is often better to leave well enough alone.

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BSC - Balance Scorecard / Example BANKS / ACTIVITIES

Rating Rating Pricing Service IT (EBS tools) Responsiveness Innovat°/solut° Credit Network Miscell. (*) SCORING Ranking S&P Total Weighting factors: # 17.5% 15.0% 15.0% 7.5% 7.5% 5.0% 20.0% 7.5% 5.0% 100.0% American Credit Bank AA 1 3.125 4 4 3 3 3 4 3 1 1 European Credit Int'l 2 AA2.900 4 5 3 2 2 3 1 2 4 Banque Parisienne 3 BBB+ 2.775 2 3 4 2 2 3 3 3 2 Bank of credit 4 BBB+ 2.725 2 3 3 3 2 1 4 2 2 Bof North Europe 5 A 2.600 3 2 3 3 4 3 2 2 2 Deutsche Kredit 6 AA+ 2.575 5 1 2 4 3 2 2 1 3 Spanish credit bank 7 A2.450 3 2 3 2 2 3 2 3 2 Scoring 1 to 5 (1 being "weak" and 5 being "excellent")

(*) historic of relationship / low turnover of staff / knowledge of customer sector & business / partnership with parent company / etc…

2.9.3

Best practices in BAM (“Bank Account Management”)

Some people may be of the opinion that this exercise is useless or purely a waste of time. However, in terms of good treasury practices and in terms of internal auditing or even just for the CFO, this type of information is crucial. Without a BBSC or a statement of statistics on the activities entrusted to each bank, how can you ensure optimal side-‐ business distribution to each one? Even though it includes a measure of subjectivity and evaluation, this exercise offers the advantage of providing guidelines which, over time and with the benefit of hindsight, help to adequately manage bank relationships and keep a track record of adherence to the bank policy adopted by the treasury. It is at once an activity report and a management tool. Leaving bank relationship management solely to the whims of the treasurers, in a discretionary manner, sometimes based on personal preferences, or allocating a transaction to one bank as opposed to another for subjective reasons could eventually turn out to be foolish and ineffective. Now more than ever, bank relationships must be managed with a view to the long term, based on a well-‐defined strategy. In a world where banks continue to consolidate and merge, where access to credit is increasingly difficult to obtain, and where banks must find their profits in their core activities rather than through pure speculation on volatile structured products, it is crucial to foster loyalty with and give priority to one’s banking partners. These days, it would be a mistake to overlook the benefits of this approach. As a result, there is a pressing need to first establish a bank relations policy defining the principles and criteria of partnership, followed by an activity monitoring tool allocated to each one, combined with a performance dashboard for each in order to refine the strategy and optimise the banking relationship while fostering loyalty over time. This is how you will preserve your banking relationships over the long term.

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2.10 Monitoring Performance in the Treasury Function “To many, total abstinence is easier than perfect moderation” (Saint Augustine of Hyppo)

2.10.1 Performance, a synonym for profit?

Measuring treasury function performance is a tricky business, and some people claim it is impossible. What should the performance measurement criteria (KPIs) be? What can realistically be put in place? How can a CFO measure the level of satisfaction with his treasury manager's work? These are the questions that this article is intended to answer. Let us disentangle the mysteries of performance indicators (Balanced Score Cards) in quest of value added metrics. When we start talking about treasury performance, plenty of people naïvely think that this can only be done providing we are operating in a purely speculative or trading context. Performance would then be easily measured and the total net savings achieved would be the key element for calculating the efficiency achieved by the treasurer, and at same time for calculating his annual bonus. Unfortunately, this view is far too narrow. Might it mean that treasurers operating in a "service" or "cost centre" environment could not measure performance, or even worse, could not achieve any performance?

2.10.2 Why measure performance?

The treasurer's job has changed fundamentally over the last few years. The role has become more technical and the scope of work broader than ever before. Treasurers have moved towards a role of partner to those around them. They have a central position. The target set for them by the CFO (Chief Financial Officer) is to add value to the company's financial activities. However, performance measurement in treasury management is somewhat nebulous. Plenty of people talk about it and claim to apply it; but in practice, very few truly apply it.

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Treasury Stakeholders

But how are we to measure or assess this "(financial) value added" of which treasurers are an undisputed key architect? Few treasurers can give details of how they are assessed by their CFOs. Nevertheless, they are. But on what bases? Performance enables you to: 1. compare cost effectiveness against the comprehensiveness of controls 2. transform a behaviour into a targeted performance indicator 3. measure decision-‐making cost/benefit advantages 4. report to the Board of Directors on the treasurer's activities and value added 5. Help give a better understanding of the treasurer's role within the group and the role of each team member within the treasury department.

2.10.3 KPI problems

The main difficulty with value added is measuring it. Behind the success factors (KSF – "Key Success Factors") or performance indicators (KPI – "Key Performance Indicators"), ideally we want to be able to measure this value added. Sometimes this is possible using "quite" quantitative elements. At other times, this is completely impossible and only qualitative elements can be used to identify the actual contribution. By means of such identification, the CFO can set the targets for treasury department and individual performance.

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KPIs are one measure of performance and value added, and a necessary guide to the proper management of the department. In a three tier pyramid of types of treasurer role (1. Operating, 2. analysis and 3. strategy), KPIs belong to the second tier. To let treasurers see their jobs move up to the third tier of strategy, they have to move through the second, for which performance evaluation is an essential step.

2.10.4 Environment of increasing supervision

Today’s world of finance is currently governed by the all too well-‐known Sarbanes-‐Oxley Act, by corporate governance measures (the Lippens Code in Belgium, the Tabaksblad in the Netherlands, the LSF in France, etc.), by Basel II (and Basel III) and by the IFRS accounting standards. Unfortunately these are not "best practices" but laws or directives applicable to countries and their nationals. Never before have treasurers had to produce so much information or data for the annual report. With the application of IFRS 7, we estimate the treasurer's contribution to the financial section of the annual report to be between 15% and 18% (depending on the sophistication of the financial instruments being used). Against this background, it is vital to be efficient in quality and in the time taken to produce the required financial information.

2.10.5 A tricky balancing act

The difficulty is how to strike the right balance between on one hand low operating cost, limited resources, the need for automation, shortage of time, the world's dearest resource, and prevention and, on the other hand, value added services, segregation of duties, detecting problems in good time and the fairness and accuracy of the figures produced. This balance is one of the most difficult to achieve. The magic triangle of minimum cost, maximum efficiency and extensive control is still a major target for all treasurers.

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2.10.6 The impact of systems on treasury management In the world of modern treasury, technology holds pride of place. To improve efficiency and control, you need to have coherent procedures, to save time, to cut down mistakes, to be less dependent on people, to improve controls qualitatively, to segregate everyone's tasks and duties, to have better safeguards and more effective audit. It is clear that Straight Through Processing (STP), pre-‐defining transaction flows and pre-‐ coding accounting entries, web solutions, online transaction confirmations, online trading platforms, and tracing systems (audit trails) are all part of a toolbox that is essential for better management.

2.10.7 Moving to value added

Recent surveys show how the philosophy of treasury management centres has changed by moving to a value added approach. 70% now use value added against 10% using "profit centres" and 20% using "cost centres" according to a 2006 PwC survey. This is a proactive approach, no longer reactive. The idea is to make treasury management a structured decision-‐making support, providing information and specialist services. By setting KPIs, behaviour could change.

2.10.8 Targeted KPIs to change behaviour

A. Increasing control supports the business (by monitoring limits and observance of applicable policies, by centralising processes, by automating, and by identifying risks more quickly, etc. The support provided to business activities can be measured by indicators such as the number of limits exceeded, correction time, percentage treasury FTEs against total headquarters staff, number of documents checked, number of manual transactions, number of errors, compliance with internal policies, transaction speed, etc. B. Seeking opportunities for creating value can lead to quicker risk identification, guard against market fluctuations, improve the accuracy of future provisions, result in using more appropriate instruments, etc. Factors that could be used to measure the quest for value are average hedging period, daily results of trading operations (where authorised), analysis according to various scenarios, etc. C. Cost reduction through automation, netting, payment factories, shared service centres, a better credit rating and STP. KPIs might be cost per transaction, the number of external as opposed to internal transactions, the transfer error rate, or the cost of borrowing compared to a benchmark with a similar credit rating. D. Reducing and managing risks by identifying them, real-‐time quantification, better communication of policies and procedures to be followed, improved sensitivity and

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stress scenarios, regular IFRS hedging effectiveness tests. KPIs might for example be changes in income statement volatility without using hedge accounting (simulated accounts), analysts’ positions on the completeness of procedures, mitigation measures in place, the percentage of qualifying hedging relationships under IAS 39, etc. E. Operating using "centres of excellence" by means of satisfaction surveys with the Business Units (BUs) or by improving reports and the time taken to produce them. Excellence can be measured by the affiliates' level of satisfaction, or the percentage of BUs using treasury services, by comparison with other treasury centres (via consultants), by comparison of bank costs, by distribution of bank transactions in compliance with the set banking policy, etc. F. Building up a highly efficient staff by attracting and retaining "talents" by offering training and performance bonuses and career opportunities. Performance can then be measured by "rating" new employees, the link between salary or promotion and performance, personnel turnover, etc. Treasurers must "consolidate" staff expertise – this is the scarcest resource in these times of a shortage of talented people and competent financial staff.

2.10.9 Treasury department performance table

People often say that in practice it is impossible or complicated to set benchmark criteria for you. Even if we cannot disprove this frequently encountered prejudice, we are not going to limit ourselves to things that are easy. A performance table, also called a "balanced score card" should be based on four main features: PERSONNEL CUSTOMERS FINANCE ASPECTS PROCEDURES For each of these parameters, a series of performance or procedure indicators should be set and followed, to provide the comparison needed for proper performance management. The criteria fall into two types: QUALITATIVE QUANTITATIVE

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We can talk not only about KPIs and KSFs, but also about General Treasury Indicators (GTIs). Some indicators can only assign a place to the treasury function as a whole, or compared with the whole of finance department. Some depend on treasurer action and management, while others are independent of treasurer action in isolation. Obviously, treasurers cannot act on all "shareholder value" parameters or levers, but they can contribute to the effort, for example through the cost of capital or the working capital requirement on sales. The figures are only meaningful when compared to other similar or earlier figures. Figures have to be compared against themselves or against these comparators. You therefore have to build up a database and keep it up-‐to-‐date to make it meaningful and useful. Unfortunately, it is often the "benchmark" comparator that is lacking. Not much effort is made to build up comparators of this type, which would enable treasurers to compare their work with best practice. The PwC European Survey and Annual Benchmark SLG are two examples.

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2.10.10 Putting the treasury function into perspective By using a few simple figures and outcomes, treasurers can give a clear picture of the transactions being processed and show the volumes being handled day-‐to-‐day. For example, the total of funds transferred in a year in EUR; the average transfer in EUR, the number of hedging contracts or "hedge relationships" in place; the number of transfers per day or even the same figures per person. With these few figures, humble treasurers who are often poor communicators can give a snapshot of the transactions that they handle. Some of us would certainly be surprised by the volume being handled by our peers. But it might also be worthwhile measuring the number of articles published by treasurers promoting their companies, and their excellence or innovative nature.

2.10.11 Treasurers in the limelight – an opportunity?

Treasury departments have been the limelight for the last few years, although unwillingly. Now, however, they have the opportunity to demonstrate their "value added", and to measure its scale, while providing yet more transparency. The number of pages contributed by treasurers to the annual report would be instructive in this context. When treasurers reduce liquidity risk, they are working at creating value. When they make a non-‐taxable margin on the subsidiary's hedge, they are making a contribution. When they maintain optimal banking relationships by giving an appropriate slice of the cake to each bank, they are creating value. In the past, treasurers have often been seen as expensive with no value added. We have to fight against these two preconceived ideas. Treasury support is essential in decision-‐ making and for financial reports. That is why we need to take care in setting key performance indicators specific to the treasury function. From these indicators, its performance and that of its personnel can be assessed. From them, the CFO can set treasury department targets. Through a more innovative approach, different to that of other finance departments, treasury management can break out into the open. It can move closer to operational activities and to senior management, with a more strategic role than it had beforehand. With a modicum of rigour and by targeting its management objectives, treasurers can differentiate themselves positively. They are being offered a real opportunity to mark out their function and to be bold enough to assess it, by comparison to themselves, by comparison to their colleagues and peers, and by comparison to other finance personnel. Setting you properly determined target increases accuracy; and defining an identified centre, even though that may be difficult to achieve, can improve performance. Life is an on-‐going challenge!

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2.11 Are treasurers becoming “super financial reporters"? “Water generally flows downhill in terms of reporting” (Bob Bennett)

2.11.1 Do you like financial reporting?

Time and again we have explained and given details of the various financial reports that treasurers are responsible for, that they have to produce and circulate to various stakeholders. A new type of stakeholder has to be added to the list, long as it may already be: regulators, and particularly the well-‐known European ESMA, for reports relating to OTC type derivative products. It would be fair to say that if you don't like financial reporting don't become a treasurer because this part of the treasurer's workload has not suffered from the crisis, or more accurately is a victim of the on-‐going crisis. The leitmotif on information to be disclosed is "ever more". So we should not be surprised when a colleague asks us, "but what are you going to do with all this information you have put together"? This is an excellent question, but unfortunately usually when legislation is in place it is too late to try to ask it. Treasurer associations work in the dark and defend the interests of treasurers, even though many know nothing about this or only realize after the decision is made. No one is a prophet in his own country. This includes the EACT and the national associations just as much as anyone else.

2.11.2 Good news for financial reporting addicts

We could say there was good news for those who like financial reporting because they will have their fill in 2013 with IFRS 13 and EMIR on Over-‐the-‐Counter derivatives. Plenty of treasurers seem not to have taken this in yet. They are in danger of finding reality catching up with them very soon, we fear. We would encourage all of them to prepare themselves as soon as possible to be ready to deliver the financial information required in the appropriate formats. We would particularly like to go over the EMIR reform again. We are in fact exempt from posting collateral for OTC type derivative transactions. This is of course right and proper, but it was harder than it would seem to defend. We should remember that intra-‐group transactions are excluded from the scope of this regulation for the collateralization requirement. We should also note the exemption granted to non-‐ financial counterparties (i.e. non-‐bank corporate treasurers, or what some people pompously call the "real economy"). However, the exemption must meet certain

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criteria. Provided the transaction relates to hedging (hedging means covering / protecting an underlying operational risk, for example transaction for which "hedge accounting" is applied or financial instrument which is leaning with transactional risks back against), we are exempt. For transactions not qualifying as hedging, we have to adhere to a maximum limit by nominal volume of transactions. However, this means there is an option, just in no way an obligation, not to grant collateral to your bank counterparty. All these new regulations impose reporting requirements to produce greater transparency and better information for the readers of financial statements. For example, IFRS 7, IFRS 9 and soon IFRS 13, or even EMIR are trying to put things right and meet one of the main objectives of the G20 after the Pittsburgh summit in 2009. As always, we may criticize the way it is done, the burden it imposes or we may ask ourselves what will be done with the information. But the question to ask ourselves is that of the point of the reports or rather how to complete them.

2.11.3 Some major post Pittsburgh G-‐20 regulations are closely correlated and interconnected

(x) Dodd – Frank in USA

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How does the exemption principle work? Who is exempt? From when are we no longer exempt? What limits and thresholds have been laid down? These are the major questions that ESMA intends to answer. The final document should, in principle, be finished off and published at the end of 2012, to come into force as of 2013.

EMIR THRESHOLD LEVELS FOR CCP – COLLATERALIZATION

per asset class -‐ set-‐up by adding up nominal value of all Thresholds OTC contracts (excluding intercompany transactions/contracts)

5 ASSET CLASSES TO BE CONSIDERED:

(for contracts not subject to exemption irrespective of whether they

are in or out of the money)

EUR 1 bln in nominal value for CDS contracts

EUR 1 bln in nominal value for Equity Derivative contracts

EUR 3 bn in nominal value for Interest Rate contracts

EUR 3 bln in nominal value for FX derivative contracts EUR 3 bln in nominal value for commodity contracts and other derivatives not defined in 1 to 4

Tainting rule for all classes when breach in one (or more) asset

class thresholds. However, obligation to pass via CCPs dealt

after breach(es)

2.11.4 Treasurers, the new "great reporters" of finance? Treasurers are yet again asked to contribute to deliver financial reports. As the great modern reporters of finance, they have to disclose everything and lay all their cards on the table. Not all reports are limited to just figures and tables. They also have to provide text and narrative to explain what they are doing, their strategies, risk management, etc. There is one single catch phrase: ever more financial reporting. This is a self-‐evident truth and, unfortunately, is like an unstoppable tsunami. This endless crisis has

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unexpected and unwanted consequences for the "real economy". Treasurers are caught in the crossfire of post-‐crisis regulatory measures. They must resign themselves to it and accept it, even if they believe that it will not necessarily or fully reduce systemic risk. The future will tell us that, and we shall see whether we manage to avert the next crisis.

TRADE REPORTING REQUIREMENTS

Reporting obligations shall apply to ALL OTC derivatives contracts entered into before 16th August 2012 and outstanding on the reporting start date

Parties Registered office (address)

Beneficiary of the rights and obligations arising from the contract

Main characteristics of the contract (e.g. maturity, notional value, price,

settlement date, etc…)

Direct link (if any) to commercial activity

Part of portfolio > clearing thresholds (yes or not)

Trade qualifying (or not) as intra-‐group transaction

Reference to any Master Agreement

Details of whether collateral has been exchanged (and type of)

Revaluation of contract (delta between closing previous day andcurrent market price)

Electronically confirmed (or not

Date of last mark-‐to-‐market valuation

TO SUPPLY WITHIN 48H

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Perhaps there is an opportunity behind all these reports To paraphrase the new president of the French republic "reporting is where we are at now", an election campaign slogan. Even if a sensible time extension is granted, we will have to start delivering information to ESMA as of mid-‐2013, with different deadlines for different asset classes. Although there are still some points to be clarified and finalized, the latest version published by ESMA set the tone and gave a glimpse of what the final text will look like when it is finalized and brought into force in 2013. Plenty of other financial regulations are expected to appear in 2013, after long discussions and debates that have lasted for several years. The most optimistic people see in these financial reports a real opportunity to demonstrate the value of powerful and up-‐to-‐date IT applications, and to streamline work by automating it, making it more secure and efficient. Productivity in treasury departments, as everywhere else, will be a major challenge that will need to be met in the next few years. The challenge will be to know how we can produce more information, and process a greater number of transactions with limited staff and resources. The economic crisis does not help to provide us with the necessary financial resources. However, only good organization and powerful and integrated IT systems will enable us to deliver the required reports on time and in good order. This is a major organizational challenge to be dealt with at a time when the volume of work is in no way shrinking.

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2.12 Ethics in European Treasury and Financial Affairs “Good policy comes from experience, and experience comes from poor policy” (Edwart L. Prescott)

2.12.1 Background and current climate

Generally speaking, ethics have acquired great importance, and particularly in the financial world, in the wake of the widely-‐publicised and explosive scandals of the early 21st century. It is important to remember that the cases of Ahold, Enron, Arthur Andersen, Parmalat and Vivendi (among others) have shown that accounting fraud and financial malpractice can either sink a company or cause it serious harm, due to the actions of a handful of irresponsible individuals. America’s celebrated market watchdog, the SEC, has imposed its view of the situation and the American Senate has issued legislation in the form of the much debated Sarbanes-‐Oxley Act (or SOX, named after its main architects). Distorting a company’s reputation, particularly with regard to financial affairs and accounting can have extremely serious consequences for its shareholders and employees. Clearly, as is often the case, the answer has come in the form of heavy penalties (even custodial sentences in the USA) and the divulgence of financial information (disclosure, to coin the American term). The rules have even become nightmarish to implement, and the quantity of information published makes for time-‐consuming and laborious reading of annual reports and internet sites. Surely, even in finance, you can have too much of a good thing? We are entitled to ask ourselves the question, even though some maintain that there is a need to legislate in order to impose what companies and their shareholders do not seem to be able to do of their own accord in the field of internal audits. The risk to reputation has loomed large and heavy. Moreover, it often features prominently among the top three places in the classification of general enterprise risks (see « Enterprise Risk Management reporting »).

2.12.2 Ethics and Treasury

A company’s treasury department is not exempt from this risk of fraud. It must, even more so than its colleagues in the financial world, respect a certain level of ethics, given the amounts at stake and the importance of its transactions for financial survival. Nobody can deny the importance now granted to the treasury department in a company such as Ahold, nor the huge growth in its treasury staff. The values which a company wishes to transmit must support the ethical rules of the business area in which it intends

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to operate. A company can hardly expect to apply principles if the conduct of its employees does not respect them. The actions of all employees, particularly in finance, translate and express these basic values. If the actions conflict with the values, the corporate image can be distorted or even tarnished, if the conduct is unlawful or fails to comply with generally accepted principles. Each of us, as an employee of a company but first and foremost as human beings, should have our own ethical principles (often similar in our Western societies). These values and principles can vary from one individual to another. Each of us has our own moral values in the form of an informal code of ethics, which governs our everyday lives, but also our work. Treasurers and financial officers are not exempt from this personal code of ethics. Problems can arise if the company’s code comes into conflict with our personal rules. An individual’s personal reputation is also exposed. Apart from anything else, our reputation is what we hold most dear, and is something that we should never lose. Moreover, these ethical rules should be applied to the different categories of individuals with whom a treasurer comes into contact.

Treasury Ethics Towards Partners & Stakeholders shareholders

staff

Treasury Ethics

(other) suppliers

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banks

2.12.3 Codification of ethical principles Certain ethical principles (the main ones) are laid down in a variety of documents. Others (usually the less important ones) are not even written. They remain verbal principles, generally accepted or transmitted, most often by management. Treasury & Corporate Finance (T&CF) Ethic Principles Codification

General Treasury Policy (= Master Document incl. major ethic principle)

* Written Principles

GENERAL CORPORATE ETHIC PRINCIPLES

Ethic Principles

** Common Principles non-written

(written or/and not written) Applied to T&CF too

Other Treasury Policies (e.g. bank policy, FX/IR policy, asset management policies, etc…)

Major principles are included into the Company “Code of Ethics”. * Written document validated by Treasury (1) and Audit Committee (2) ** Verbal/non-written principles known by treasury staff and converged by management

This codification, often a consequence of SOX, has had a major impact on the everyday lives and functions of a treasury department and the rest of the financial world in general, and will continue to do so. The dominant idea is still to avoid incidents and prevent fraud. The responsibility has been placed on the shoulders of Management (in this particular case, on the CFO – Chief Financial Officer). Following in the footsteps of the accounting standards, the American ethical culture, more rules-‐based than its European counterpart, is now leaving its mark on European treasury departments. We prefer to formalise a system of rules rather than preserving a few discretionary, unwritten principles and values. Unfortunately, these new rules involve more paperwork than in the past.

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2.12.4 Respect for ethical rules In order to respect this system of rules from a range of sources, written or unwritten, formal or informal, the financial official, treasurer or other employee must ensure transparency, impartiality and task segregation, among other things. For instance, it is important for a treasurer to respect the impartiality required during a call for tenders, and guarantee fair competition among all suppliers. The price set may be unusually favourable, due to a bank error. An ethical treasurer should ask for the quotation to be checked before proceeding to trade. When using trading platforms, ethical compliance can be more problematic, and can present a dilemma for the treasurer. Another example would be the refusal of gifts which could suggest bias in making decisions. Money laundering is another risk that weighs upon a treasury department, and one that it must guard against. The interests of the company must always be put first, as long as these interests do not obstruct or contravene any laws in force. As with accounting standards, transparency is necessary in order to ensure control and demonstrate respect for the rules. The protection of data (printed or computerised) is crucial in order to guarantee compliance with rules.

How to respect treasury ethics ? Objective

Respect of Company General Business Ethic Principles (“Code of Ethic”) and Preservation of Company Best Interests By ensuring :  Transparency & Communication of Decisions  Fairness & Fair Competition via RFP/Tenders  Respect of Company Treasury & Corporate Finance Mission  Segregation of Duties (Banks office v. front-office, 4-eye principle)  Track records (confirmations, documentation, database)  InternalControls/Validation/Processes/ Procedures and Policies

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2.12.5 Code of ethics It is essential to codify ethical rules as comprehensively and exhaustively as possible. These rules must be known to their recipients and easily accessible to all. On occasion, the code must be able to adapt to the requirements of a particular region or country. The rules which apply in the United Arab Emirates may differ from those administered in China or Germany. There is sometimes a need to accept differences, in most cases through integrating typically local conventions (such as positive discrimination, although religious laws, such as the case of Islam, can sometimes be stricter). However, in any exceptional case, there is a need to give a very precise account of the difference, and its context, in order to avoid any abuse or misinterpretation by employees or the possibility of it being used as a defence in the event of a dispute. They must also apply to the majority without exception (except for the legal exceptions referred to above). «The rules of ethics apply to everyone », just like the law. It is also clear that codification can be counter-‐productive, if it alters previous modes of operation. Ethical rules can put a stop to long-‐standing traditional practices. And what about the choice of the less well-‐established path, a fiscal principle often put forward to justify sidestepping a more unfavourable local law? A Cornelian dilemma can arise, in which the Compliance Officer or Internal Auditor may have to step in.

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Financial Code of Ethics Example of structure I. II. III. IV.

V. VI.

Introduction – Context Description – Preamble Employees involved – Target group that must adhere to the rules of the financial code (exhaustive list of functions and departments) Definitions – Glossary (to make sure all rules and concepts are understood) What all employees belonging to the target group shall respect : I. e.g. - acting honestly and ethically II. - avoiding conflicts of interest III. - compliance with applicable laws and regulations IV. - protection of the company assets and resources V. - providing reliable financial reporting and disclosures VI. - ensuring reliable internal controls VII. - maintaining proper professional competence level VIII. - reporting to Compliance Officer (if any) IX. - etc… Sanctions and penalties in case of non-respect of code of ethics ** Amendments to procedure and rules (if and when applicable)¨¨ * Code of ethics currently published on external and internal websites ** Each employee of target group must adhere and confirm this adhesion to the code Any person who acknowledges to breach shall immediately report it Whistle blower protection is usually set up to protect employees reporting breaches. *** Any amendment must be disclosed in Annual Report NB: Environment Ethics could sometimes be codified too and is more recent.

2.12.6 Rules codification

Complete and exhaustive codification of rules is probably not the ideal. The right path lies, as is often the case, somewhere between the two extremes. A small amount of codification is better than none at all. However, if done to excess, it can also cause harm to the extent that operations become impossible. The art consists of summarising the essential basic rules in a few pages. There are examples illustrating our ideas, produced by large companies, to which we refer you. Once prescribed, the rules must be explained, transmitted and accepted by staff before they are enforced. This process will take a little time and will cost money, but the result is worth the effort. It must not be forgotten that at times this is even a necessity, an unavoidable regulatory or market requirement. Therefore, whether we like it or not, the rules of morality in the world of business and finance are becoming applied with ever increasing frequency. Their formalisation clarifies grey areas and prevents risks, while enabling punishments to be applied to wrongdoers. Even if you are not obligated or forced to comply, a treasury department should have laid down its internal rules so that it can set an example to other financial departments. A treasurer handles vast sums of money, a fact which in itself justifies a higher degree of ethical conduct than that of other people. Treasurers can show that they have become more virtuous than ever, and that the phenomenal developments which have affected

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their jobs over the past few years have forced them to become so. Moreover, every manager must transmit his or her own style and ethical principles, if they are valid. Reminders are often necessary to ensure that nobody forgets to comply with the basic rules of professional morality in the world of business.

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2.13 Changes in the TMS Market – A Broader Range of Products “There is more to life than increasing its speed’ (Mahatma Gandhi)

2.13.1 The Consolidation Trend on the TMS Market Over the past few years, the Treasury Management System (TMS) market has changed significantly. Consolidation, combined with horizontal integration, has limited product availability. Now the battle has begun between ERP solutions and more specialized, integrated product packages. A combination of impressive technological developments from suppliers and the ever increasing needs of treasurers have put more complete, higher-‐performance product lines on the market than ever before. What treasurers want is STP (“Straight Through Processing”), real-‐time management, communication protocol standardization, user-‐friendly solutions, automation of repetitive, low-‐value-‐ added processes, and integrated systems. Over the past few years, the market has been consolidating. For example, without according more importance to one solution than another, there was SunGard – AvantGard, which acquired Integra-‐T, GETPAID, Trax and even XRT Globe$. Its competitor, Wallstreet, did the same with Trema (which itself had previously acquired Richmond). Is this the end of the merger trend? Certainly not. The purpose of these mergers is to strengthen the companies’ footholds in the market while consolidating the underlying technologies. Their objective is to integrate the treasury parts (TMS such as Quantum or XRT), with cash management (Integra-‐T, Globe$), Accounts Payable (A/P, with Trax and XES) and Accounts Receivable (A/R, with Getpaid or Coveris), as well as with the means of communication offered by Trax, XES and e-‐TX.

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How to well manage the Financial Supply Chain ? By optimizing the Cash Flow Cycle Checking credit worthiness

Credit Management

Issuance of Invoices

Reconciliation TMS

Electronic Billing presentment & payment

Settlement & Payment

Forecast of Cash Cash & Liquidity Management

In-House cash

Collection of Cash

Collection Management

Financing of WorkCap Resolving of Dispute (if any)

Treasury & Risk Management

Dispose Management

The chain is complete, or almost entirely integrated. Anticipating the movement of future purchases, even someone with little imagination could guess that Wallstreet will try to make acquisitions to supplement its Trema F/Kit and Alterna/CMM package. Wouldn’t DataLog be the perfect target for them? Perhaps… but we should not forget that some smaller companies prefer to remain independent, which they believe makes them more responsive and efficient and keeps them closer to the client. There are arguments to support both points of view.

2.13.2 Market Fragmentation

This market has remained fragmented, despite the consolidation described above. The smallest companies are active locally, such as Sage or Kyriba in France. Newcomers have arrived, such as City Financials (now Wallstreet systems). At the same time ERPs like Peoplesoft, Oracle and JDEdwards are strengthening their positions. Other related specialized products could also be targets, such as FXall or 360T, Reval or SuperDerivatives, Speranza Systems, and others. The required functionalities are increasingly complex and require significant efforts to meet client needs, such as IFRS 7 & IAS 39, risk management reports (e.g. KontrAG, Cadbury and Bouton), compliance with Sarbox, and coming soon, the future E-‐Sox, Workcap, and more specific cash flow forecasts, among others.

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2.13.3 Clash There seems to be a clash between two camps. On the one hand we have ERPs, with their heavy artillery and enormous fire power, and on the other hand we have the specialized packages, such as the two described previously. Both have their advantages and disadvantages. Our intention is not to favor one solution over another, but the market is clearly taking shape; the specialized products, at the head of their class, need to sharpen their swords to compete with the heavy machinery. How long a seller stays in business over the long term, as well as its reliability, and its broader, more integrated product line will be major factors in determining how successfully it can compete. The arrival of the corporate product line from Swift is a good indication of this. Everyone senses that they should make a move and that the future of the market is already taking shape. With its recent purchase of Trax, AvantGard now offers a solution that creates a link between ERP, TMS and the other modules with ad hoc securities and controls, while providing access to the Single Windows concept from SWIFT. For example, AvantGard offers Quantum, Liquidity Express (LEX), Dashboard, GTM, APS2, Netting, Cash Predictor, Account Compliance, Risk, GETPAID and Receivable/Order-‐to-‐Cash. Without promoting any particular supplier, we will say that this kind of product line is a clear indicator of the company’s strong desire to broaden its offering.

2.13.4 Remaining Targets

Targets are becoming scarce after such widespread consolidation and lateral acquisitions. However, products such as Datalog or Alsyon could be prime targets for a company such as Wallstreet. In the field of reevaluation products, Reval or SuperDerivatives come to mind; as for exchange platforms, we think of FX All and 360T (which is already allied with Misys for CMS and ICD) or even Exidio. Other predators, such as SimCorp or Misys, could also be tempted by such an approach. Although the market seems to have been sucked dry, here and there we are still seeing new potential targets cropping up.

2.13.5 The Big Decision: ERP versus Specialized Products

It is easy to understand why a multinational group would make the strategic choice to select central ERP (Enterprise Resource Planning) and a horizontal, non-‐fragmented approach. However, it is also tempting to opt for specialized, “best of breed” technology, which is often better adapted. Do ERP solutions meet the needs of companies in a dynamic economic environment? The increasing number of available solutions, even when perfectly interfaced, comes at a price. ERP solutions often have a weak link, and sometimes the treasury component is

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very specific. The more a company operates in a mobile, changing environment, the more the ERP product shows its deficiencies. Whether a company chooses an ERP solution will depend on its group IT policy, whether it is pursuing a streamlining strategy, and the idea of capitalizing on a technology and a particular language, where technical human resources often fall short.

Key-factors of ERPs versus specialist solutions ERP

Specialist Solutions

•

Highly controlled centrally by IT team

•

More end-user driven

•

Efficiency for single business

•

Efficiency for complex business

•

Slow to implement changes

•

Upgrade cycle < 1 year

•

Investment in specialist knowledge & skills is variable

•

Investment in specialist knowledge & skills is paramount

•

Inherent interface

•

Less widely available resources

•

Broad functionality

•

Domain focus

•

Tied to investment cycle

•

ROI based

It is easy to understand the dilemma and the internal battles between operational teams and IT personnel. The primary arguments asserted by the proponents of ERP is that specialized solution companies do not stay in business very long, and they have interfacing problems. For this reason, the creation of a mini-‐ERP could be an interesting strategic response.

2.13.6 Mini-‐ERPs

Specialized financial solution sellers have adopted a sales strategy of Financial Value Chain integration. By purchasing competitors and producers of related specialized solutions, they are reinforcing their product, limiting competition and offering a more integrated panel of products. In fact, they could be described as little ERPs, considering the broad, complete line of services they offer. With this approach, they have provided an answer to the two main arguments against them. They integrate the complete financial chain, from one end to the other, while optimizing it. But what if a series of 100% ERP solutions came to dominate SAPs or other Oracle products? This offer is adaptable and is built gradually by module. At a time when financial departments are pushing for maximized performance, this is one of the levers to press. In a Sarbox world, the benefits of automation and internal controls are crucial.

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Improving the order-‐to-‐cash cycle affords an opportunity to be more competitive, consistent and effective with respect to the frenetic competition. Productivity can be financial and increase operational productivity. It also improves risk management and increases visibility while cutting costs.

2.13.7 Financial Reporting

The same phenomenon has been observed in the financial reporting sector. The group Business Objects (BO) recently acquired Cartesis. The purchase of this corporate financial and management software publisher is indicative of the objective pursued by the main companies in this sector to supplement their products in other areas of the market, such as performance management platforms, financial reporting, consolidation, financial governance, risk management and regulatory compliance auditing. With this acquisition, BO, has demonstrated that, like Oracle, it wishes to create a complete, integrated set of Business Intelligence (BI) services. Just as we saw with the software for the treasury business, we are seeing the same type of consolidation of all the tools in the chain. The product line has been broadened to better meet client needs. With Hyperion, Siebel and the ERP Peoplesoft, Oracle paved the road to integration in the BI sector. Here again, it is easy to imagine that the trend will continue in the years to come, with other acquisitions allowing the “big fish” to further cushion their dominant positions.

2.13.8 Financial News Duopoly

The merger between Reuters and Thomson, which were numbers 2 and 3 worldwide, respectively, will give rise to a giant worldwide leader in financial news with a market share of 34% (as opposed to 33% for Bloomberg). What will be left for the others? Financial news is necessary to feed market data to the TMS, but the selection of news providers will be rather limited. It may be easier, but it is doubtful that this will have a positive impact on prices for the user. We could conceivably see a comprehensive, non-‐ flexible offering of financial services, based on high, fixed rates, without a real possibility of negotiation. Is there room in these markets for anything else but the global-‐scale “monsters”? In this case, this merger is another example of the consolidation that is affecting all sectors of finance IT in the general sense. This over-‐consolidation is cause for concern over the medium term. However, Rupert Murdoch among others, has not hidden his interest in Dow Jones (no. 7 worldwide), which would reestablish the competitive balance. In some cases, consolidation may become necessary, or even helpful. The reinforcement of smaller entities can give them the size, network, contact, support and permanence that earn client trust. Size is weighed against service, power against flexibility, permanence against personalized follow-‐up, and even standardization against

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specialized adaptation. As with everything, consolidation up to a certain degree of choice is advisable. Beyond that point, consolidation can deprive users of their freedom and become limiting for them.

2.13.9 Consolidation phase

The treasury product market has entered into an extreme consolidation phase. This trend will have both positive and negative effects for users. Greater size is not the solution to every problem. But for those who fear the all-‐powerful ERP, is it not preferable? The alternative is not vast, but it has its advantages. Interfacing will remain the key to the successful integration of the financial service chain. Integration and STP are and will remain the nirvana sought by all treasurers who aim for absolute efficiency. Can they find happiness in this environment of market consolidation without alienating themselves from their waning number of suppliers? Let us hope that the improvements that have been promised us will not be counterproductive. The job has become more complex over the past few years and treasurers are hoping to see technology finally meet all its needs, regardless of how it happens, even if it means market consolidation.

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2.14 Automated Confirmation Matching Settlement “I just invent, then wait until man comes around to needing what I’ve invented” (R. Buckminster Fuller)

2.14.1 Manuals processes and STP

As a result of companies reengineering of internal treasury procedures and in the context of the implementation of ERP / TMS or Corporate Finance Management Solution, multinational companies often decide to implement CMS, the market leader for treasury transactions confirmation matching. The impetus for corporate treasurers to seek the Holy Grail of Straight Thought Processing (STP) has become even more acute in today’s financial markets. Faced with increased competition, the emergence of electronic trading systems and portals, the onslaught of industry initiatives such as Basel II / III and CLS, reduced expense budgets, managers are again exploring ways to raise efficiency, reduce risk, lower operational costs and increase profits. The lifecycle of most financial transactions has for primary components: trading – confirmation – settlement -‐ reconciliation (see Erreur ! Source du renvoi introuvable.). Manual procedures, multiple service providers, incompatible databases characterize the “traditional” operational process. Moreover, a large percentage of industry participant still communicate critical information via facsimile and telex, the phone and through insecure proprietary networks and in a not standardized way. As a result, the complete revolution of the lifecycle takes two or three days delays and does not allow the back-‐office to identify and resolve costly errors in a timely manner. If all manual interventions have to be circumscribed and even better eliminated, STP remains however a true illusion for corporate treasurers. In this imbroglio, some technology providers offer useful and easy to implement solutions. We want to present the practical experience of groups that chose to implement CSM, a transaction matching system distributed by Misys.

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2.14.2 Corporates Motivations Reengineering of group internal procedures unveiled that the lifecycle of treasury transactions was, as stated before, mostly manual and did not take into account the task’s segregation between the front and back-‐offices functions. Because choosing an optimal STP solution to automate the confirmation process allows as an organization to redefine their confirmation and settlement model and consequently easily and quickly realize true STP benefits, groups in general decide to foresee CMS in the new treasury architecture. First of all, all major banks are member of the system and CMS supports most of the treasury transactions like Forex, Money Market and derivatives products. Having all counterparts’ banks on the system and cover the treasury department financial transactions are indeed the key success factors of the implementation. As a result and after have convinced a majority of banks, groups try to reach a rate of 99% of its treasury transactions matched by the system. Additionally, the platform is independent, offers multiple alternate paths of receiving and sending information. And, last but not least, CMS business model allows corporates to pay on a transaction basis with a small monthly license fee, meaning that the system is even cheap to use! Once CMS is in place, it becomes the driving force behind the organizational changes. The processing focus on transactions shifts from operational intensive to exception processing. But an automation of the confirmation process also gives other substantial advantages to corporates treasury department. First, by suppressing the paperwork, companies avoid that confirmations are sometimes not sent or lost causing reminders from bank counterparties. Historical data are also immediately available using the paperless archiving. Secondly, the solution suppresses operational risk generated by unconfirmed transactions and allows treasurers to catch potentially costly errors fasters. Some treasury managers do not realize this, but catching errors faster has to be considered as major benefits as it will allow the traders to offset error deals without delay and consequently avoid costs in value date or market conditions. In addition, some systems propose to manage and communicate automatically settlement instructions to the bank counterparty, which add a supplementary guaranty against human errors and frauds. Finally, automatic confirmation will increase middle office efficiency. Time consuming activities like handling of mail confirmations and manual matching are not required anymore and it frees the time of middle office by focusing only on exceptions.

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2.14.3 Implement the solution CMS is an easy integrated solution to set up within group’s technical architecture. It proposes indeed an ASP model and works on pure standard SWIFT MT300 messages which make the implementation rather easy and straight forward. As described in Figure, after dealing, the treasury system (e.g. SAP CFM) will make the SWIFT MT300. This message is taken by a CMS little piece of software using the Internet to communicate with CMS Matching Server. On the other hand, the counterpart bank sends its SWIFT MT300 to the same matching server using the SWIFT network. We emphasize on the fact that the process is fully automated without any human intervention. The only pre-‐requisite to get the system works is the parameterization of the counterparty identification on both parts: in the counterparty referential of the corporate, the counterpart bank is simply identified by its SWIFT BIC code, and in the banking counterparty referential, the corporate is identified by a pseudo BIC code provided by CMS. Via the web browser, the group middle-‐office is able to consult the matching status of their deals. Erreur ! Source du renvoi introuvable. shows an example of such a screen. The top section shows the list of all messages sent by the corporate and the bottom section shows the list of all messages sent by bank counterparties. The system use colors, which show which transactions, have been matched automatically by the server (in green). There are messages for which the corresponding counterpart’s message have not been received (in yellow) and cancelled transactions (in red). The web application provides of course extended filter, screen customization and export facilities.

2.14.4 Confirmation Matching Settlement solutions

Even if the implementation of CMS is not always originally in the scope a treasury project, companies are now using robust, reliable and best practice solutions, which improve and accelerate errors and mismatching tracking and consequently generates savings. This automation will serve as a catalyst to improve the rest of the processes like linking an on line trading platform, managing settlement instructions database and enriching information provided to reconciliation and accounting systems.

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Traditional life cycle of FX operations

Confirmation (from (from bank.GT) bank)

Trading (front-office) FRONT-OFFICE Normal process

Incompatibledatabasis

Settlement

Reconciliation

BACK-OFFICE

RTL Group confirmation



MT3xx

Bank confirmation

Internet

SWIFT

 MT3xx

CrossMar Matching server Internet

Consult Matching status Accounting

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Counterparty Bank

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2.15 Managing Market Risks with Acquisitions in Emerging Countries “A man has no more character than he can command in a time of adversity” (François Masquelier)

2.15.1 Types of issues encountered

Acquisitions in emerging countries are never easy for numerous reasons. For example, the acquirer has to overcome local legal issues which sometimes could be extremely complex given the absence of written rules and procedures, compared to Western Europe. Moreover, the group acquirer could also face political issues. It often must satisfy irrational constraints that it is not always used to. Having said that, we would like to underline another type of difficulty and risks it could encounter in investing in such countries with highly volatile currencies, high interest rates and inflation in parallel to over-‐performing growth. These issues very often oblige investors to organize their funding in a stronger currency to lower charges of interest. However, it also confronts them to foreign exchange risks. These are the types of problems the acquirer will have to solve. By using different leverages and mixing products, it will be in position to optimize return on assets purchased. The financial issues are pre-‐ and post-‐acquisition.

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Acquisition Structure EU

Acquirer

Local Company (Holding) J-V

Local co-shareholder(s)

Investments

Emerging country

Assets / Equipment

2.15.2 Pre-‐acquisition financial risks Prior to the acquisition, after having signed a long form agreement, a shareholder agreement or any sort of committing documents, the company will be exposed to the purchase currency until the payment flows are processed. It could last a couple of months, depending on conditions or due diligences to be performed. Some companies hedge the FOREX exposure even before they have been committed. They then use a series of options which are combined to finance purchased ones. This can be extremely expensive and is never guaranteed to be recovered. Some companies then consider that these costs are directly linked to the acquisition project, which is at risk. It could be viewed as costs related to the project, keeping in mind the risk of losing all (expenses as well as hedging costs). Some other groups prefer waiting for the signature of a committing document prior to any hedging strategy.

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2.15.3 Post-‐acquisition financial risks 2.15.3.1 Consolidation treatment issue One of the first issues is to define the consolidation treatment to be applied to the Joint Venture (JV). The accounting method adopted could impact the group financial statements. In some cases, with a minority participation or “at equity” consolidation treatment, the accounting impact is nil, although financially they remain exposed. In other cases, the consolidation will be proportional or full (if at least it can demonstrate a “de facto” control). Very often, treasurers think in terms of accounting volatility before deciding the adequate hedging / funding solution to be adopted. For the inter-‐company (partial) funding, there is also the issue of the accounting qualification of the loan. Is the group funding an interest bearing repayable loan or a non repayable one (at least within the next 5 years)? In other words, could we benefit from IAS 21 favorable treatment and “freeze” into CTA (Change in Translation Adjustments – equity accounting) the change in fair value of the inter-‐company loan? It is a very interesting treatment but dangerous in the long run if and when it is repaid, as the CTA will be released and could severely impact P&L statement. 2.15.3.2 Funding currency The assumption taken is a local external funding given co-‐shareholders. Often, local partners do not want to finance it directly. Therefore, in order to balance shareholders efforts, the local company recourses to local bank funding. In these type of countries (e.g. Turkey, Russia, Brazil), a local currency funding could be very expensive as interest rates are extremely high. On the other hand, the funding in a stronger currency (and therefore cheaper interest rates) also presents disadvantages as the repayment could become expensive, especially if the local currency is devalued, vis-‐à-‐vis the strong one (usually the functional currency of acquirer). It could be a dilemma for treasurers; the cost of funding versus currency risk. They, the treasurer, will have to take into account the cash flows in foreign currencies, which could reduce FOREX exposure and offset risks with a sort of natural hedge. In these cases, the mixed-‐funding model can be applied, offering a cheaper funding solution, compared to an entirely local one.

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Example of comparison of pro’ pro’s and con’ con’s of debt based on debt currency Debt in USD

USD Debt

Natural Hedge of transaction risk Possible Hedge of Transaction risk Natural Hedge of B/S Natural Hedge of Cash Flows Cost of Hedge Debt Liquidity Liquidity of Hedging Instrument to deal Risks market position (“Carry Trade”)

+ ++ -+ + + + --

EUR Debt

++ + + + -

Local ccy Debt

++ ++ ++ --+ ++

2.15.3.3 Hedging of funding currency (if necessary) If the acquirer opts for the foreign currency funding (which could be for example USD for a EUR functional currency based company), they will have to consider a part hedging or capping of the risks, to the maximum level.

2.15.4 Methodology proposed

The Net Change in Cash (NCC) over the couple of years of the financing (tenor) has to be determined precisely (1). If the local asset has some in flows in USD or in EUR, it will automatically reduce the net funding exposure. The variability of this NCC should be minimized at a 95% confidence level. Then, we need to define the impact of FX on NCC and its variability, on average and worst case scenario (2). The treasurer should evaluate risk (variability of NCC)/return (expected NCC) in each scenario. From this analysis, it will determine the efficient frontier scenario with highest return and lowest risk (3). The last phase consists in evaluating tactical options as well as pricing and timing implications (4). By running different assumptions on percentage of USD (or EUR) funding, you can find the most adequate proportion of currency financing, with a 95% confidence level.

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2.15.5 Cash Flow Statement Projections The treasurer must start from a cash flow statement for the number of years corresponding to the financing (i.e. from revenue minus operating costs, to determine EBITDA minus taxes, Capex, to determine Free Cash Flow (pre-‐interest), interest paid, FCF available for debt, senior debt repayment and then the Net Change in Cash). From the business model, the treasurer will have to analyze the currency risk from a cash flow perspective. The variability of NCC depends on local currency, USD and EUR debt currency mix used. When the Cash Flow is set up, the treasurer could play with funding assumptions and FX rates (or even IR) to define optimum strategy. The factors, like correlations of USD versus local currency and EUR versus local currency, are important. The hedging should not be full of course if not there is no advantage of borrowing in a cheaper currency. The right level of hedging is more complex to delimit. The financial products to be dealt depend on cost. Some zero cost structures should be envisaged (e.g. strip of options; strip of collars or strip of cancellable forwards). With help and support from large banks, like BNP Paribas, for example, the treasurer could run the scenario to determine the appropriate combination of products and hedging percentage. The idea is to benefit from part of the upside if any while protecting against major downsides and to define the boundaries of possible movements (according to V@R analysis with a 95% confidence level). In each case, depending on countries analyzed, it is essential to start from market assumptions and expectations (e.g. HRK, HUF or TRY to converge to EUR at a certain moment in time; weakness of USD in general, lower interest rates in coming years). The carry trades are supporting the emerging currencies but are also sources of risk. The local positive developments of the economy support local currency but imply risks of inflation, does not exclude huge swings up and down, cycles and risks of political instability (for example: former republics in ex-‐USSR, Kurds in Turkey Islamist terrorists in Pakistan).

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Different Risk linked to steps of an acquisition Increase of shareholding

Initial participation

Nature of Risks Before acquisition completed

Control / Consolidation

Currency concerned

Risk Maturity

Risk of USD increase

Couple of months

Risk of USD increase

> 6 months- couple of years

= transaction risk on equity portion

Before control taking = transaction risk on new equity portion

After acquisition • Transaction risk (if sale back)

• B/S risk (translation risk) •“Impairment test” risk • Covenant risk at SPV/local holding level

• Risk of local currency decrease • “ “ • “ “ • “ “

vs. EUR vs. EUR (*) vs. EUR (on LT) vs. debt ccy

• First couple of years until sale

• Risk of local currency decrease vs. EUR • “ “ vs. EUR (on LT)

• First couple of years until sale

After control taking • B/S risk (translation risk) • “Impairment test” risk • EBITDA risk • Cash flow risk • Covenant risk at SPV/local holding level

• Risk of local currency increase vs. EUR of debt ccy • Risk of local currency decrease vs. debt ccy

* Functional currency of SPV/holding = local currency – acquisition in USD

2.15.6 Few sound conclusions to keep in mind There is no sole solution applicable for any acquisition in emerging countries. At least there are recommended approaches as described above. In general, we can admit that FX is the main financial risk, more than the interest rate (IR), even in Turkey where real rates are the highest in the world. It is also recommended to borrow in a cheaper currency, than in the local one. However, such cheaper funding generates FX risk which should be partly hedged. We can notice that, at settlement, spot rates appear very often lower than initial forward rates would have been. Therefore, the forward strategy may not be really appropriate and very expensive. The hedging instruments should be zero-‐cost types to reduce up-‐front cost of plain vanilla options. Mix solution for funding and for hedging are a way to weight the impact and the potential volatility. The IR must also be partly fixed in first years (at least) to guarantee the debt service. The transaction risk should be hedged with optional products until the cash payment of the acquisition price. For the local currency cash flows, it is advised to consider hedging the first couple of years and to continue in future on a roll-‐over basis to always have covered next year(s) cash flows.

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When your funding and hedging strategies are decided, you also need to sell them to (local) co-‐shareholders. Bear in mind, they could have different views and be exposed to different risks. You also need to sign an ISDA agreement and, if you are hedging and funding at local holding level, you need to negotiate credit facilities with local banks. By modeling the cash flows and determining the NCC, a treasurer can design the most adequate strategy to implement for the acquisition. In addition they can run a stress scenario to measure sensitivity of the acquisition. The adopted strategy should be aligned and incorporated into the global group risk profile to possibly benefit from natural hedging, if any. Investing in foreign emerging country could be financially challenging and it requires lot of attention from group treasurers.

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3 Part III Cash Management

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3.1 Cash generation capacity "People only recognize necessity when a crisis is upon them" (Jean Monnet)

3.1.1

Back to "true" financial values

Only a few years back, corporations looked only to their stock market valuations and the growth in their revenues. This period led to the recently-‐decried excesses of corporate phagocytosis in which some groups tried to absorb other monsters on the pretext of synergies. The synergies were no more than figments of the imagination of some CEOs. We have established the limits of how far integration can go and how difficult it is to bond together sometimes very different businesses. Many people thought that it was possible to grow only through acquisitions. They accepted paying steep prices for enormous assets without measuring the acquisition’s capacity to generate value. Companies took on huge debt, often threatening their survival. It looks as if one of the benefits of the troubles of 2002, the year of all our economic woes, is the return to traditional financial values. Companies have gone back to the basic principles of the need for purchased assets themselves to be able to finance at least the cost of the borrowings needed to fund them. It looks as though the fundamentals of financial management have (again) become decisive criteria in judging the quality of a company rather than it’s sometimes rather out-‐of-‐control acquisition strategy. It's a bit like the hare and the tortoise.

3.1.2

Liquidity risk

Some treasurers, when asked, do not mention liquidity risk as one of the risks they guard against. It is however clear that it is an extremely important risk. Treasurers must satisfy themselves that companies can meet their future financial commitments. To do so, they must have sufficient cash or appropriate lines of credit and alternative sources of finance. However, it is not good to accumulate surplus tradable securities simply as a precautionary measure. There are many companies with shareholders that allow cash to be accumulated without thinking about reinvesting it in assets able to give a high return on investment or even about paying it out as dividends. Excess is always harmful, and treasurers must ensure the company has enough liquidity while still managing cash and lines of credit effectively. Treasurers with disproportionate or excessive confirmed lines of credit will

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pay high and unnecessary commitment fees. These fees will be to the detriment of the group's financial management. Treasurers are a sort of guardian of the temple, but they must not take it easy behind a screen of over protectiveness or excessive caution. Today, more so than formerly or during periods of euphoria, companies are keen to ensure that they have secure sources of cash or lines of credit. This has once again become a crucial task for the corporate treasurer: making sure that there is always cash and that financial commitments can be met at all times. The treasurer has once again become a key figure in the company. There has been a sea change, and treasurers have once again become the closest colleagues of the CEOs of corporations such as France Télécom, Vivendi, Pacific Gas & Electricity and others which have experienced similar problems. By definition, the ways in which we do things are changing. We are seeing a return to a more "traditional" bank lending market, often secured or confirmed, which provides assurance of liquidity when crises hit. Although nobody, of course, ever thought that the banks' credit provision function had become an incidental one.

3.1.3

Cost of finance

3.1.3.1 Widening spreads The cost of finance, although it has not lost its relevance, has become less crucial to many corporations in real difficulties. However, it is still one of the factors to be considered. Excessive borrowing by some groups and the slow rate of return on investment has caused an increase in the overall cost of finance. This makes the group’s difficulties worse. They bought everything they could lay their hands on, they took on heavy borrowings and since in a recessionary environment the return on the assets is very far from what they counted on, they are downgraded by the ratings agencies. Rating downgrades lead to a large increase in interest spreads. The vicious cycle of credit rating has affected a number of companies, some of which have sunk to junk bond status in less than two years. The explosion in the cost of finance is a further drag on corporations that are already experiencing other difficulties. The hike in the cost of credit, or sometimes exclusion from certain markets, can put groups in a very difficult position. A group seeing its credit rating slide to A3/P3 will no longer have access to the Euro Commercial Paper (ECP) market. 3.1.3.2 Spread-‐widening factors In 2001-‐2002, the credit rating agencies highlighted the infamous "rating triggers” problem, which conceded the option to demand early repayment. Their perverse and

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sometimes fatal aspects then became apparent to everyone. As a general rule, there are no syndicated loans without financial covenants, a sort of powerful incentive. The more difficulties that a corporation with borrowings experiences, the higher the spread it will have to pay on its borrowings and bonds on the capital markets. If by ill luck the economic environment is less favourable and interest rates are rising, this can have a double whammy effect and speed up the onset of difficulties or precipitate collapse. Today groups try to avoid early repayment clauses that might contaminate all of the company's borrowings. 3.1.3.3 Financial ratios More than ever, the chief financial officer is on the lookout for and worried about key financial ratios. The ratings agencies have refined their evaluation of specific clauses in loan contracts and study and monitor liquidity more carefully – as with Moody's rating agency, for example, which uses the L.R.A. (Liquidity Rating Assessment) liquidity evaluation metric. This amounts to individualised information on a company's liquidity. It mainly affects the issuers of commercial paper. This revival of interest in cash clearly demonstrates that the treasury environment has changed completely, and that there has been a true return to traditional values such as cash and liquidity, together with all the means of achieving them. We need to ask ourselves how companies would react if they had to face a situation of not having access to the commercial paper markets in the short or medium term.

3.1.4

Actual liquidity and potential liquidity

3.1.4.1 Confirmed lines of credit Real liquidity is the sum of all short-‐term investments (that can easily be turned into cash or which are very liquid) and cash. Alongside this actual liquidity, there is potential liquidity. Potential liquidity is made up of the company's lines of credit, granted by banks. These can only be considered as potential liquidity if they are "confirmed", meaning "committed credit facilities", in banking terminology. Many people still think that a line of credit confirmed by a document or deed is a "confirmed" line. Obviously, this is completely wrong. A line cannot be considered as confirmed unless it is covered by a written document stipulating on what strictly defined conditions the bank can withdraw and refuse to provide the funding. It usually goes hand in hand with paying financing fees, called commitment fees, or reservation fees, which are supposed to cover the finance companies’ costs in tying up equity under the Basel I or the future Basel II criteria.

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Some commercial paper markets require reserve lines of credit, also called backup facilities, to ensure that the company can (re)finance itself from bank sources if there is no liquidity on the short term markets, or if they fail. The idea is, adding together commitment fees on the lines of credit and the spread on the commercial paper, to pay a lower spread in total or at least the same spread as it is charged by the banks. Equally important is the idea of diversifying your sources of finance and having access to other investors. Ensuring that your programmes have backup facilities is a good start. But companies must ensure that they have enough unconditional 364-‐day bilateral committed lines with no financial covenants to prevent a ratings agency downgrade. In any case, the greater and more diversified a company's sources of funds are, the more it can enjoy the luxury of being demanding in terms of spread, and it can be aggressive. Conversely, financial clauses containing ratios have the advantage of giving a better spread if the credit rating and the situation improve. This is a financial incentive, which cuts both ways. Borrowers can conduct tough negotiations on these clauses, but they must bear in mind that they need liquidity. Liquidity comes at a price: basis points in proportion to financial ratios or to the credit rating. Lines of credit and cash are still the company's absolute priority, even at the price of some concessions. 3.1.4.2 Securitization and other methods available to treasurers Companies are also looking for an answer to their liquidity problem in their own balance sheets. They are doing some soul-‐searching to think up ways of improving their Working Capital Requirement (WCR). They are looking at using “securitization", improved management of the "trade receivables" line, and keeping down the risk of default. Securitization, which has lost its cosmetic appeal because of the difficulty under IAS (IFRS) and under US GAAP of achieving de-‐consolidation of the assets, still has the advantage of diversification. Companies are seeking to streamline their cash management by multilateral netting using cross-‐border cash pooling and by centralising financing. We are therefore talking about implementing a set of measures, rather than just a single one.

3.1.5

The position of the banks

Banks are significantly reducing the amount of loans granted because of Basel II, and for better allocation of their equity. However, the stock market stagnation that we have seen since 1999 and low interest rates have encouraged them to keep on providing large syndicated loans, but with spreads more in line with the risks incurred. There is a real risk that we will see the supply of credit shrink in the future. They will lend only to the rich, as the old saying goes, or more accurately to the biggest and most robust.

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In this type of situation, those with low or weak credit ratings will be the ones to suffer from the change. You have to stay within bounds and not take on too much borrowing. This is one possible solution. You could also consider selling surplus or non-‐essential assets. We are going back to traditional principle of focusing on the company's core business. The golden rule would seem be that it is better to diversify your sources of finance than to diversify your businesses.

3.1.6

Selectivity in making loans

3.1.6.1 Bank selectivity Banks are slowly becoming more selective about which companies they will lend to. Company borrowings are up and the value of some assets has been cut to a fraction of the original, thus undermining groups acquiring many assets. The banks themselves must also show greater profitability and reduce their bad risks, along with excessive amounts outstanding from certain types of debtor, and excessive credit risk on any one single debtor. 3.1.6.2 Using an appropriate bank policy Treasurers who neglect their banks or are too aggressive in their bank strategy now find themselves empty-‐handed when they go to these providers of funds. The long-‐term nature of the relationship with banks should be put to the fore in any corporate strategy and in any bank relationship policy. Today, more so than in the past, treasurers must keep the banks happy and give them a big enough share of transactions and deals. They must give their banks enough extra business and the profit that goes with it to offset the low margins on lending (even if these have been on the rise over the last few months). 3.1.6.3 Banks are no longer loan providers The case-‐by-‐case "everything at the cheapest price" approach will suffer badly now. It would be better to give your merger and acquisition business to banks who still know what the word "lending" means. The prospects are bright for traditional banks that understand how to allocate their funds to the best effect. The fact that the credit market has been skewed for many years has ended up by paying off in a depressed period – the trickiest time for many. Some banks will need to do a complete overhaul of their marketing approach. "Niche" banks, which many people believed in a few years ago, now seem to have been somewhat left behind. Surely credit is and always will be the heart and soul of trade?

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Sadly, the markets have closed. The stock markets have been flagging since 2000, and can no longer raise the same volume of funds. The same goes for the alternative markets, such as the convertible bond market. The bond market is also suffering the tribulations of widening spreads. The banks have suffered heavy losses because of defaults on loans they granted. They have been rather shabbily treated by companies showing little respect for their banks' profitability. To a certain extent treasurers have also been victims of the system, and victims of their own approach of seeking the lowest price. Loyalty to and respect for your bank are now virtues.

3.1.7

Keeping subsidiaries' financing requirements under control

3.1.7.1 Lending control units Some international group treasurers have devised a system for keeping control of loans granted to their subsidiaries. Since they act as banker to their affiliates, it is quite reasonable that they should set up a lending department, similar to that in a bank, to keep a close eye on lines of credit granted to subsidiaries and any overruns on them. This is especially necessary when there are cash pooling arrangements for the subsidiaries in place, because overruns might pass unnoticed. Some subsidiaries might siphon cash off from group pooled funds. So control systems must be set up to spot any overruns. 3.1.7.2 Proper documentation of loans made To achieve this, such projects must also conduct a complete review of the documentation to be put in place to regulate the way loans are granted to subsidiaries. This is very useful with joint ventures, associations or economic interest groupings. Treasurers need to know what the subsidiary spends the money on and check that it is not really recapitalisation by the back door. The type of loan made matters when foreign currency is involved because treasurers need to know whether they need to hedge foreign exchange risk or not. Under IAS 21, for example, it might be what is termed a net investment in a foreign entity, similar to capital and consequently, in principle, not repayable in the immediate future. Action therefore needs to be taken on cash and cash equivalents at all levels. The role of the treasurer here is to back up management accountants and make everyone aware of the importance of proper cash management within the group. The priorities are changing and the treasurer's job is evolving.

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3.1.7.3 Cash flow forecasts Chief Financial Officers realise the importance of cash flow forecasts, and the need to ensure that their company has at least as much cash as it needs. They are trying to streamline short-‐term finance and to pass funds generated by operations towards central treasury. Internet based IT solutions exist. Unlike the bubble of the same name, they provide efficient tools for anticipating and optimal working. This is an important issue for treasurers. They have a new role or have recovered their old role of managing future cash flows and optimising the company's cash and customer receivables.

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3.2 The Magic Triangle of Asset Management “Don’t work for money; that will bring only limited satisfaction” (Kathy Ireland)

3.2.1

War chest

We all know that many companies have accumulated veritable war chests over the past few years, in the form of enormous liquidity surpluses to be invested on the markets. One quarter of all European companies have more than 100 million euros in liquidities in their portfolios, according to several European surveys. A treasurer’s dilemma is to determine how to maximize revenues on liquidities while protecting them against volatility and credit risk. Most European companies, either due to an overly prudent attitude or because they are not paying attention, could improve their liquidity management with a more dynamic approach. Credit institutions offer a full range of more or less structured products such as “Money Market” accounts, which allow for a more aggressive, more ambitious approach in terms of return on investment. We have also seen this “liquidity management” market develop at a phenomenal pace, growing to six times its size within nearly six years. Who else can say as much? The size of the amounts in question has inevitably forced companies to diversify their investments and has contributed to organizing an existing, yet generally relatively undeveloped market (with the exception, in France, of the famous “treasury mutual funds”, the so-‐called “Sicav’s de trésorerie”). This extreme prudence, in combination with recovering economies, has breathed new life into a liquidity market that had previously been relatively passive. The example of the American market, which has been developing for over 30 years, gives us an idea of what Europe can expect in terms of potential growth (www.immfa.org).

3.2.2

Magic Triangle

The magic triangle consists of maximizing return (what was a real challenge since early August subprime crisis), protecting liquidity and flexibility, and reducing risk by diversifying the underlying securities in which one is investing (higher concern since summer 2007). This equation is far from being impossible for those who give themselves the necessary means and set specific objectives. Treasurers are asked to combine excellence in financial management with the “best practices” in risk management. Of course, the strategy will depend on the type of company in question. The main distinction is between companies that are listed on the stock market (“public companies”) and those that are not listed (“private companies”). Of course, public companies are generally more prudent and more sensitive to volatility than private companies. The degree and threshold of tolerance are higher for the latter.

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Asset Management triple objective Maximization of return (v. benchmark)

Reduction of risks (by diversifications)

3.2.3

Portfolio of Assets

Insurance of liquidities

No Decision-‐Making Tools

Unfortunately, there are no effective, inexpensive tools to help companies manage their liquidities optimally. One possible solution is to hire a third party (e.g. AAA). Another is to establish a more dynamic internal management policy. However, nothing will ever replace practical experience. To paraphrase a common expression, it is by investing that a treasurer becomes an asset manager. He must learn to sense this market, which may, at first, seem simple and less volatile than others. Information abounds, without being consolidated or combined into a single platform. Likewise, reevaluation tools are lacking. In some cases, a treasurer is forced to manage by proxy and entrust the job to third parties. Is it better to learn than to outsource? One could reason that using external consultants always comes at a cost, which “better” management would more than offset. Unfortunately, this is not always the case. It remains advantageous to avoid depending on an external consultant, who, in any case, will only have a due care obligation. In addition, an investment fund is already, by definition, a manner of outsourcing management to an experienced, professional third party. Outsourcing and subcontracting are sometimes necessary for validating strategies and choices, obtaining information for financial reports or for making your asset management more “professional.” However, a fund is, by definition, a way to make

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one’s asset management adequately professional over the short-‐term, by hiring a specialist. The individuals working in this market play the role of “educator,” which it is an important role to fill, to provide the skills and comfort level necessary for this kind of management, if it is going to be (more) dynamic (than simply making a bank deposit, although afterwards and during summer time it would not have been the worst choice). No one expects to receive a pamphlet from his banker on the list of funds available or the prices received for such management. On the other hand, a treasurer will expect his consultant to provide informed opinions and to demonstrate his ability to outperform the market or the benchmark index. In any case, treasurers must remain extremely reactive (see summer crisis) in order to adapt portfolio to market circumstances and movements. The summer subprime crisis clearly demonstrated how difficult asset management could be.

3.2.4

STP and Online Platforms

Wouldn’t the Holy Grail be a completely integrated platform that offers a way to process all asset management products on line, to electronically, instantaneously confirm transactions, to obtain all NAVs in real time, to compare relative and absolute performance, to reevaluate portfolios while activating stress and V@R simulations for accounting purposes, particularly to offer decision-‐making advice, and the supreme privilege, to prove effective risk management with a snapshot of the portfolio thus fragmented? This is what we call “EDP” (Electronic Dealing Platforms). The El Dorado of Asset Management may not be as far off as you think… Isn’t the key to also reduce operational risks and increase internal controls? The advent of automation in this field should be on its way, as was the case with foreign exchange (FOREX) risk management. Such a tool could make it possible to better monitor fund content, and determine whether certain funds have content and profiles that are so similar that one could hardly describe them as diversified. A content comparison and fund mapping would also be very helpful. It is also worth pointing out that SWIFT is apparently planning to add asset management components to its SCORE service for “corporates,” which is indicative of the new appetite that is developing for this type of investment.

3.2.5

A Combined Approach

The principle hidden behind dynamic management is rather simple. In order to reduce the credit risk created by concentrating colossal amounts into a single organization, in a “traditional” bank deposit, you can invest in monetary funds from various categories. However, there is more than one good approach. Everyone must adapt to their own particularities, limitations and strategies. There are as many different approaches as there are companies. However, by combining products, making your approach more dynamic and clearly defining your objectives and expected performance levels

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“Cash” + Funds

6 – 12 months timeline (larger time horizon)

Enhanced Cash Funds

More volatile lessliquid assets, riskier but optimization of return oriented ≥ 12 months

Future

Types of Money Market Funds Available 156

No risks Higher risks

maturity daily liquidity stable NAV

High amount invested

Liquidity Funds

≤ 60 days average

Low amount invested

Time line

beforehand, it is possible to succeed. The size of funds and manager solvency appear as very important criteria to take into consideration when investing. The trick is to find a clever combination of underlying products to meet the three objectives of the magic triangle. Clearly, the timeframe that you set will be important, since it will help to improve revenue, even if only by making the rate curves steeper and by amortizing the impact of isolated economic events. Patience is also a great virtue when it comes to asset management… One solution used by treasurers is to “cut up” the maturity dates of deposits and investments (for those who take direct action on markets such as the ECP market) in order to see the effects regularly and thus always have liquidities on hand. In general, it has been observed that the major groups invested approximately 10 to 15% of their liquidities in monetary funds that were not handled according to IAS 7 par. 6 (“cash & cash equivalents”) on the balance sheet. Their more medium-‐term nature, their greater volatility with respect to the EONIA (>0.25%) as well as their greater sensitivity to movements in the short-‐term interest rates (>0.5%), among other reasons, make it impossible for them to be categorized in the IFRS (see the Official Journal EU 13/10/03 – L261/34)

3.2.6

Liquidity Planning

One of the most complex tasks for a treasurer is to establish cash forecasts that are specific enough to optimize the subsequent management of liquidities. The lack of effective cash flow forecasts and the overly prudent approach of trying to make every investment as short-‐term as possible make management complicated and less than optimal. Rarely does a treasurer have to withdraw quickly from a fund unexpectedly. The actual timeframes are often longer than what was applied for the length of time of the investment. With a longer horizon, a treasurer would naturally increase his overall yield. This is certainly a point of improvement for many centralized treasuries.

3.2.7

Regulations

Legislation (e.g. MiFID, Basel II, Solvency II) could be a major catalyst for change in this developing industry, just as user needs should start to shape products in the near future. Combining products is a subtle art. It is necessary to respect one’s banking counterparts, who are still hoping for a piece of the pie. Asset management policy should be in line with banking relations policy. The choice of benchmarks is key, and must be put into perspective to avoid putting undue pressure on the treasurer seeking maximum return. Such pressure could result in a distortion in the portfolio or in taking ill-‐advised risks. An objective must remain within reach in order to be effective and motivating. However, this does not preclude performance measurement, the creed of modern treasury management.

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3.3 How corporates use overabundance of cash? “God shared equally: he gave food to the rich and hunger to the poor” (Michel Coluchi known as “Coluche”)

3.3.1

Abundance, Excess or Effective Management of Liquidities?

Treasurers in Europe are brimming with liquidities. How is this affecting them? Many people are wondering how to best allocate these liquidities while having the least possible negative impact on value. However, there are not many alternative solutions. Hasn’t excessive prudence resulted in some bad investments for international groups in the past? The patent abundance of liquidities on the markets and in the accounting ledgers of European companies could be cause for concern, considering how exaggerated it seems. Prudence is always an advisable approach, but excess of any kind is dangerous. The old adage “all things in moderation” also applies to liquidity management. And yet, in this context of abundance, now more than ever treasurers are tracking down cash everywhere it can be found and are seeking to concentrate it by all means possible.

3.3.2

The Rise in Cash, A Major Objective

For the past few years, international groups have been trying to increase the cash lying dormant in their subsidiaries as much as possible, through inter-‐company loans or through cash pooling. Or, better yet, the ideal situation remains increasing cash in the form of dividends (even when there are a few tax-‐related complications and losses transferred upward to the parent company), as these liquidities will no longer be repaid in interest by the treasury center. However, when the subsidiary is consolidated into the group’s accounting figures but the group does not hold 100% of that subsidiary’s assets, the net cash position will be partially affected as a result. If the goal is to limit net debt or to maximize net cash, leaving liquidities in the subsidiary may paradoxically be more advantageous from a purely cosmetic accounting standpoint.

3.3.3

Where Ratings Agencies Stand

The ratings agencies are no longer taking into account cash that is inaccessibly held by the subsidiaries and that the treasury center cannot bring up in the form of a loan. The occasional situation in which it is impossible to bring up cash can be due to various technical, legal or auditing reasons, or even due to political reasons within the group.

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This notion of accessible cash tends to impose itself and forces groups to rethink the idea of truly available liquidities. Agencies have (re-‐)focused on a more financial notion of debt / net cash than the IFRS consolidated accounting notion, which can sometimes be very different. The financial reality tends to emerge in front of the accounting approach, which are occasionally somewhat artificial.

3.3.4

Excess or Surplus: More Than Just Liquidity Reserves

It seems obvious that, over the past three or four years of a difficult economy, generally speaking, companies in all sectors have accumulated very significant liquidity reserves. Yet, as is often the case in the aftermath of a problem, the natural tendency is to overcompensate. Today, European companies are brimming over with liquidities in a context of interest rates that are still relatively low (even if they are gradually increasing). However, in an effort to create a sense of security, some have gone from maintaining a simple, comfortable cushion of liquidity to lying on a cozy, yet oversized mattress of cash. More recently still, the accumulation of liquidities has been so colossal that it would seem that these groups have opted for the entire bedding store. After a few years of generalized over-‐indebtedness (like the Telecom companies in the 21st century), most companies have gotten themselves out of debt. Moreover, liquidities abound on the capital markets and credit spreads are at their lowest point and are extremely attractive. Banks and investors are falling all over themselves to offer low-‐ margin credit. There are not always takers for this abundant supply, as many companies are “once bitten, twice shy” after the goodwill impairments that were fatal to them, having clearly paid for assets at well above their value. This is the paradox of supply and demand. It is when the need for liquidities is low that they are the least expensive. On the other hand, when the darkness of winter falls, loans are pricier due to the rarity of liquidities.

3.3.5

Alternative Uses of the Cash

Companies that are short on acquisitions often decide to buy back their own stocks, for lack of opportunities to invest in promising projects or acquisitions. This way, they satisfy the shareholders for whom accumulation is a sign of value destruction rather than value creation. Once again, it would seem to be a paradox for the rare individual who sees safety in a cash reserve but who forgets the cost of it. On the contrary, an accumulation of cash could even make the company more vulnerable, as potential prey for avid raiders who would see that as a fabulous opportunity to maximize their investments through the use of more appropriate leverage. This could be a risk that company management teams are overlooking. Buying back shares boosts the stock and restores balance to the debt/equity ratio, while significantly reducing available cash.

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3.3.6

Communication with the Markets

With the requirements of the new IFRS 7 accounting standard on financial instruments, now more than ever it has become important to communicate liquidity risk and to clearly determine, for someone reading the annual report, the risk with which the company could be faced, its sensitivity to an increase in interest rates and its ability to fulfill its future commitments. In this case, detailed communication of liquidities is required and is comforting to the company’s shareholders and partners. The art lies in determining how to do this and to what extent. Having enough liquidity to purchase one’s biggest competitor three times over seems a bit excessive. Liquidities can also be in foreign currencies other than the currency in which the company operates and can offer other advantages for covering exchange risks.

3.3.7

Cash & Cash Equivalents under IFRS

Many companies want investments in high-‐yield monetary products (such as money market funds) to be treated on the accounting ledgers as “cash & cash equivalents,” so that they are deducted from debt or counted in the consolidated net cash position calculation. This notion, more often debated in France, has allowed French treasurers and the AMF (the French Security Exchange Regulatory Agency) to set minimum criteria for obtaining this accounting classification (e.g. minimum volatility and timeframe). When making an investment, the treasurer must keep in mind the profile of the fund in which he is investing in order to determine the appropriate accounting classification or to determine any risk of exclusion.

3.3.8

Dynamic Liquidity Management or Operational Yield

In an environment of overabundant liquidities, it is necessary to seek optimal yield, even if, regardless of performance with respect to the EONIA, EURIBOR or LIBOR rate, it will never be able to compensate for the lack of yield that an operational asset would ideally offer the shareholder. This is only one way to minimize the negative impact of excess liquidity, but it does not resolve the underlying problem. A JPMorgan survey recently revealed that there was a tendency in Europe to resort to extremely liquid money market funds (see JPMorgan-‐AC-‐EACT survey / www.jpmorgan.com). Companies are looking for high ratings, risk diversification, improved yield and liquid investments that are easy to get out of when necessary. European investments in money market funds seem to be more significant than in the USA. The marginal coefficient of higher-‐yield investments (and greater risk) remains limited in an effort to be prudent. However, this alpha will subsidize the entire profitability of the portfolio, even when it remains completely marginal, since the

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profitability of money market funds, even when greater than the LIBOR, remains dissatisfactory for an international company. Europeans seem to have a preference for safe, liquid strategies and are generally risk-‐averse. For example, the reputation of the fund manager, the service level and track records are important factors in the decision-‐ making process. They seem to prefer mutualized, diversified investments to direct investments in commercial paper, for example (See www.mytreasury.org ).

3.3.9

Shortened Cycles and Limited Visibility

Don’t the economy and the lives of companies experience regular cycles of abundance and shortage or ups and downs? In this more volatile, more complex economic environment, companies’ visibility is lessened. Since the horizon appears to be a bit cloudy, the human tendency to gather reserves is easily explained, although it may appear to be financially ineffective and even value-‐reducing. This obvious, unhealthy tendency to accumulate liquidities without being able to justify them can be easily explained by economic reasons, by greater market volatility, by the quarterly publication of listed companies’ accounting figures, or even by the precariousness of shortening cycles. European companies need to adopt a more Anglo-‐Saxon, more financial approach that favors debt leverage. Unfortunately, “good business” is not currently very popular. Prices are driven by investment funds or pension funds, and particularly American ones, eager for investments at any price. The dilemma faced by European companies and their shareholders is therefore obvious and complex.

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3.4 How to create value in better managing surplus of cash? “People have a lot of cash in hand. They’re ready to invest” (Felipe Brandao)

3.4.1

Cash surplus

For the past few years, liquid assets have been abundant and accumulating. While waiting for an allocation as an investment or acquisition, European companies are faced with the problems of investing their surplus cash under the best possible conditions, but with a certain degree of security. It is a real challenge for any treasurer. For a few years now, companies have accumulated ‘war chests’ in the form of liquid assets. They had a tendency to over-‐accumulate riches by precaution and over-‐reaction after a few tough years of managing high indebtedness. Financial managements have become terribly cautious and no longer loosen their purse strings without a guarantee of not having to record any goodwill impairment due to an unjustified extra price. The past has left indelible traces and deep stigmas. Having barely recovered from their hefty debt that was finally absorbed and still convalescing, companies are nevertheless seeking to optimise or improve their interest revenues. They now know the problem rich people face: what to do with my funds? Failing to invest their liquidities in operating assets that will help achieve returns on investment at least equal or superior to the group target profitability, they will seek to place their funds with minimum security and a satisfying return. We could qualify them as ”defensive investment”.

3.4.2

Return on cash surplus

The problem in an environment of relatively low interest rates lies in the frame of the circle of asset management. How to increase one’s return on funds invested without risk, with a quick mobilisation and without entrance or exit fees? Many European treasurers are disappointed and sad to get returns similar to EONIA flat. Unfortunately, to get a better return, the equation is quite simple: more risk and more time horizon help potentially accumulate investment revenue. Inversely, no risk or little risk with a very short time horizon only ensures a weak return similar to the classic benchmarks or budget rates. The difficulty lies in the subtle mix and alchemy of the time and risk factors on interests and/or capital. In any case, investments with a normal return destroy the value for the shareholder. Is it not better to invest funds in an asset with higher returns?

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3.4.3

Selection criteria of money market funds

When it comes to selecting Money Market Funds (MMF) where the company authorises the treasurer to invest the cash surplus, precise objective, qualitative and quantitative criteria must be determined. It is wise to have a well-‐defined asset management policy in order to able to easily determine the acceptable and unacceptable funds. Among the potential criteria to remember, we believe that the following criteria are important and recommended: The size of the funds being managed, which we recommend should ideally be equal or exceed EUR 1,000,000,000 The history of the funds and its creation date (ideally superior to three years in order to have sufficient distance and track records) Historical performances with regard to the reference index of EONIA or EURIBOR. They should be equal or superior to the index plus a margin to be defined (even though this past indicator does not in any way guarantee the future, it helps distinguish the funds) The volatility or maximum sensitivity range to the evolution of the interest rates by 100 base points The rating by agencies such as TheMorningStar or Standard & Poors, for example. The more stars are granted, the better rated the funds will be, just like great restaurants. Although some companies prefer a more classic rating of the S&P, Fitch or Moody’s type, the high ratings will also diminish the net performance of the funds. The downside of the security is its lower return (www.morningstar.com & well-‐known www.standardandpoors.com) Management of funds by a bank or specialist of such activities (e.g. Axa, Blackrock, Fidelity). Some companies refuse to work with funds managed by banks outside the scope of their usual banking relations (asset management policy is often kinked to bank relationship policy). However, it is useful to define the other documents or conditions that need to be met. It is necessary to have a copy of the prospectus, the basic document describing of the fund. It details the strategies, the legal and fixed internal limits and the signature spreading strategies, which will provide a more or less higher return. It is good to know the proportions of products and the underlying ratings invested.

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The fees linked to the fund must be previously known and the entrance and exit fees negotiated or eliminated for corporations. One can imagine limiting the maximum amount to be invested in a fund at a percentage of this and even at an absolute maximum amount. It would be wrong to disproportionately invest in a small fund. We think that 5% of the global size of the fund is acceptable. Knowing the methodologies used by the agencies and organisations that rate the funds is essential to seize the rating and establish the objective. It is also necessary to have a daily availability. The fees linked to the outperformance must be identified from the start in order to avoid surprises. The element of duration must be also addressed. It is recommended to establish a comprehensive list of criteria, as well as qualitative or quantitative objectives to select these fund investment targets. The main idea is to really know the strategy and return objectives in order to clearly define what one will or will not do.

3.4.4

Return objective

When the benchmark or return objective is established, it becomes easier to define the investment strategy and spread of different products of a family of funds. The treasurer will be able to use the alpha to think about one fund over another in order to improve and boost its global return. The art lies in the adequate mix and diversification of the MMF portfolios used. The diversification is a measure of the limitation of risks. And the recourse to investors and professional managers offers a greater guarantee of the desirable outperformance, even if it is not said aloud. Afterwards, the treasurer will regularly measure the performance. Then, they will be able to choose the strategy to adopt and modify if needed to get the best funds for the duration. The quality of the performance on the medium term is always a favourable element, failing to be a future guarantee. The time factor will provide useful indications on the quality of the fund manager. However, as is often the case with financial products, nothing will ever match the use and experience to be acquired by the practice and investment in a fund. This experience will help refine the results and ability of the treasurer to seize strategies and product mix. It is this alchemy between the monetary funds on the very short term (and secure by definition) and the funds on the medium or long term (and less secure in any case on a shorter time horizon), which will be crucial. A real art is acquired by the practice and wise advice of managers who will advise the treasurer.

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3.4.5

Dynamic management

If the treasurer is looking to optimise their return all while respecting the previously defined strategies and rules, they will have to spread their portfolio and use product families. The performances can be obtained from various sources. We feel that the REUTERS source is efficient because it helps measure the performance retrospectively with regard to the rating of their choice, whether it is EONIA, EURIBOR or another.

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Afterwards, the monthly follow up of effective performances will help ensure a proper strategy for the performance objectives wanted and eventually adapt the portfolio to optimise it. In dynamic management, the mix is not set.

3.4.6

Choosing one’s investment

The treasurer’s daily choice is complex. They unfortunately do not have the right tools to find the most adequate monetary product that meets their own internal constraints even if classic paid information providers exist for subscribers (Reuters, Bloomberg, etc.). There also exist different dealing platforms (e.g. STN, ICD, FundConnect, etc… These platforms are negotiation space for different products of asset management as well as a unique source of comparative price information. With a more dynamic and secure management of its cash surplus, the European treasurers will create value. This value and their performances will also be measurable. And is this not the added value that makes the treasurer an essential part of modern financial management?

3.4.7

What is equivalent to cash?

“Money: power at its most liquid” (Mason Cooley) Cash or equivalent? The IAS 7 "cash equivalent" concept is a key question that treasurers must always bear in mind. Offsetting liquid assets against debt reduces a group's net debt. The problem resides in the interpretive nature of the accounting standard. How do you work out a guide to the rules to be followed in deciding in which types of products a company's surplus cash may or may not be invested? That is the question we are going to try to answer. The question of knowing what qualifies or does not qualify as a cash equivalent under IAS 7 is no easy task. International groups and multinational corporations often set themselves the target of classifying their assets as cash or as cash equivalents (under IFRS accounting rules) to offset their liquid/very liquid assets against any external debt that the company may have and thus to report the lowest possible net debt figure (i.e. Gross Debt – Gross Cash = Net Debt/Net Cash position). Since one company is often only a subsidiary of another even bigger one, even if you are in a "long" position (net cash rich position), the shareholder company consolidating your company may well be rather interested in your company being as liquid as possible (in the sense of very short-‐term

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investments), if it is in a "short" position (net cash poor position). The question is therefore neither academic nor without consequences. Unfortunately the IAS 7 standard is subject to interpretation by IFRIC. Unlike IAS 39, for example, this standard could be considered to be "principle-‐based" rather than "rule-‐based". This interpretive nature makes the question yet more difficult. You need to convince your external auditors of the "short-‐term" nature of your assets, failing which you risk having them re-‐ categorized as longer term assets in the balance sheet and annual report, and therefore not deducted from any gross debt you may have. The difficulty also arises from the lack of any literature or documentation on the question. It is therefore best to decide in advance, in your investment policy, what is or is not to be considered as "cash" or "cash equivalents" to forestall any subsequent comments or re-‐categorization at the time of the quarterly, half yearly or annual reports.

3.4.8

Environment of low or negative interest rates

The environment of very low interest rates, even slightly negative of late, is an incentive for looking for additional return on investments. However, looking for additional return and yield will inevitably involve taking certain risks and lengthening the investment period. If for example we have invested in short-‐term money market funds, we may be tempted to invest in funds with a longer investment period. The risk would then be not adhering to the criteria set out in IAS 7. Looking for yield is synonymous with taking additional risk and lengthening the average investment period and/or greater volatility and sensitivity, which are incompatible with some IAS 7 criteria. We need to know what the accounting consequences of these investments might be. Current market circumstances are such that some money market funds, such as the IMMFA short-‐term funds, are closed to all new investment and may not be available for a long time. Fund managers and sponsors sometimes even ask you to agree to units being cancelled, which is synonymous with disguised negative interest. Current economic circumstances all combine to encourage you to reconsider your short-‐term investments and radically overhaul your investment strategy. This is therefore an ideal moment to ask yourself this question and lay down your own guidelines on short-‐term investment to prevent any dispute with the auditors, and clearly set your own in-‐house limits in your capacity as a treasurer. However, this is an aspect of professional best practice that few treasurers really address. Scant guidance on defining cash equivalents IAS 7 gives only outline and relatively terse guidance on defining the "cash equivalent" concept. The accounting standard gives no clear, easy-‐to-‐follow rule for defining the

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types of assets that will qualify for this purely short term equivalent treatment. The standard (IAS 7 -‐ PARA 47) recommends that you should yourself define this concept and what you plan to include in it. The idea is that the slightest change in this definition will be seen, under IAS 8, as a change in accounting policy. Consistency and continuity in the application and interpretation of accounting rules is a major principle to be adhered to and to be demonstrated to the external auditors.

3.4.9

What sort of things are equivalent to cash?

Overnight deposits and current accounts are obviously considered as pure cash. If short-‐ term bank deposits (demand deposits) are repayable without penalty on giving 24 hours' notice, they are also cash equivalents. As the standard is not rigid or prescriptive, "preparers" of the annual accounts have some room for interpretation. The maximum investment period, in general, is considered as being three months (IAS 7 – PARA 7). The closeness to the maturity date keeps down the risk of any significant change in value. The main basic principle in the cash concept is preserving the principal. Irrespective of the counterparty used, a certificate of deposit, a deposit, and a money market fund (MMF) all qualify as required. A set of criteria must be adhered to. Four main criteria must be considered. However, for money market funds, each of these criteria may itself be broken down into more specific sub-‐criteria. For example, WAM (Weighted Average Maturity), WAL (Weighted Average Life), the benchmark index, sensitivity, the maximum term of each asset not exceeding a certain period, asset concentration, etc. We recommend you consider and delimit your reference criteria, which should ideally be quantifiable so that you can monitor them and adhere to them. Ideally we would have to advise going for a broad definition (provided the external auditors will agree it) to leave yourself the option of including more "aggressive" money market funds with higher yields or funds which might be categorized as less "pure". Although the definitions may be quite similar, they vary between different bodies such as the AMF (Autorité des Marchés Financiers in France), the IMMFA (Institutional Money Market Funds Association), the SEC (Security & Exchange Commission), the credit rating agencies, CESR (Committee of European Securities Regulators), etc.

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3.4.10 Prevention through a clear and transparent policy We have to recommend that all treasurers conscientiously review the principles of their asset management policies, and additionally incorporate into them the IAS 7 principles and criteria that they intend to adhere to. Ideally, they will even have it approved by the external auditors and by their Audit Committee to avoid any subsequent unpleasant and tricky disputes. Setting out a working framework for you is well worthwhile at a time when the counterparty risk aspect is more prominent than ever before. There is cash and cash, short-‐term and very short-‐term and also money market funds and pseudo money market funds. This new search for alternative yield might force us to take risks that we would prefer not to take and to invest for a longer term, at the risk of seeing these investments re-‐ categorized and restated on the balance sheet.

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Reviewing investment policy Since market conditions are exceptional and interest rates almost nil or even slightly negative in EUR, this is perhaps an opportunity to reconsider your investment strategy and benefit by setting down your IAS 7 application criteria to prevent any disputes on the balance sheet accounting treatment of deposits or assets invested. This is all the more necessary now that some money market funds are closed to new investment and returns on very short-‐term investments are rock bottom. Treasurers must proactively define the types of investment that they may invest in, in line with the accounting treatment qualification criteria applicable to them (to the extent that qualification is important to the business). Defining what is cash and what is not is therefore not as straightforward as you might think. IAS 7 is an example of a principle-‐based type of standard, as all future IFRS accounting standards are expected to be. The room left for interpretation is a good thing from the technical point of view. However, from the practical point of view, it may give rise to lengthy and heated discussions with your external auditors, to convince them of the interpretation to be adopted. Consistency, continuity, clarity and prior definition of the principles and rules adopted by the company are essential from the accounting point

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3.5 Controlling means planning ahead! “To many, total abstinence is easier than perfect moderation” (Saint Augustine of Hippo)

3.5.1

The treasurer as adventurer

Everyone claims to practice Cash Flow Forecasting (CFF) or is able to predict their liquidity requirements in good time. But can anyone really claim to excel in this exercise, sometimes akin to an art? Liquidity is becoming rare and expensive these days. Better to try and secure it by anticipating your financial needs. When it comes to cash management for non-‐financial companies, cash flow forecasting is still a major source of great inefficiency. For various reasons, businesses seem to be backwards, clumsy or lazy when they have to anticipate their liquidity requirements and the financial flows that affect them, for better or worse. For instance, we can cite inadequate direct and indirect methods (the indirect method being particularly complex in practice), unsophisticated computer programs (often the rather inappropriately named Excel spread sheet), the displeasure in the face of such a difficult task or even the admission of inability, when the figures present large and inexplicable discrepancies. CFF is very difficult. Nobody has ever said anything different. It is a cliff face we need to tackle while knowing that our first attempts will be painful and possibly fruitless. But surely, the treasurer is the adventurer of modern finance? More than ever before, we have to remain extremely liquid in order to be highly reactive, financially speaking. Over the past few years, liquidity has once again become a virtue that we have to cultivate meticulously. To guarantee it, we have to anticipate requirements and secure cash reserves and availability, or failing that, adequate lines of credit (‘committed’ and partially ‘uncommitted’). Cash Flow Forecast needs to: Be regular Be repetitive Be iterative Have a long learning curve Be open to ex-‐post review Be constant Be disciplined (to be effective)

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However, while more than ever before companies will have to prepare themselves financially in an extremely volatile and unstable economic climate, some of them still fail to practice cash flow forecasting. Others do so, but with weak tools (about 75%). Yet almost all businesses, even the most virtuous, recognize that there are no longer that many possibilities for improving complementary information and processes at the same time. Many are still afraid to admit it, while knowing that their medium-‐term forecasts (6 to 15 months) are not very reliable or even inexistent. There is a need to remain cautious and, if we want enough provisions to see us through the winter, we need to anticipate the consolidated requirements at group level.

3.5.2

Credit is more expensive!

For several months we have been witnessing a six-‐fold cumulative effect which is making it harder to obtain credit: A Hike in the interest rate B Widening of credit spreads C Over-‐prudence on the part of lenders who are not only selective in terms of quantity but also quality, a new development D Increased credit rotation and transferability (banking difficulties) E Changing lenders (an army of more exotic banks enter into syndications) F Reduction in tenor (3 or 5 years are becoming the maximum terms, albeit renewable). Paradoxically, credit is becoming rarer at a time when the world’s liquid assets have never been so large. The current crisis has basically been caused or aggravated by the lack of confidence, starting with the banks themselves. Credit has become a rare commodity but paradoxically accessible – to the wealthiest. The popular saying “only the rich get richer” has never been so true.

3.5.3

Why effective CFF?

Improving CFF therefore comes at the bottom of the list of priorities for CFOs and treasurers, whatever their company’s size. It is a necessity, and the best practice in this area is the quarterly CFF, using a dedicated, automated, consolidated and revised

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computer program (review of projected CFF and review of retrospective CFF in relation to profits realized) under the IFRS. Just because it is a difficult exercise is no excuse for evading or avoiding it. On the contrary, it is precisely because it is difficult that we really need to apply ourselves to the task. If CFF is efficient, it enables a more accurate and refined management of the liquidity and credit required. The more accurate it is, the more the liquidity lines can be fine-‐ tuned, which will lead to a reduction in global financial costs and free up future borrowing capacity for subsequent acquisitions.

Cash

Flow

Working

Investment

Capital

Inefficiencies

Forecast

Financial Costs

* periods of deposit to compensate uncertainties, amounts placed too small to maintain of financial net, better allocation of investment types

3.5.4

Proper forecasting means proper communication

If we are to feel the beneficial effects of CFF, information must be shared among every division in the group. There is all too often a lack of internal communication within a group, which explains the inefficiency or inaccuracy of cash flow information. Conversely however, good CFF will improve intra-‐group communications and communication between subsidiaries and the group treasury (as IAS 39/ IFRS 7 did). This is all the more important since human nature is such that the information will still be very conservative or even too underestimated, and consequently the group’s overall liquidity management being inefficient. CFF is also an exercise in integrated communication and confidence, which goes beyond the purely technical aspect of producing forecast figures. It is an exercise that implies hard work, discipline, method and ex-‐post reviews, in order to achieve continuous improvements.

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3.5.5

Technical barrier

Another major obstacle to the development of CFF at group level is the lack of an integrated reporting system. Although the local forecasting models can range from a simple spreadsheet to a dedicated software program, consolidation of the whole requires an integrated tool that permits conversion into the group’s operational currency, inter-‐company offsetting, the handling of taxes (e.g.VAT) and dividends, and other technical adjustments and consolidation scope. Often, through a group reporting and consolidation tool such as MAGNITUDE, head office can put together the information using a common tool which everyone has mastered, in an accurate format known to everyone, using universally accepted accounting terminology, starting with the net cash net debt situation. While it seems clear that every CFO has to have efficient CFF at branch level, it seems that many of them are fumbling their way around with their only limit being an annual budget (sometimes not revised). At group level, a tool built on the basis of a spreadsheet will be unstable, too weak and will present risks in terms of errors and maintenance costs. It is therefore last in the list of recommended solutions. The proper tool should be solid, ideally known by everyone, integrated or compatible for use with the ERP (Enterprise Resource Planning) and/or the TMS (Treasury Management System). Changes have to be tracked and comments have to be added if necessary, in order to explain a figure or a discrepancy.

3.5.6

Reliable cash-‐flow forecast, holly Grail of treasurers

Some studies claim that about 10% of international companies have no CFF at all. As for the remainder, a huge percentage admits that their forecasts are precarious, ineffective and approximate. However, today, taking into account the economic situation which is restricted to say the least and the increasingly difficult access to credit, CFF is vital. Not to use it would be pure madness. Why cross the Atlantic without a compass? One recommendation is to start with already mastered tools (such as spreadsheets) in order to instill discipline into the group along with greater accuracy, while asking for variations to be explained on the grounds that this will indirectly generate the necessary internal discipline. There is also a need to be diplomatic, enter into discussions and educate fellow workers. It is a long, drawn-‐out process. Finally, there is a need for feedback, as there is nothing more frustrating than having to feed information to your parent company without having any reply, comment or even any understanding of the usefulness of the report. Good communication is still a key element of successful CFF. In order to better manage working capital, oil the wheels of the financial supply chain and improve financial results, CFOs and their treasurers must have excellent CFF. Forecasts of future cash flows are to accounting what homeopathy or preventive Chinese medicine are to allopathy!

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3.6 Cash-‐Flow Forecasting is KING “If you have to forecast, forecast often” (Edgar R. Fieldler)

3.6.1

Need for reliable forecasts

Nobody could deny the importance of having accurate and reliable Cash-‐Flow Forecasts (CFF). More than ever, it is essential to be able to anticipate your need for funds (or to estimate any surplus) to ensure appropriate facilities are put in place to match. The premium price of credit and its relative scarcity make it imperative to determine actual future requirements better. Many firms are trying to produce better quality cash flow forecasts. However, very few multinationals are succeeding in this. So what are the keys to good forecasting? The cost of credit has risen very sharply over the last few years. Credit has become a scarce commodity and, like all luxury products, is available only to the most financially sound groups. Today, not being of "investment grade" quality is an enormous handicap in the bank lending market. The bond market would appear to compensate for this lack, as do stock-‐market issues, although these are on the decline or still at a very low level, after a financial earthquake unique in the history of modern finance. Since credit is ever scarcer and ever more expensive, even where credit lines are not utilised, it is vital to ensure that they are appropriate in scale and to ensure that surplus capacity is not committed to simply on the grounds of prudence. By arranging facilities that exactly match their bank lending needs with a minimum of financial cushioning, firms will reduce their financing costs and their costs of arranging lines of credit ("Commitment fees"). Since the latter have risen sharply, they need to be kept in check. However, to keep their credit facilities to the minimum necessary plus a small safety margin, they need very accurate cash flow forecasts.

3.6.2

Forecasting for better management

Managing is forecasting. And in order to forecast, internal discipline must be inculcated right down to subsidiary level (i.e. Profit Centre/Business Unit). Unfortunately invoices do not get paid in profit, but in cash. This explains why the treasury manager, the custodian of the cash, has become a center of attention and why Cash Flow Forecasts (CFF) have become so essential. Many have tried it, but few have succeeded in practice. For many, CFFs are simply a sort of budget revision exercise. Others make do with cash flow statements reporting the situation after the event. However, CFFs ought to be consolidated (in IFRS format) at least quarterly, with a monthly review, with forecasts going forward to at least the end of the current financial year and with a subsequent

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review to explain the variances and to instill forecasting discipline. But how many firms are actually capable of producing forecasts worthy of the name? If your forecasts are reliable, you can even test them using stress test scenarios. Effort put into forecasting is not incompatible with robust action on working capital requirement ("Working Capital Need"). By working on accounts receivable, accounts payable and stock, you can improve the reliability of cash flow forecasts. Everyone is hunting for cash and tries to pool cash centrally in order to optimize the net cash position and their financing costs. This cash is the oxygen or the fuel needed for the firm's survival. Thinking along similar lines, it is important to measure the "Cash Conversion Ratio" (OCC = FCF/EBITA as a %) or the capacity to convert operating profit before tax and depreciation into "Free Cash-‐Flow" (FCF). This is the measure of performance and the capacity to keep generating cash.

3.6.3

Rules to be followed for good forecasting

1. DISCIPLINE AND SCOPE OF COVERAGE Generally, the thing that is most often missing is discipline within an international group. Discipline and rigor are necessary for producing quality forecasts. Similarly, the scope of coverage (which ideally should be complete full consolidation) is often partial. The level at which forecasts are prepared is also key in this process (sub-‐ consolidation/Business Unit – BU level or operating subsidiary level / Reporting Unit -‐

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RU). It is obvious that the level of granularity and inputting data in the finest detail will improve the reliability of data and the completeness of the consolidated figures. This is why it is important to bear in mind the consolidation scope and forecasts of future flows. The use of identical definitions and similar software applications also aids data accuracy. 2. CENTRAL SOFTWARE APPLICATION AND MIX OF METHODS Choosing software is a tricky business. Obviously everyone has their own ways of doing it. Nevertheless, we think that using a single consolidation and reporting application for preparing future cash position and cash flow reports is a real advantage. With monthly balance sheets and income statements, it is possible to mix the direct (based on in/out flows) and indirect methods (based on balance sheet movements), giving more information and means of explaining variances. This is because the difficulty is often giving explanations after the event of the variations observed. Information on working capital is also essential and must be forecast and monitored quarterly. We should however note that many multinational group BUs/RUs use Excel spreadsheets for their local forecasts and for preparing partial balance sheets and income statements. These two factors then make it possible to mix direct and indirect methods. 3. CHECKS AND EXPLANATIONS AFTER THE EVENT Subsidiaries must be required to explain divergences from forecast (actual against forecast + forecast against re-‐forecast). Requiring explanations inevitably imposes discipline and gives the exercise greater accuracy and value. The narrative portions of the CFF report are also important. 4. CRITICAL POINTS Of the many potential problems and critical points, inter-‐company returns are important (they can be symmetrical or non-‐symmetrical, as defined in advance). They must allow for offsetting and clearing of balances in order to give a consolidated picture. It is necessary to distinguish inter-‐company transactions external to the BU from ones internal to it. Input should therefore ideally take place at the lowest subsidiary level possible, thereby ensuring that the information is as relevant and as reliable as possible (i.e. the RU level). Similarly, the VAT aspect can also give rise to misunderstandings and must be clearly defined. The concept of "accessible" cash is also crucial. At the end of the day, it is only the cash pooled at head office level, and therefore "accessible", that can be taken into consideration and is really worthwhile forecasting. For a number of reasons (JVs, minority interests, "idle cash ", etc.), not all cash can be reported to central treasury. Head office (or local) adjustments, also called "lifting" may also modify overall profit for a number of reasons. The consolidation percentage should be included, but sometimes

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a subsidiary consolidated at equity can report funds to the central pool (although the opposite is most often found). This is why consolidation software, if perfectly in line with the application for reporting both the cash position and cash flows, will provide consistency and facilitate the exercise. The consolidation scope must be as consistent as possible over the various budgeting, forecasting and accounting periods, so as to provide consistency and comparability. If possible, the same definitions should be used at the financial accounting, consolidation and treasury level as at the internal reporting level. These common definitions will generate KPIs (Key Performance Indicators). Otherwise, they will not be speaking the same language. What is the "cash" concept? "Free cash flow" or rather the "cash conversion factor"? The methods chosen (direct or indirect) are not of great importance, provided they produce a reliable result. However, the direct method, the one most appropriate to cash, would appear to be the best. In the interests of greater consistency, foreign exchange (FX) should be treated as it would be for budget or consolidation purposes. The interfaces between the IT applications used will be crucial for providing as many links and similarities as possible between the reports and the software applications. If a local software application is used to prepare monthly forecast balance sheets which themselves give forecasts of future cash flows, (indirect method), the interface will be more than just useful. Finally, explanations and narratives must be included in the CFF reports in order to give an understanding at central level of the assumptions used and for checking that they are consistent. Better cash-‐flow forecasts mean cost saving Reliable forecasts of future cash flows are still a tricky exercise and a cliff to be scaled. This steep slope must however not prevent the treasury manager working on qualitative improvements and greater completeness of CFFs. You need to invest money to save money. However it is not just a question of putting in an IT system. Forecasting is a subtle art, needing consummate technique and it has a long, almost continuous, learning curve. Thoroughness must be inculcated. This accuracy will come with practice and by monitoring forecasts with a qualitative review after the event. That is the price of quality. The ability to convert operating profit (EBITA) into Free Cash-‐Flow is essential for survival in an economic world which has in parts become somewhat savage and cruel (Cash Conversion = Operating Free Cash Flow/EBITA = xx% per BU/per RU). In order to accurately forecast a firm's financial position and future net borrowings, the CFF requires real discipline right through to subsidiary level. We cannot afford to skimp on that these days.

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3.7 Cape on cash “From abundance springs satiety” (Titus Livius)

3.7.1

Visibility on cash

Today, the treasurers must face what we could call the virtuous trilogy consisting of three key disciplines in their function: forecasting, concentrating and investing. Cash flow forecasting is not the easiest one as it is rather complex to properly and efficiently implement. Cash flow forecasts are useful provided they have a certain minimum degree of accuracy allowing treasurers to adopt appropriate corporate finance management. Treasurers need to have a greater visibility on the evolution of bank balances and the indebtedness level of the group. They have to think about concentrating cash as far as possible while optimizing tax situation of the group. More and more often, they have to make deposit or investments of their cash surpluses, as more and more, groups generate cash rather than creating debts. The last few years, multinational companies invested less in risky M&A operations. Lastly, what we call “cash management” definitively remains a core activity of any treasurer.

3.7.2

Cash flow forecasting

Increased focus on corporate governance and Sarboxing imply, for treasurers, an even greater need of visibility on group liquidities generated. Furthermore, forecast does not imply only short-‐term visibility, very useful for cash pooling management, but also medium term view, up to twelve rolling months, for credit facilities and capital market programs management. The treasurers have to clearly define (potential) cash needs in coming months to better size credit facilities or programs. But such a cash flow management requires controlling psychological and technical issues. It is necessary to succeed in passing over the unavoidable internal resistance and in creating a real discipline, which too often is missing. The effort will unable each affiliate to more appropriately manage its own cash needs.

3.7.3

A corporate case study

In such a context, couple of years ago, corporate group ABC decided to launch a project for implementing a cash flow forecast process in each division. The first step was to define objectives of the project, scope, cash flow components, methodology to follow, frequency of reporting requested and lastly data transmission tool(s) to be used. The objective was triple:

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Determining estimated net indebtedness of the group (or cash net surplus) Defining indebtedness/cash evolution per profit center Estimating the cash conversion ratio6 for each affiliate and the group as a whole, which will be sort of benchmark and division target

The profit centers included in the scope represented roughly 95% of the whole group.

3.7.4

Definition issue

The definitions used for the terms referring to the cash flow notion were exactly the one as described by the IFRS accounting rules. The chart below starts from a net cash position as of N -‐ 1, which after the operating cash flows, investing cash flows and financial monthly cash flows gives net position end of next month and so on for the next twelve months, on a rolling basis.

Cash Conversion Ratio (CCR) = Free Cash Flow / EBITA It measures the capacity to convert operating result into cash. By monthly defining CCR per entity, the treasurer could define each affiliate cash conversion cycle. Making capital work harder. 6

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Net Debt

EUR

2 004 Janv 2005 Fev 2005 Opening Forecast Forecast 198 001 198 001 549 207

Operating Cash Flow

… Forecast …

Dec 2005 Forecast …

351 206

282 512

381 744 1 113 -31 651

316 283 721 -34 492

351 206

282 512

…

7 846

549 207

831 720

…

481 808

Free Cash Flow

66 078

-17 740

…

39 201

YTD FREE CASH FLOW

66 078

48 338

…

547 986

YTD EBITA within the scope

58 021

50 210

88%

104%

Cash from sales Other cash in (operating) Payroll cash out …

EUR EUR EUR

Investing Operations Acquis. of NC assets and market. sec. Proceed fr. sale of int. & tang. assets …

Capital increase / decrease …

EUR

Cash & cash equiv. variation

EUR

Closing net debt

EUR

198 001

Cash Conversion Ratio

… … …

446 597 493 064 1 485 -47 952

EUR EUR

Financing Operations

181

612 489 …

89%

3.7.5

Cash conversion

A road show was organized at each profit center involved in order to answer specific questions, explain processes set up and create awareness of cash forecasting. The controllers, the CFO’s and local internal tax advisers were involved and trained, as well as all whom had to master and handle inflows and outflows. It is essential to note that the dedicated controller in charge of the profit center must validate each forecast before consolidating data. Group ABC uses its consolidation and information tools, Carat Cartesys (renamed “Magnitude” in 2005) to avoid multiplying IT software’s used for financial data upstream. With such a consolidation tool, Group ABC is able to consolidate on a similar manner and with same rules and methods all figures in order to define a forecasted net debt position under IFRS. It allows calculating automatically all related ratios on a standardized way. Lastly, it gives means to colleagues to have access to the same information. Cash flow forecasts are reviewed every quarter. That exercise directly follows the quarterly consolidated closing. It gives ABC at each review occasion to analyze all initial forecasts versus realized and to draw conclusions and information useful from past quarter. The quarterly review allows to improve where possible and to refine further information precision. It is an exercise where by experiencing and practicing affiliates could really improve the quality of forecasts in terms of exactness of amounts and accuracy of timing. From such an iterative process, ABC group defines the sizing of capital market programs (EMTN, ECP, BCP,… uses and needs) and credit facilities due to consistent forecasts versus reality. The forecast methodologies used differ from profit center to profit center depending on the size of each and the complexity of activities and related companies, which need to be sub-‐consolidated. Divisions having numerous sub-‐affiliates mainly use the indirect method based on balance sheet, while other use the direct method via bank balances when their activities and sub-‐group is less complex and smaller. So far, the group has not imposed any specific and sole method as situations are different from unit to unit and as results are satisfactory whatever the method used. ABC group preferred to give affiliates certain flexibility on method used provided targets are reached with a similar degree of precision and efficiency.

3.7.6

Learning by practicing

From the experience on cash flow forecasts, we could draw few conclusions and recommendations: Priority to definitions, terminology, scope(s) and targets

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Insurance of having the full support and dedication from all CFO’s, as well as from all controllers Information and training sessions to explain the why’s and the how’s Low expectations for first exercises. Then in a second stage, results should be improved. Pertinence of results will naturally increase with experience. The learning curve will gradually steep

With a good common sense and an excellent communication intra group, you could present to your CFO accurate cash flow forecasts, which are realistic and a good working basis to reach defined objectives. The logical next step for ABC group was to launch later a project on its needs in working capital to action different levelers generating liquidities (or consuming cash) in order to even further refine treasury forecasts. As managing is anticipating, this target should be the one of every single treasurer, isn’t it?

3.7.7

Optimising working capital

More attention than ever now needs to be paid to Working Capital. How can it be optimised? What should the treasury manager’s role be in a working capital requirement maximisation project? How can results be measured and compared against group KPIs? It’s an opportunity for hands-‐on action and for gaining a better understanding of the way the business operates. The real question is: how can we improve the flow of the working capital requirement and instil discipline right down to operational subsidiary level? The main idea of such a project is to create value by identifying and acting upon the various levers for reducing the working capital requirement. To do this, you need to understand your own organisational structure and determine the specific points of action required (because a particular business and sector is not the same as another). These specific characteristics need to be taken into account and the cash available used for a broad range of requirements and objectives (in addition to financing (any) working capital requirement), such as the purchase of assets, CAPEX requirements, buyback of own shares (if there really is a cash surplus) or for research and development. At the end of the day, it’s a simple issue of efficiency and speeding up cash flows. The more cash flow can be accelerated, the greater the positive effect that will flow through to the company's share price, reducing the cost of finance and interest payments. Reducing working capital requirement is not a quick, single-‐stage, easy process. It is gradual and long and involves constant effort and discipline that needs to be maintained and inculcated in small doses into the subsidiaries.

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Working Capital Cycle

Equity + loans

Payables

$ IT cash Receivables

Overheads, etc.

Inventories

Sales

Making progress is like dieting. The first thing to do when you decide to lose weight (or improve your "Working Capital Need") is to buy an accurate set of scales. The treasury manager’s scales will be a set of KPIs such as “acid test”, “quick ratio”, DSO, DIO or DPO, for example. No scales, no progress. For pounds lost, percentage reductions or number of days fewer we need to consistently measure them on a regular basis. A good reference point would be to say that if the business generated 12.5% cash flow on revenues, this would mean that an improvement of €1 million of working capital would equate to €8 million in turnover. It is therefore crucial to reduce the number of days’ working capital (the DWC) needed to generate the cash so badly needed these days, without at the same time in one way or another disadvantaging the business by comparison to its competitors (an increase in liquidity does not come only from additional lines of credit). The art consists of aiming into the distance (LT) while working on targets close at hand (CT). This is a project that needs to be "sold" in-‐house. Unfortunately, this is not as straightforward as it might first seem.

3.7.8

No scales, no diet

As with all projects, you need to set guidelines, procedures and rules that the whole management structure needs to abide by to be certain of the effect of a given dosage. The troops need to be made aware of them and need to be motivated, primarily by means of bonuses or collective public reports at CFO meetings (as with “Weight Watchers”, where the effectiveness of the diet is repeatedly compared). Money and pride can be two excellent persuaders for "forcing" colleagues to adopt "good behaviour" in financial terms. If Working Capital is not added to the list of figures in the management report, will anyone bother about it? No scales, no diet!

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A CFO working to improve his DSO for example, for the good of everyone, should be encouraged, motivated and rewarded. How many businesses calculate senior management bonuses using such figures as a basis? Very few, we tend to think. We need to develop an approach that is more proactive and also more financial, so that it is not solely operational. It is not only the EBIT(D)A that counts, but the way you get to it. Capital needs to be made to work harder. Why focusing on Working Capital? Economic Environment Adversely Affects Corporates 1.

Reduced access to credit

Increased cost of credit

Increased pressure from stakeholders

Customers delaying payment of their bills

Customers & suppliers experiencing financial difficulty

NB : economic environment can also impact business with delayed refinancing ; restricted investment; increased bad debt exposure & reduced CAPEX spend

3.7.9

Working Capital, the right alchemy

WCN (Working Capital Need) has three components: Receivables (the lowest) Stock (the lowest provided it does not affect operations and sales compared to competitors) Payables (the highest) It is the right dosage of these ingredients that matters. The treasury manager can act as a dietician to improve the balance of these ingredients. (1. and 3. at least). It doesn’t take a financial genius to conclude that DSO (1) should be reduced and DPO (3) increased. Simple, isn't it? Adjusting stock is a bit trickier (2). You therefore need to set up internal procedures to get the best WCN without alarming suppliers, who are on their guard, or customers, undermined by the crisis (for example policies and rules for customer discount; rules for factoring and credit assurance, rules of conduct to be followed and "good practice", IT applications to be used, ideally the same throughout the group to facilitate WCN monitoring).

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Optimisation of Working Capital to unlock the hidden value within the company

Target

Optimisation of Working Capital to unable generation of (1) More profit (2) Using less capital (3) While reducing risk

Trade Finance: Finance making it work for both buyer and supplier Cross Border Cash Optimisation: Optimisation improving net cash balances

Means

MultiMulti-Bank Cash Concentration: automatic control of local balances Supply Finance Chain: Chain building new partnerships for business growth and success

3.7.10 Making a working capital project work You need to act upon the different factors by balancing each of the doses judiciously. Traditionally, finance would act upon the recovery of receivables and supplier payments, without affecting the position of stock much, since this is more to do with logistics than with operations. However, there is something that can be worked on to beneficial effect -‐ supply chain finance. Let us look at how we can act on each of these. Integrated Integratedsolutions solutionsdrive driveefficiencies efficienciesstraight straightto to the bottom line the bottom line Unlock Unlock++leverage leveragetrapped trappedcash cash Streamline Streamlineits itssupply supplychain chain Improve Improvepayments paymentsefficiency efficiency Convert Convertto tocash cashfaster faster

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A. Increasing Days Purchases Outstanding (DPO) 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

Constant, consistent measurements throughout the group Transparency Predefined strategy and approach (taking local specifics into account)  targets per entity Set targets for bonus calculations Look into reasons for late payments Send out invoices quicker Monitor slow and late payment (direct debits, simplifying the recovery process, improving reconciliation procedures) Pro-active monitoring of customers to speed up receipt of cash Discounting, if appropriate in financial terms, proportionate and effective Renegotiation of terms and conditions with each customer with the group's financial strategy firmly in view. Deliveries skewed towards the month-end (if possible) Figures and reports on DSO (e.g. overdue/month, benchmark with competitors, cash sensitivity customers; contracts or SLAs in place) Set-up a true customer/credit policy

B. Increasing Days Purchases Outstanding (DPO) 1. 2. 3. 4.

Set the longest number of days for payment (review the terms and conditions) Negotiate a long-term approach with suppliers (terms versus a long-term supply contract) Take advantage of size, especially with the smallest suppliers, and concentrate on fewer suppliers to achieve better terms from volumes. A multiplicity of suppliers can be harmful in terms of payment conditions. Compare supplier terms within the group

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C. Improving Supply Chain Finance 1. 2. 3.

Adopt a group approach to factoring and supplier finance. Supplier financing programmes (who will deliver goods on deferred terms). Extension of payment periods where suppliers are pre-financed by the customer's bank. The idea is to achieve a leveraging effect by shortening payment periods through adjustments to discount periods (= alternative source of finance). These days, it is possible to improve cash flow and the cash position by monetising these receivables. The saving is achieved by centralising expertise and resources at the level of the centralised group treasury department.

Supplier Financing Scheme A A delivering of goods + invoicing

Purchaser Receipt of goods E-Payment of invoice at maturity

Core

B C

Bank

Receivable payment agreement + assignment of payment rights Payment less discount of interest

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pli up

ers

For a number of years, banks have provided wide-‐ranging support for improving supply chains and for seeking efficiency by reducing the capital bogged down in daily operations (operational business), thereby helping to improve the "cash conversion factor". Some banks offer online web-‐based solutions (providing a secure point of access for monitoring suppliers with visibility throughout the purchase-‐to-‐payment cycle). The bank can help to cement relations and create a true partnership between group purchasers and their suppliers.

3.7.11 Slim down your WCN

Not taking care of your WCN would be folly. In the current climate (and Basel III will not solve anything) it has become, like cash generation and free cash flow, perhaps more important than the P&L itself. The economy is wallowing in a sort of recession and credit is still a scarce and dear commodity for everybody, especially small businesses. Under these conditions, the working capital cycle has become a fundamental goal and target. Companies need to focus on "freeing up" capital. Using a coordinated, disciplined and pragmatic approach, without the need for an infusion of magic or science, it is possible to slim down your WCN. A good database of consistent data, a track record for comparison purposes and the setting of a number of basic KPIs are the starting points for a good slimming system that’s low in capital -‐ calories that cost businesses so dearly. Garfield used to say “diet” is “die” with a “t”. If true, it means that corporations and treasurers must take care of their working capital to optimize it as far as possible.

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3.8 Cash-‐pooling, myths and realities “Creditors have better memories than debtors” (Benjamin Franklin)

3.8.1

Cash pooling, the vector of centralisation

Given the increasing complexity of the economic environment, the intensification of risk and the emergence of new opportunities, cash management has become the focus of ever greater attention. Over the years, this function has expanded and become more entrenched within international groups. This change generally accompanies the current trend towards steady centralisation of treasury activities. Cash pooling forms part of this centralising trend.

3.8.2

Cash pooling -‐ definition

Cash pooling means pooling all cash and all fungible cash equivalents. French translations of English words very often do not readily give an idea of the mechanisms or products being discussed. We are talking about a banking technique in which the current-‐account balances of the group or a company are offset for the purpose of calculating interest. The group therefore receives interest on its whole cash position. Cash pooling is a solution to the problem of being out of sync, the simultaneous existence of a net creditor position in one company, and a net debtor position in another. We do not need to set out the many advantages offered by the technique of pooling balances: better return on cash, greater negotiating power through centralisation and harmonisation, economies of scale, greater visibility, etc. Today, thanks to the arrival of the EUR, to legislative changes, to developments in technology and bank creativity, treasurers have customised solutions available to them. These are very satisfactory for managing day-‐to-‐day surpluses or bank balances held in the different countries in which business is conducted. "Follow-‐the-‐sun" solutions exist to cover various geographical regions.

3.8.3

Obstacles to perfect balance levelling

Even though we must emphasise the obstacles that still exist, we may observe that the treasury function has made great progress over the last few years and can streamline the management of cash and financing requirements. Treasurers can level the balances of their accounts or, depending on the technique used, the levels of interest rates, and through that they can significantly reduce their financing cost or increase their interest

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income, even beyond the boundaries of the countries from which they manage their cash centrally. The dream of every treasurer has not yet been achieved. Their ultimate goal would of course be to pool, at same day value, all their bank accounts, irrespective of bank, regardless of currency and moreover, beyond the frontiers of Europe. This unfortunately is still a pipe dream which still looks a long way off. However, solutions are beginning to emerge that move towards this treasurer's El Dorado. Day-‐to-‐day cash management For a group operating internationally, cash management gives rise to many issues and difficulties that need to be overcome or minimised. Monitoring cash positions and producing reports for that purpose are essential for an international company. The economic difficulties at the start of the third millennium only increase the need for the best management of cash. In spite of the continuing existence of legal and tax obstacles, there are efficient cash pooling techniques in existence that can be applied locally or even across a country's borders. Financial controllers are on the lookout for tools and techniques to simplify report production and streamline bank account management. Their ultimate goal is to keep down the group's financial costs or maximise its financial revenue by better movement of funds through the various entities. Treasurers also want to improve their overview of the group's internal sources of finance and supervise its affiliates' adherence to authorised credit limits.

3.8.4

Existing cash pooling techniques

There are two main types of pooling: notional cash pooling and netting, also called zero balancing or sweeping in the trade. We may observe that there was originally only one, with the concept covering only notional pooling. The balance levelling technique is also misunderstood and therefore wrongly likened to the notional system. Since both forms of cash pooling offer quite similar benefits, the choice will depend on the group's culture and structure. 3.8.4.1 The principle of target balancing or zero balancing Target balancing is a technique for aggregating the requirements and resources of various accounts and enables the consolidated balances to be managed centrally from one single bank account. Treasurers can then manage the position of the central account by applying appropriate balancing investments or borrowings. The aim is to bring the account balances to a pre-‐set level (or even to zero) by pooling the surpluses or offsetting balances by means of a central account, called the "master account". Removing the margin between interest payable and interest receivable optimises cash management. This way the company creates a series of loans and deposits between its

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subsidiaries, usually called "inter-‐companies loans and borrowings". Through the target balancing that this creates, the company has a sort of internal bank available to it. The central account will be responsible for calculating, recording and redistributing the income generated by these inter-‐company loans, which were themselves generated by target/zero balancing. Solutions of this type can even be used in conjunction with local cash pooling, managed in a more traditional style. Cash management can therefore be carried out on two or more levels. For example, the company sets up zero balance type domestic cash pooling between the local subsidiaries of a single division and offsets this balance, credit or debit, with the balance of the master account of the business line by means of balances of pre-‐set or targeted amounts at a second level. The treasurer thus combines local management with a powerful local partner and international management with another sound partner. Obviously, such management arrangements involve extreme care in reporting payments or receipts of funds and in short-‐term forecasting. Obviously, whether it is borrowing or depositing, the central cash function is likely to obtain more favourable (pre-‐negotiated) financial terms than its local subsidiaries, because of the consolidated totals involved or because of the group's size and potential for the bank. 3.8.4.2 Notional pooling Alongside levelling to target balances, some banks offer notional or virtual pooling, which provides an international approach to cash management. The idea is to automatically offset the rates of debit or credit interest on the various bank accounts. The virtual nature of this technique avoids the need to make physical transfers of funds from one account to another. The bank calculates the interest payable or receivable as if there were one single bank account, then it analyses out the interest cost or income per entity. We should note that some countries do not allow use of this notional technique. France, for example, prohibits payment of interest on current account balances, thus preventing this virtual technique from being used. It is usually necessary to carry out an assessment to see which system suits the company best or which has the optimal cost/benefit ratio. Political choices are not neutral at this technical level. Some entities may of course prefer, where possible, not to be "dispossessed" of their assets by joining a system based on notional pooling. But where a subsidiary belongs to an international group with at least 51% control, we know that it is sometimes, in certain decentralised groups, politically tricky to persuade them to completely relinquish possession of their surplus cash. The treasurer’s role needs to be extremely persuasive in order to avoid wasting funds within the group, even if the problem entities are sometimes not controlled and therefore retain relative independence.

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3.8.5

Choice of location

The choice of location for centralised cash management is not tax neutral. It is a matter of being careful to find a place that best suits the group's natural position.

3.8.6

Set up

When the technical choices have been made, there is the matter of setting up the cash pooling arrangement. Setting it up can take many long months while all the documents and agreements are being signed. The initial stages of cash pooling, particularly internationally, are always tortuous and difficult. You have to break in the machine and oil all the components before everyone involved gets to grips with what is needed. Without being a particularly exotic or complex adventure, cash pooling is still a lengthy and tedious exercise in building a structure and making it run reasonably smoothly.

3.8.7

Choosing the type of cash pooling

The choice between notional type cash pooling and zero balancing cash pooling (and its “target balance” variant) always needs to be evaluated on a case-‐by-‐case basis. It involves a quantified assessment made in advance to work out which formula suits the group best. Sometimes a mixture of various formulae is possible. Fund transfers and their cost can be a handicap compared to notional pooling, which works without moving funds. Even though we are in the SEPA era, we cannot fail to observe that any cross-‐border transfer is still very expensive. By contrast, virtual pooling has the disadvantage of the fees associated with the bank's obligation to hold funds for offsetting the bank balances. This technical reserve increases the costs of the notional system compared to the real system. A comparative calculation therefore becomes necessary. In target balancing and zero balancing, physical transfers from account to account incur costs but also generate inter-‐company loans or borrowings in a single group. These may give rise to tax liabilities or deductions at source on interest payable or receivable. It is also important to bear in mind the problem of transfer pricing and observance of the great tax principle of arm's length when selecting and setting up a pooling system. Generally, major banks dealing with cash management offer solutions tailored to the needs of their customers. Whichever solution is selected, they enable the customer to manage up to several hundred accounts in the one place in which they decide to pool their cash. Current techniques and advances in IT provide simple and real-‐time cash management. Coordinating accounts and using a single bank substantially cut the cost of operating bank accounts. A group opting for this management structure will cut its human resource requirements, both centrally and locally, and will generate significant time savings and productivity gains. Having many persons involved and dispersed

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accounts are always sources of potential error and inefficiency. By contrast, continuing to use local accounts, but pooling them, can make sense because it is easier and faster for the subsidiaries to collect the funds (we might think of LCR whose collection record is often a cause of concern to companies). At the end of the day, the system doesn't matter much, provided that a substantial saving is made. Balancing out accounts, which might be compared to the principle of vessels connected to each other, is a win-‐win situation for everybody. Each party receives more (or pays less) in proportion to its contribution to the process. We should note that there is sometimes a problem about financial culture. In the USA, notional pooling is little known. The Americans don't think it would work. A European treasurer who wants to set up such a structure risks running into a certain amount of resistance from his management on the other side of the Atlantic.

3.8.8

Disadvantages of notional cash pooling

Where a bank enters into a notional pooling contract with a group, it accepts that it will pay the group interest on all its cash, that is to say its net position. It records the credit and debit balances as assets and liabilities in its balance sheet. As the accounting entries represent the bank's assets and liabilities to a single group, we may reflect on how far the group's net position could be used as a basis for supervising the solvency of credit institutions, the well-‐known Cooke/McDonough ratios, even though different legal entities are sometimes involved. Credit institutions are required to adhere to standards laid down by European Directive 89/647/EC on solvency ratios, along with those set out by the Basel Committee formed in 1975 within the Bank for International Settlements (BIS). This ratio requires them to hold minimum equity equal to or greater than 8% of the weighted average of loans that the grant. Banks therefore have to keep a margin in reserve, which implies a cost for the customer.

3.8.9

Multi-‐bank approach

Treasurers should ideally consider finding a multi-‐bank solution. Where a group that needs to borrow and has to use bank finance or even capital markets finance (commercial paper for example), it needs to ensure it is supported by sound and trustworthy partners. This trustworthiness costs and will cost increasingly more in terms of return to be offered to the bank. Banks are increasingly less inclined to act as charitable bodies for corporate customers, even though some still do, and lose money in that specific sector. In an evolving and uncertain market, treasurers need to give their banks a certain volume of business and transactions. This is the primary reason for which, irrespective of financial product, they should always prefer the multiple approaches. Even though it may not be as easy, treasurers would prefer to use several banks rather than just one.

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Some groups with borrowings in the billions of euros cannot survive without a whole syndicate of banks. Profitability for bankers, however, can derive from transactions going through its accounts and the payments made out of them. Some financial institutions have understood this trend very well. Somewhat like e-‐trading portals, where the same funds trend prevails, realistic bankers are facing up to the obvious: customers do not want to give all their business to one bank. For reasons of competition, they prefer to have more than one available. In fact, treasurers very often have no choice; they have to split their business to make everything work well as a whole. Right now, liquidity has become very highly prized and the most critical element in a business' survival. Treasurers therefore seek to maintain and assure liquidity, irrespective of the price. This may involve using several partners. Only a minority has the luxury of having only a single banker concentrating the whole of the group's funds worldwide. American and even some European banks already offer the option of pooling different currencies, in different countries and even in different banks. Clearly this is not a widespread technique, but it would seem to work even though it is not found much in practice. It needs agreements between banks. The customer ends up telling its bankers what it needs, so indirectly it determines the development of the techniques that it wants to have available to it.

3.8.10 Is multi-‐currency cash pooling even possible?

Yes, some banks offer this service to their customers. This would obviously be notional cash pooling, on which the bank would calculate credit and debit interest on the basis of reference rates (EURIBOR, LIBOR, etc.), making no margin. Interest is then (partially) offset. However, because this is notional pooling, the bank will require remuneration for its cost of capital. Sometimes banks also require a minimum margin to be paid. This is still not a perfect or optimal solution, but it has certain benefits for treasurers. Even if the interest rates are different (interest rate differential), treasurers can net off interest payable and receivable more efficiently without resorting to currency swaps for using a surplus in one currency to plug a gap in another.

3.8.11 The future of cash pooling We can easily foresee the European Union wiping out the last legal and tax obstacles to centralised cash management. There will still be divergences or differences here and there, to hinder the process of making procedures uniform within the Eurozone. European expansion and other countries adopting the euro will only increase the benefit of such structures. Technology, too, will contribute to improving the treasurer's job and making it easier. We may hope for a downward harmonisation in the cost of transfers within the European region or at least within the Eurozone (SEPA project). Multi-‐bank and multicurrency solutions already exist, although they may not yet be

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widespread and fully effective in all credit institutions. It is undeniable that progress has been unbroken under pressure from corporate treasurers. There are in fact only a few bankers really able to support their customers in such matters. But these banks are still working on it and will continue to improve the solutions they offer to their customers. It will become ever easier to make payments, the cut-‐off times will be longer and the solutions will transform themselves into multi-‐ bank and multi-‐currency products. Perhaps they will even be able to find a way around natural obstacles such as different time zones. Even though enormous progress has been made over the last few years, we clearly see that there are still many opportunities for development and plenty of room for creativity on the part of banks.

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3.9 Money, a scarce commodity “The lack of money is the root of all evil” (Mark Twain)

3.9.1

Money, a commodity

Since September 2008 money has become a scarce commodity and therefore very expensive. The world of finance has never been so brim full of cash – but cash is still scarce. Indeed, the banks do not want to lend even to each other. Has confidence evaporated? The world of finance has probably entered a new era. Money is a commodity, but is probably the only one that everybody needs. Today, bankers more than anybody else are crying out for it. Money has no smell or color, and is often in an intangible form. It is fungible – interchangeable – even though its value may vary. It is even referred to as “liquid”. Even though it is intangible, it has become scarce, and like all scarce things it has gone up in price. However many words we see fit to call it by – dough, readies, dosh, bread, bucks, spondoolicks or brass – it is still something we cannot get away from, and everyone wants to have it. “Money, too dear; too much, life is beyond price...” sang Téléphone.7 In French, it is known by the name of a precious metal – silver – but it often comes in virtual form as lines on a computer screen, when not in tangible form as a piece of paper.

3.9.2

Liquidity risk

With money scarce and credit harder to come by, the importance of liquid funds is easy to grasp. Without liquid funds, a commercial company would bleed dry and be unable to pay its bills, and then go into receivership. Credit is the lifeblood of commerce. Without credit, business activity would die away. But what protection is there against this risk that has become critical in the last few weeks? All treasury managers must ensure that cash is always available, and that they have liquid funds (in the sense of reserves that are available or could quickly be turned into cash). There are several techniques – which are often combined – for ensuring liquidity and achieving the best financial position for a business. When the risk increases and access to credit becomes really tricky, any method of improving and maintaining the (minimum) necessary liquidity for growth or survival becomes fair. 7 A French 1980s rock band – “Argent, trop cher, trop grand; la vie n’a pas de prix!”… »

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How to protect the company against liquidity risk? Treasury Centralisation Cross-Border-Pooling (“Follow-the-Sun” solutions) Good Cash-Flow Forecasting Working Capital Continuous Improvement Diversification and Calibrating of Sources of Funding Optimisation of Cost of Funding or/and Mitigation of Liquidity Risk

3.9.3

How to ensure liquidity

The simplest thing is to keep funds available in a very liquid form, readily convertible into cash and held at a solid and solvent bank (although that is now sometimes easier said than done). Failing that, you need lines of credit (ideally “confirmed”, in the sense of “committed”). However, it is healthy and advisable to diversify sources of credit. EMTN8, or (E)CP9 programs could be used, or you go onto the capital markets (bonds and convertible bonds), US private placements, etc. In the end, the simplest thing is to try to reduce your working capital requirement and to pool cash at a central location, to reduce the group’s net borrowing position. That obviously means accurate cash flow forecasts. With a suitable cash flow forecast, the business can get a better idea of its position so as to work out its needs and therefore the credit lines or other financing means that it needs to put in place.

3.9.4

Diversifying sources of funding

Good financial practice recommends that sources of financing be diversified. This is all the more true now that liquidity risk has become one of the greatest risks that the treasury manager faces. The Black September and Red October crises of 2008 were a cruel reminder to anyone who had forgotten that. 8 Euro Medium Term 9 Euro Commercial Paper

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Sources de financement

Bank Credit

Capital Markets

Interco

CAPITAL

Equity

Quasi-Equity (subordinated/ Senior Debt) Parent Company Loan Bond / Private placements / EMTN issues ECP Issues* L.T Credit facilities S.T Credit facilities * +ABS programs

NB : Proportion of each possible component depends on each enterprise. Appropriate level to be defined by shareholders to possibly optimize gearing and leverage

It is essential to diversify business sources of funding, to guard against any one of them drying up. Excessive leverage, or under-‐capitalization, can turn out to be a handicap in a credit crunch or times of liquidity shortage. September and October can be seen as a superb demonstration of a stress scenario. Stock markets plummeted, with IPOs and rights issues almost impossible and next to non-‐existent. Capital markets are profoundly affected. Commercial paper has dried up altogether for the meanwhile. Uncommitted credit facilities are completely unreliable and unpredictable in the current environment of wrecked banks. Committed long-‐ and medium-‐term credit facilities are tricky to put in place, and when they are set up some banks may try not to fulfill their obligation in delivering liquidities. “Market Flex” and “market disruption” clauses could be used to get out of lending when margins, counterparty risks or refinancing give the bank a major or vital problem. Who will be the first to dare to invoke “market disruption”?

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The question of the right mix of components making up the means of finance remains very awkward. There is no ideal structure.

Leverage v. Capitalisation Lower Risk

Higher Risk

EQUITY

DEBT DEBT Lower Leverage (lower cost of funding)

Higher Leverage (higher cost of funding)

Conversely, in tense credit crunch times, excessive leverage can be a major disadvantage.

3.9.5

Changing spreads and benchmark rates

The cost of finance has just changed drastically. Today’s benchmark rates are no longer LIBOR or EURIBOR but often the “cost of funding”, a hazy and fluid concept if there ever was one. Onto this cost of funding (protection for the banker and uncertainty for the borrower) must be added the spread. This had already widened before the crisis by at least 50 or 60 basis points. Credit at 4.50% plus a spread of 100 basis points can now reach 6.50% or more, despite current cut of interest reference rate by the European Central Bank. Interest cost therefore becomes huge in a troubled economic and commercial environment. The cost of servicing debt will penalize corporations if interest rates do not come down sharply in the coming months. Moreover, high inflation dampens the enthusiasm of central banks for reducing key rates. The ECB’s economic orthodoxy should rather favor an exceptional flexibility, dictated by even more exceptional circumstances.

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3.9.6

Fantastic Live Scenario

This autumn must have been the worst season for many bankers and treasury managers. September was perhaps a marvelous opportunity to test extreme scenarios worthy of a Grisham novel. If you got through it and refinanced in the turmoil, you can consider that your sources of finance were well enough diversified and on the right scale. Nothing worse can happen now. Every cloud has a silver lining. We have to learn the lessons of this crisis and apply the principles derived from it to liquidity risk management, for being either long or short in terms of cash. We now know that the worst is never a certainty.

3.9.7

Nothing could less certain…

We live in times that none of us living today has experienced before. It seems pointless to me to worry about whether this crisis is worse, the same or less bad than that of 1929. We would not be breaking new ground if we said that it will be a turning point in the story of modern finance. Tiny credit spreads certainly gave rise to toxic financial products with excessive yields that were therefore essentially dangerous. Some criticize the bankers who acted as accomplices in investing in explosive products, others claim that this is the consequence of the subprime lending crisis, yet others blame the credit rating agencies or investment banks. Others condemn regulatory and supervisory bodies for failing in their duties. The more objective maintain that there was a collective failing. It has spread extreme volatility throughout all world financial markets. Will we learn the lessons? Nothing could be less certain. Financiers, particularly bankers, often fall back (sooner or later) into their bad old ways. They may have got their fingers burnt, but not so badly burnt that they will not fall for the same old things again. They insist on blundering off the rails time and again, in spite of all the warnings.

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3.10 "Industrialising" your payments: a luxury or necessity? “If we don’t succeed, we run the risk of failure” (Dan Quayle)

3.10.1 Costs and compliance

Why step up from the craft workshop stage for payments to the higher "industrial" level? Setting up a "payment factory" is no longer just a fashion statement or a luxury reserved for the biggest companies. Speeding up cash flow and ensuring payments are secure has become a duty in the world of SEPA with its XML format. We want to describe how you can reduce banking costs while at the same time complying better with the new regulations on internal controls. Most international groups are at the craft workshop stage in terms of payments and financial transfers. Of course SEPA, a project as wondrous as it is ambitious, is seeing delays in final implementation. There are some delays in bringing in and launching the "Direct Debits" and "Credit Cards", the two further sections of SEPA. As always, technological and technical revolutions do not please everybody. The various people involved on the ground, motivated by various contradictory objectives, have tended to put a brake on the process rather than speeding it up. However, from now on treasury managers must be proactive and be prepared for a world in "SEPA colour", which will soon make their surroundings look different. More than ever, this is a time of drastic cost-‐cutting. Why not have a go at banking costs? Why put up with fragmentation of bank accounts and being unable to control banking costs and charges? The treasury manager often pores over spreads, credit or interest rate spreads, and neglects costs that may be insidious, small and scattered, but which if consolidated would present a real opportunity for streamlining financial management. Furthermore new measures, deriving from the transposition of the European 8th Directive on internal controls, give us a second wonderful reason to launch such a project of a "payment factory".

3.10.2 Industrialising payments

By mechanising payments through a Swiftnet connection (for files on "Fin" and/or on "FileAct" format) we move to a single industry communication channel that can be used throughout Europe (and not just E.U. either).

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Anticipating the move to the future XML ISO 20022 European standard format offers the advantage of enabling us to set up today the structure that will be required in the medium term. Besides, you have to equip yourself with a computer application (e.g. DATALOG) for converting local formats (if the subsidiary keeps its own local format) to SEPA format and/or to communicate with subsidiaries (uploading extracts and transferring payments). Ideally these payments would be made in the ERP itself or in a payment factory application. The aim therefore is to standardise the format used, to use a single channel for cash inflows and outflows (bank extracts – payments/wire transfers) and to automate the processes by interfacing the IT application with the ERP (or the accounting system). The aim is also to make (in – out) transfers more secure and to become more independent of the banks. We often have to rely on several E.B.S’s (Electronic Banking Systems) and the service provided by banks locally. With a payment factory, the payment process can be made more professional from an earlier stage and can be standardised at the level of the method of payment. Industrialisation will come from an end to the fragmentation of existing systems and from the option of interfacing a more appropriate non-‐bank IT application with the central ERP.

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3.10.3 Cost-‐return of a payment factory How much would such a project cost? That depends on the extent of the rollout, the applications used, the level of integration and interfacing as well as the formats adopted. The costs depend upon a number of factors: the IT application, for converting files and encrypting data; the Swiftnet application; the “service bureau” (if you use one for outsourcing this service) and the consultancy fees at various levels (in-‐house or external). On an annual basis, the cost will boil down to maintenance of the application (+/-‐ 20% of the licence fee); the Swift messaging costs (per message) and the “service bureau”. Conversely, to sell the project in-‐house, incorporating a qualitative element into the Return on Investment (ROI) calculation would seem unavoidable. This is absolutely necessary to demonstrate that the project is overall neutral. Of course, depending on the country, you can make greater or lesser savings (e.g. in France and Spain the savings are potentially higher than in Germany or Belgium). However, whether or not Group Treasury (GT) re-‐invoices its subsidiaries to offset the payment factory setup costs, the

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savings will not be enough to justify the investment. By incorporating the "internal controls" aspect, the significant increase in security through encrypting sensitive data, the ERP interface and the reduction in operational risks, the project takes on a whole new dimension. Under the national transpositions of the European 8th Directive (e.g. BilMog in Germany, the AMF report in France), this aspect of strengthening internal controls comes to the fore and provides great grounds for selling the project to group finance department. In moving to the XML format and to Swiftnet, the group will be taking a giant stride towards simplifying and standardising internal payment processes. Generally, there is one EBS per country (and even sometimes more than one). Eventually, there would be only one for all payment types (FileAct + Fin).

3.10.4 Advantages

A payment factory project could have enormous advantages:

This list is not exhaustive and shows us the extent to which the qualitative aspect is a core one, or even the main aspect of the project. It is clear that complete control and visibility over the management of bank accounts is a major strength, even without going as far as "paying on behalf of". Treasury management can then become extremely centralised.

3.10.5 Payment factory, part of the financial IT strategy

As with an industrial revolution, such a project will take time to roll out fully. Certainly, it has a high initial cost. However, given the qualitative and quantitative benefits, it will easily pay for itself in a period of three years (maximum). It must form part of group IT strategy. GT must call the tune and preach the good word to its subsidiaries. It provides

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enormous opportunities for reviewing procedures, processes and organisational structure, particularly bank inflows and payments. For example, it is the means for reviewing the process of selecting banks from a technical standpoint. This aspect may further be incorporated into the "Bank Balanced Score Card" (BBSC) as a selection criterion. Unfortunately, once adopted there is no going back. It's like the well-‐known advertising slogan "If you try it, you're hooked".

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3.11 Red 7 … the winning number for Money Market Funds? “After a day’s walk everything has twice its usual value” (G. M. Trevelyan)

3.11.1 Accounting issues

The accounting issues encountered by many treasurers when they invest in Money Market Funds (MMF) are often mentioned. IMMFA (Institutional Money Market Funds Association) has recently issued two interesting policy papers about the international standards IAS 7 and IFRS 7. These documents were aimed at providing guidance for fund users. The accounting issues related to investments in treasury-‐style money market funds, such as those offered by members of IMMFA (Institutional Money Market Funds Association – www.immfa.org), are two-‐fold: (1) The classification as “cash & cash equivalents” in order to be deductible from gross debt or to increase the company’s net cash flow, and (2) More recently, the methodology used and reported in IFRS for Fair Value Measurement. IMMFA’s aim was to explain how to account for these short-‐term investments and to facilitate the work of users with their external auditors (www.iasb.org). These elements also need to be put into perspective with IMMFA’s revised Code of Practice, as well as several other similar initiatives aimed at redefining better the criteria of MMF’s treasury-‐style (e.g. CESR – Committee of European Securities Regulators – published in May 2010 and effective in July 2011, cfr. www.cesr-‐eu.org)

3.11.2 Qualification as “Cash & Cash Equivalent”(*)

IMMFA has issued a document intended to provide investors in its own Money Market Funds with further guidance on the treatment of investments under IAS 7 statement of cash-‐flows (effective since July 1994). There are just recommendations that need to be confirmed by external auditors and to comply with internal accounting policies of the concerned reporting entities. The purpose of this standard (IAS 7 para. 6) is to give information to users on the ability to generate cash and the utilization of this cash, as well as the net liquidity position. The tenor of the investments is a key element to assess the highly liquid character of a placement. These days, after the financial crisis, this classification is not neutral for companies having a large indebtedness and highly leveraged.

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The standard gives a definition and sets out the four main criteria to be met for such a classification. 1. Short-‐Term 2. Highly liquid 3. Readily convertible to known amounts of cash 4. Subject to insignificant risk of changes in value This analysis is determined on a case-‐by-‐case basis, each quarter. It consumes lot of time of treasurers and does not bring any added-‐value. IFRIC (International Financial Reporting Interpretation Committee) received a request in December 2008 for providing with guidance on this definition of “cash equivalents”. It answered in March 2009 that “MMF which operate under a specific regulatory regime (such as rule 2a-‐7 of investment act 1940 in the US) should meet the definition of cash equivalents”10. It also later stated that “existing criteria within IAS 7 were sufficiently clear”. It is not because an investment can be converted to cash at any time that it is automatically cash equivalent. The amount of cash to be received must be known at the time of the investment. The last criterion on the change in value is also very important for this analysis. Ideally, what IMMFA and treasurers would recommend is the automatic classification of their MMF’s into “cash equivalents” without having to demonstrate these criteria are met. Being IMMFA funds should a sufficient proof that these criteria are fully met. They wanted to give some guidance on this de facto accounting treatment. Furthermore, this determination should be feasible from the terms and conditions of the instruments and without having to look though the whole underlying assets. At least, it gave us an idea of IFRIC thinking and gives elements for discussions with external auditors on this classification.

3.11.3 How to demonstrate criteria are met?

If you have invested in IMMFA triple-‐A funds, the criteria should be met. They are “convertible at all times” (1) as requested in fund’s prospectus and IMMFA code of practice. Their MMF’s provide same day liquidity, enabling an investor to access his cash 10 …”units that don’t have a maturity date, but that are readily convertible into an amount of cash that is known at inception are subject to an insignificant risk of future change in value. They thus meet the critical criteria in IAS 7 and can be considered ‘in substance’ cash equivalents in accordance with paragraph 7 of IAS 7…”

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on the day of his request (if sent before cut-‐off times of course). But it is also invested into “a known amount of cash” (2) as required (again) in the prospectus and code of practice. IMMFA funds provide Constant Net Asset Value (CNAV) allowing ascertaining the value of his investment at all times (3). On the limited change in value, the criterion is met because of the short term nature of the investments and the high quality of underlying assets (4). However, IMMFA has stringent criteria that help (e.g. triple-‐A rating imposing high quality of assets; 5% minimum of assets available on Over/Night basis and 20% within five days; WAM – Weighted Average Maturity of not more than 60 days as requested by CESR, rating agencies and IMMFA code; WAFinalM of not more than 120 days; escalation procedure to monitor variances between amortised cost and mark-‐to-‐market value of assets (material variance commences at 10 basis points). All the criteria demonstrate that the propensity for IMMFA funds to deteriorate in value is therefore extremely limited. Eventually, with restricted WAM, the short term of three months or less from date of acquisition is respected too. As consequence of these listed elements, an IMMFA fund must be considered as “cash equivalent” under IAS 7. In addition, we should keep in mind that IMMFA funds must comply with other stringent criteria such as UCITS Directive, rating agencies own constraints and the newly reviewed Code of Practice of IMMFA. The combination of these criteria impacts underlying assets invested. They must be of a minimum credit quality of A1/P1/F1; minimum 20% in securities maturing within five business days and a final maturity of government debt of 397 days.

3.11.4 IFRS 7 disclosures issue

The IFRS 7 imposes certain disclosure requirements in relation to the financial instruments held by the preparers. In March 2009, IFRS has amended its standard to enhance disclosures about the Fair Value Measurement (FVM) and also liquidity risks. Each preparer must classify FVM under a hierarchy which is based upon the significance of the inputs used in making measurement. It is the well-‐known new IFRS 3-‐level hierarchy pyramid for fair valuation, which was highly debated and commented last year.

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3-Level Fair Value Hierarchy Disclosure on FV Measurement

Quoted prices for similar instruments

Level 1

Level 2

Directly observable market inputs other than level 1. inputs

Level 3

Inputs not based on observable market data.

(IFRS 7-27A-27B)

The level within which the FVM is classified must be based upon the lowest level of input used for instrument’s valuation. However, when we look at MMF investments, they should be considered as an investment in equity. The investor is of course not directly investing into the underlying assets. Therefore, it seems obvious and not necessary to look through to the underlying assets within the portfolio of the MMF. It is also consistent with FAS 157 standard. Funds are themselves audited and triply rated by the major agencies. If the sponsors of a MMF are IMMFA members, for example, they have already met stringent classification requirements. Why considering this as self-‐ explanatory?

3.11.5 Criteria for first level of the fair value pyramid

The MMF must be quoted in an “active market”. The prices are regularly available to investors. The NAV (Net Asset Value) is declared and published on a daily basis. These prices represent actual and regularly occurring transactions at arm’s length. The NAV represents the price at which a subscription but also redemption occurs. They have access to their investments on a same-‐day basis. They are eventually measured at an unadjusted price the reporting date. The NAV’s are calculated on a daily basis. They are

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no unobservable data which could impact FVM of a share in a MMF. It seems sufficient to demonstrate the FVM of a share in a MMF should be recorded under level 1 of the hierarchy proposed by IASB.

3.11.6 Interpretation from IFRIC needed

In the absence of more precise information from IASB and IFRIC (International Financial Reporting Interpretation Committee) about the qualifying criteria for IAS 7, the IMMFA document (which we should be supported and discriminated by all of the treasurers’ associations in Europe and by European Association of Corporate Treasurers -‐ EACT) takes on its full meaning and usefulness. It will help convince auditors that IMMFA-‐type funds should be treated for accounting purposes as “cash equivalents” (which seems obvious). IMMFA has not skimped on its efforts and work in the past few months in arguing for greater transparency, quality and security, particularly through its Code of Practice, which is a high-‐quality document. We obviously support IMMFA’s proposal to classify its members’ money market funds as Level 1 for fair value measurements, according to the three-‐level methodology and hierarchy established by IASB in IFRS 7. 27A-‐27B. These efforts at clarification have also demonstrated the desire to better position “pure” (treasury-‐style) Money Market Funds. It should be remembered that some companies were surprised to see the value of their assets drop, when they thought they were investing in “pure” Money Market Funds, as they were investing in dynamic or enhanced monetary funds. It might be advisable to adopt a “controlled appellation” system like the French AOC for wines, cheeses and other farm products, in order to protect investors from the wrongful or deceptive use of MMF terminology. We definitely think so. To see a positive side to this financial crisis, we should accept the idea that it has enabled us to enhance information and protection of all investors, including corporate ones. This greater transparency and reliability of information disclosed were required by the London G20, couple of years ago, in order to better inform end-‐users. These recent initiatives from IMMFA are, in our opinion, excellent means to give their funds a real quality stamp. However, we know that some other MMF’s can also fulfil these guidelines or equivalent one’s (e.g. CESR). Therefore, they could apply for a similar accounting treatment under IFRS.

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3.12 Security is beyond price, but perhaps times have changed. “Finance is the art of passing currency from hand to hand until it finally disappears” (Robert W. Samoff)

3.12.1 Priority given to counterparty security.

Over the last five years, corporate treasurers have (re)-‐discovered a forgotten and theoretical risk, that of possible default by their bank counterparty. Clearly, for negotiating financial instruments the risk of non-‐delivery is small, and the possibility exists of recovering deposited collateral. For cash deposits, on the other hand, there is indeed a real risk of losing the whole amount. Treasurers have therefore become extremely cautious when investing their cash – and these cash surpluses, by the way, have kept on accumulating. This is paradoxical. While counterparty risk was rising and interest rates were falling, the amounts being invested were growing. Fearing uncertainty and because of future needs, treasurers have preferred short-‐term investment (a maximum of 3 months to fulfil the IAS 7 – "Cash and Cash Equivalents" conditions). Moreover, short-‐term investing is a way of mitigating default risk. Another strategy involved investing in money market funds, particularly ones with a high credit rating ("AAA") so as to subcontract the management and achieve greater diversity. This strategy worked well especially in an environment of falling interest rates, which gave returns of EONIA plus XX basis points. Unfortunately, rates ended up hitting the floor and returns became ever slimmer, finally becoming nil or negative. The plan was to preserve the principal, even at the expense of return. Unfortunately there is no longer any room for sophistication. Stay "short" and stick with low risk. However, today this security has a cost. It is this cost that presents a problem for many treasurers.

3.12.2 Security has a price, but not just any price

Security now has a price: no return or even a negative return, the last straw for treasurers with cash surpluses. How strange it is to have to pay to invest your funds. And perhaps… In the short-‐term we may end up booking an interest charge on a bank investment. Unbelievable, isn't it? IMMFA "AAA" rated funds are closed to new investment, victims of their "Constant NAV" approach. We can readily imagine that, if the low interest rates situation persists (and we have to fear that it will), these same IMMFA funds may possibly even have to

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repay their investor clients. The economic situation is such that it is not impossible to envisage this. So you are asking me what we should do. The real challenge lies in reviewing investment strategies and revisiting policies to adapt them to one of the most exceptional economic climates ever. The alternatives are merely theoretical unless we accept that certain principles have to be reviewed.

3.12.3 Possible alternative strategies

Many companies have made use of "share buyback" operations or have distributed large dividends. However, for the remainder of their cash surpluses, they have to adopt mixed and varied strategies. By combining different products, they can increase their returns while keeping risks reasonable and still achieving an investment duration that is certainly longer but still acceptable. The solution therefore consists of maximising return by using a variety of solutions to offset a yield curve that is rather flat and close to rock bottom. There is no perfect solution. The first concession you should allow yourself is that of not qualifying as a cash equivalent under IAS 7. You need to be able to use investments of greater than 3 months, which do not count as cash equivalents. The average investment term should then improve the portfolio's overall return. By fragmenting deposits and investing them with different institutions, we can reduce risk and achieve a better spread over time. Time and the length of the investment period are the key factors to be considered. Sometimes short-‐term rates (<3 months) are such that we have to invest for much longer periods to try to obtain a reasonable rate. Here, the choice of counterparty will be important. In the same line of thinking, some banks offer loyalty products of various types: for example deposit accounts for savings or "notice accounts". These give a better return in exchange for a minimum notice period of between 30 and 35 days. These accounts have restrictions on the maximum deposit that the bank will accept. They can form part of the gamut of alternative techniques used to offset low interest rate levels. The solution certainly involves a combination of different products.

3.12.4 Nothing or less than nothing?

Interest rates are so low that they have become negative. Is your ordinary customer ready to pay up to 15 bps to have someone deign to take care of its funds? Plenty of treasurers will tell you "no way, in your dreams, pal"! This is a lose-‐lose situation. We have to accept extending to the medium term to start to obtain any small return at all. "Thank you kindly, good sir!” the treasurers reply to their bankers. We have to accept actively managed multi-‐product funds. Usually, their volatility percentage corresponds to the return above the reference interest rate. For example, a fund of this type with a volatility of 2% might give a return of around 2% – that is the general rule. The price to be paid is a small amount of volatility in the principal in the short-‐term, and patience in

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the medium term. Forearmed with patience, treasurers can go some way towards boosting their return. But none of it is simple, and most certainly everything has a cost.

3.12.5 The paradox of the thrifty squirrel

What is even more paradoxical is that companies are still shedding debt and hoarding cash in spite of the (more) difficult economic situation. The economic situation leads to caution, and nobody dares to reinvest for fear of overpaying for assets in an uncertain and depressed economic environment. They build up cash at a time when it would be better to spend it shrewdly on operational activities, which have a higher potential return. There are opportunities to be grasped but also over-‐cautiousness, as if winter was going to be long and very harsh, which is unjustified. Should realising how difficult it is to manage cash surpluses not give us an extra incentive to invest? Winter will certainly come to an end one day. Of course, we might experience a situation like the Japanese one that has lasted for many a long year (22 years already!). There has been a rejection of debt with leveraging effect, as if it were shameful and financial madness to take on debt in a reasonable way. In these times of economic turmoil, financiers can sometimes become irrational and forget the first principles of modern finance. Fear is sometimes the explanation of rather illogical behaviour.

3.12.6 “Money for Nothing” (Dire Straits)

Finally, happy treasurers are treasurers with borrowings. What a blessing it is to have debt when money is so cheap! The not so absurd idea of treasurers lending each other money may resurface. Which is the more risky at an equivalent credit rating: a European bank or a corporate? With the high risk of a bank run, thinking of Shell recently or Siemens in 2011, the future of some European institutions is fragile and precarious. Governments are struggling with their own borrowings and cannot endlessly support an industry mired in crisis. With low or negative growth rates, we may fear that governments will have other fish to fry. Ruling out a bank failure would seem to me to be foolhardy. Nobody looked to see Greece leaving the euro, but nevertheless… We need to be cautious and we need to tread carefully before changing our investment strategies. But there are also other options to be considered for diversifying risk or maximising borrowings.

3.12.7 Step off the beaten path

An interesting option that we have suggested on a number of occasions consists of utilising your cash as collateral to cut the cost of hedging, particularly foreign exchange hedging, in the medium term. Indeed, beyond one year, the cost of counterparty credit on a forward foreign-‐exchange contract is such that using collateral can prove to be a worthwhile means of investing funds to make a significant reduction in the cost of hedging. This is a positive way of taking action on the bottom line.

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Some banks offer structuring ideas to optimise your tax situation and reduce your tax expense or to boost investment returns. The idea is often the simple one of maximising the interest rate differential between two countries in which you operate. There is also what is referred to as "dynamic" funds which have longer investment horizons, higher risk concentrations or underlying assets with lower credit ratings. Here again, treasurers can invest a reasonable amount to seek a return which, at the end of the day, will improve the portfolio's overall return.

3.12.8 "Money, Money, Money… in a rich man’s world" (ABBA)

At a time when handing money over to our bank, maybe one with a pretty poor credit rating, costs us money, surely we should ask what alternatives the market is offering us? The background of interest rates which are going to stay low for quite some time and the economic situation, particularly in the finance industry, force us to react. In absolute terms, returns will remain low even though they may become better and positive. Conversely, in relative terms, the performance thus achieved will be much more attractive in a context of interest rates calculated on basis points. Today, we do not talk about percentages or fractions of a per cent, we have to talk about basis points, and the fingers of one hand are often enough to count those. The misfortunes of cash rich companies are offset by the good fortune of borrowers for whom the resource of money is abundant and almost given away free. Some companies are taking advantage of this to fix rates for the very long term and to provide finance for the future on good terms. The solutions are many and varied; provided you concede that you need to make some modifications to your investment policy, to take a certain minimum risk that is contained and controllable and to diversify your portfolio. Miracles can never happen in investment. However, a little bit of opportunism together with a little bit of boldness and change can improve your overall return. Value creation, obviously, is impossible. But when it comes to destroying value by hoarding cash which ends up costing dearly, it is best to try to destroy as little as possible. It is a fair bet that we are going to live through many long months of dearth and rock bottom, zero or even negative interest rates. The work of treasurers will consist of limiting loss in this period of recession. We will end up almost regretting that the periods of inflation and higher interest rates are gone. This is one of the challenges that await treasurers in 2013. They will have to modify their investment strategies in any way they can to face up to this particularly tricky and difficult economic environment.

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3.13 Response of Corporate Treasurers to the “Sub-‐ Primes” crisis “Worry often gives a small thing a big shadow” (Swedish Proverb)

3.13.1 Are MMFs real conservative cash investments? Last couples of years, Money Market Funds (MMF) have operated a quiet revolution. They are more and more used by Treasurers as an attractive alternative to classical bank deposits. But the recent “sub-‐prime” crisis has generated a sort of financial tsunami. Rating agencies have been criticized and banks have significantly suffered. Are MMFs really conservative cash investments? What are the reactions of treasurers, consequences on markets as well as lessons learnt? This is a real question that some European treasurers have raised last months. The sub-‐ prime housing market crisis has inevitably resulted in higher degrees of volatility and greater downside returns than corporate treasurers may normally have expected from a MMF investment. The first question is the definition of MMFs. Treasurers could doubt “MMF” is appropriate acronym for some short-‐term funds. There are 2 types of monetary vehicles: the “Treasury-‐style MMFs” and the “Investment-‐style MMFs”. Both have different types of target risk return profiles and use different instruments. We should accept a better naming convention because it could create confusion driving to potential misunderstanding and a mismatch between corporate-‐investors’ expectations and funds risk profile.

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Treasury-Style MMF*

► ◄

 AAA-Rated (Aaa/MR1+)  Stable Net Asset (NAV)**  Low return (close to EONIA if EUR)

 Underlying diversified will low volatility (>A-1/P-1 and position <5% of total)  Time horizon < 3 months  High liquidity requirements, low risk tolerance  Designed for “primary liquidities” (S.T. with preservation of capital and daily liquidity)

Investment-Style MMF

 No necessity rated  Less stake net asset value (more volatile)  Potentially higher return (few BPs over EONIA), but also return could be < EONIA  Underlying diversified in types possibly including large dated ABS or Collateralized Debt Obligations (CDOs)  Time horizon < 12 months  Lower liquidity requirements, higher risk tolerance  Designed for “secondary liquidities” (=dynamic funds or enhanced yields funds)***

* In the USA, MMF are regulated by SEC rule 2007 imposing strict rules for qualifying. In Europe, there is no overarching regulation so far although funds are compliant with UCITS III legislation. ** IMMFA (Institutional MMF Association) has a voluntary Code of Practice in place to ensure standards *** More popular in Europe and in France

The security has a price: a potential lower return. During such a crisis, the “pure” MMFs have been less affected and returns were more stable.

3.13.2 MMFs have come of age…

The last couple of years, the European liquidity cash management has gradually operated a revolution. Treasurers use more and more MMFs as an alternative to traditional bank deposits. Given better cash situation of numerous European corporations since 2002, the amounts invested in MMFs have grown over years. Abundance of liquidities, over-‐prudence on M&A operations and low interest rates have also explained this growth.

3.13.3 Surviving the markets

Although financial “lifeguards” were scanning the economic horizon for oil shock (USD 96 per barrel in November 2007), terrorist attacks on civil wars in emerging countries, it eventually came from inside the financial system. The money market shores have been unlikely swamped. The bank lending market has been hit. There were frantic financial innovations like securitization of every form of debt into tradable assets. Were risks

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better spread or does it leave markets with potential seismic failures? The risks have certainly not been spread as thought. The US mortgage market and its obvious excesses have impacted every market (e.g. hedge funds, private equity firms, MMFs, stock exchanges and banks). Banks have stopped trusting each other. If money is drying up, it could even damage good companies, directly or indirectly, as well as healthy parts of the world economy. The spreading panic demonstrated weaknesses of our modern finance system and what globalization may mean. The risk of default transfer to someone else is easy, but it could then generate risks. Who could pretend all losses have been booked on sub-‐primes? The losses announced by Citigroup, Merrill Lynch, UBS, Deutsche Bank and some other majors were scarring.

3.13.4 Absence of sufficient transparency

The crisis obviously demonstrated that some markets still lack from transparency. Fortunately, investors will learn from their patent mistake. The so-‐called “spaghetti plate” risk, implying everybody is interconnected and exposed to other’s risks became real. The Central Banks have reacted several times to show it was not a solvency crisis but rather a liquidity one. Both, banks and funds have now to disclose expenses to tend to restoring market faith. The volatility of markets could easily stop some credits. Even if main “victims” are located in the USA (e.g. New Century, Legg Mason, some US banks), Europe also counts few victims (e.g. Northern Rock, IKB, Sachsen LB). The size of the crisis was relatively limited but indirect impacts, like a financial tsunami, hit Europe. Banks and investors were alerted about risks? But as rating agencies only started to downgrade mortgage-‐backed securities in late spring, the crisis beginning was delayed to summer. We have to admit that it is not the first time that the agencies are criticized and accused of being asleep on watch. Then, we all know what happened. Two funds run by Bear Sterns collapsed. The volatility increased, spreads became widen and fears of further (bigger) losses arise. BNPParibas and Oddo suspended respectively 3 and 2 funds. According to Murphy’s Law, the crisis was exacerbated by thin liquidity due to August usual slowdown. The Federal Reserve and European Central Banks injected several times a lot of money on market, for the first time since 9/11.

3.13.5 Main consequences and lessons learnt

1. We can suspect of tougher distinction between “investment grade” and “non-‐ investment grade”, as well as pressure on spreads and higher cost for underwritten transactions 2. Lots of treasurers in Europe seem to have decided to temporarily exit form “dynamic” funds to concentrate on “pure” MMF (i.e. Treasury-‐style funds) 218

3. The treasurers fly now to quality. In France, among other countries, they realized the dangers of dynamic fund management. They seem to prefer to concentrate on lower return (around EONIA) but without risk of altering interest incomes, even if it was more a loss of opportunity rather than a realized loss. The objective is to preserve principal at least 4. Fortunately, IAS 7 had forced treasurers to prefer short term funds to quality as “cash and cash equivalent”. They were therefore less impacted 5. Some treasurers prefer now to directly invest and place many directly to borrowers or issuers. However, the (E)CP market was deeply affected 6. The classical “old” bank deposits are still useful 7. Diversification is one key to spread the risks. By investing smaller portions in different funds, treasurers have reduced concentration risks 8. They search for more information and spend more time to discuss with fund managers. They want a clearer view on risk underlying. They also look for benchmark and sensitivity testing to estimate potential risks 9. Treasurers are back to golden rules of cash management and forecasting, especially useful during a financial storm 10. Summertime was an opportunity to revisit internal policies (M&A, asset management, bank relationship). They are never enough protected

3.13.6 Credit Rating Agencies (CRA) People are convinced CRAs, could have acted with more rigor, although they are not the sole “black sheep”. Furthermore, with a more competitive environment, CRAs will be more cautious. Their dominant position was again criticized by EU and SEC. The 3 major agencies represent 95% of the market. They are no real alternative. After ENRON, they pretended not being responsible as ratings were only “opinions” constitutionally protected as a “free speech”. We guess it will be more difficult to defend this time. Issuers pay for a rating which would only be a “free speech”… Furthermore, there is a conflict of interest as you cannot imagine the “Michelin guide” giving stars to restaurants after having being paid by the restaurateurs. We thing an independent governmental body should pay for ratings or those requiring ratings. As often addressed, the issue is who will measure the “measurers”? Operations

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are more and more complex. They need highly qualified staff. But they struggle to retain them because investment banks pay higher salaries. Based on political pressures and possible lawsuits, we could expect new rules from regulators to better define framework and principles applied.

3.13.7 Cost of funding issue

Hopefully corporations were repairing the roof when sun was still shining. But there is a contagion risk and we should not exclude a credit crunch and more complicated access to bank credit. It will become more complex for low-‐rated companies to raise funds at decent price. The nice spreads of last years are certainly over. The back-‐up facilities have demonstrated their real purpose and use in credit market meltdown. The rating fees could also become more expensive in future as were making a huge portion of the revenue on structured products. This could soon change. The other perverse effect of the crisis is that everybody is suspicious about everyone else, especially bankers. The role of associations like IMMFA will be important to help “purifying” the MMF market. We could also notice that equity could become an acquisition currency again. Good treasurers need to have sufficient committed back-‐up lines in place before winter storms. Even if corporate were hit, banks were more impacted and booked bigger losses. But a positive effect can be found in possible lower multiples used for pricing M&A transactions. As lots of venture capitalists will face financing problems, we can imagine fairer prices for acquisitions.

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3.14 An X-‐Ray of Money Market Fund Risks “Ability is of little account without opportunity” (Napoléon Bonaparte)

3.14.1 Reducing the inherent risks in money market funds When investing his surplus liquidity, the main objective sought by a corporate treasurer is to guarantee recovery of the principal sum – unfortunately no simple matter in the current market. A treasurer will have seen the limits of rating agencies. A triple “A” rating is an “extra” guarantee, but not enough for an investor. The guidelines set by the French market regulator “AMF” also seem insufficient to provide assurance about the quality of an investment. This problem does not therefore come down solely to the Anglo-‐Saxon classification “Treasury-‐Style Money Market Funds (MMF)” versus “Investment Style MMF”. The idea behind the analysis conducted with the help of Alternative Advisers was to assess the inherent risk in each of a client’s portfolio funds, thus going beyond the simple analysis of accounting treatment alone, by relying on multi-‐factor analyses. Risks linked to a money market fund A money market fund is exposed to two types of risk: the interest rate risk, which can fluctuate to a limited (but real) extent, and the counterparty risks which – during a period of crisis such as the situation during autumn 2008 – can become enormous. We believe it would be helpful to study this second risk type as even if a rating agency specifically targets the credit risk, the score awarded does not prevent the inherent risk for the MMF. Fund pooling reduces the impact in the event that the risk arises, but rather than eliminating it, it conversely increases it. Investing in a fund means “outsourcing” its management to an independent professional (subcontractor) and diversifying the risks in order to reduce the potential impact. This method can thus be a helpful decision-‐making tool to complement the process of selecting a monetary fund. The analysis can be conducted regularly, on a random basis, to “scan” the investment portfolio. The consultant offers to provide global “top-‐down” classification reports on the MMF, in terms of risk quality. In the current economic climate and taking into account the prevailing volatility, such a tool could help support a company’s short-‐term investment policy. After all, you can never be too careful when it comes to entrusting your money to others. X-‐Ray on MMF The current financial crisis has affected every sector of the financial management industry. In most cases, however, the movements in financial assets, although extreme, correspond to market shocks which have already happened before (even if we have to go quite far back in time). Traditional methods of risk measurement (analysed in a mean-‐variance context, for example) could have been used to discover and classify the risks in advance. The greater the risks taken ex-‐ante (emerging shares, high-‐yield debt),

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the more painful the consequences are today. Whatever the case, we can now see that we are currently experiencing a “reality check”, which takes the form of a bursting of bubbles. In contrast to the risk ladder, other private and institutional players seeking a risk-‐free investment have put their money into money market funds. Yet (and here lies the rub), the financial crisis has also affected the performance of some of these MMF, while the traditional risk measurement methods did not enable the advance detection of a possible reduction in their value. Consultation of the majority ratings and even the use of official classifications did not provide the sought-‐after security either! Indeed, we have recently witnessed considerable falls (largely beyond the materiality level) in the fair values of certain MMF, even though they were classified as “Monetary Euro UCITS” and given 5-‐star ratings by “Morning Star”. The explanation for this fall can be found simply in the contents of the portfolio and sometimes in the default on payment of one of its underlying securities. It is clearly time to face the fact that the rating and classification of MMFs market funds is no longer enough to give an investor the prior objective security which he might expect. Moreover, even the name “money market fund” is sometimes used wrongly. This is why some professional associations recommend using proper segmentation of the range of money market products, by clearly differentiating between pure, “very short-‐term money market funds”, i.e. “treasury-‐style” funds. And those with a longer time span, investment-‐style” funds. Indeed, being considered “cash & cash equivalent” in the sense of IAS 7 is now necessary, but not sufficient. Meanwhile, because the information about how the fund portfolios are made up is not always available and analysing them is no simple matter, a solution must be found in order to make these investments secure. Reliance on multi-‐factor analyses provides us with a few solutions. Multi-‐factor models offer a better understanding of the risks. They are useful in: Understanding the sources of performance, Attributing the risks of a given strategy to different factors, Systematically predicting calculations about performance, volatility and correlation, Identifying the value created by the fund manager, and determining its alpha.

They are determined by the following equation: These models are used most frequently in hedge fund analysis, to simplify the understanding of the risks involved in such investments and the factors behind their performance. They are especially necessary here because the breakdown of the portfolios is not generally known. However, even if the details are known, a treasurer cannot necessarily validate their quality. Applying these models to an analysis of MMFs

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should give us an answer to our problem. To do this, we must first identify the risks to which money market funds are exposed. The second stage is then to identify the explanatory factors behind each of these risks. The method involves “X-‐raying” the EONIA (the traditional benchmark for “pure” money market funds in the Eurozone) risk factors and comparing them with those of the funds analysed. Scope of the study To conduct our study successfully, we selected twelve “pure” monetary UCITs which included funds governed by the laws of Luxembourg, France and English-‐speaking countries, with stable or combined daily NAV. Each of these money market funds is classified as a regular treasury-‐style fund or “fonds monétaire euro”, and its investment strategy is to achieve regular daily performance in relation to its reference index, the EONIA. Also, at the time of the study, each fund had a rating of Aaa, MR1, MR1+ or 5-‐ star Morningstar rating. The study was conducted between 2 January 2008 and 30 September 2008. The risks of money market funds: There are potentially two types of risk to which money market funds expose themselves in order to meet their management targets: interest rate risk and credit risk. The explanatory factors used to measure interest rate risk are the following indices: the 1 week EONIA swap, the short-‐term rate spread, the 1-‐3 year EuroMTS and the inflation-‐ linked EuroMTS. The explanatory factors used to measure the credit risk are the following indices: the Barclays Euro-‐Aggregate AAA, AA, A, Baa, Corporate, Finance and Euro High Yield, and the 3-‐5 year EuroMTS Covered Bond Aggregate and New EU Government Bond Aggregate.

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3.14.2 Methodology and results First, we applied the multi-‐factor model for the benchmark, in this case the EONIA, to measure both the interest rate risk and the credit risk. For each of these risks, we obtained an X-‐ray or map of the risk factors, which can be compared to that of the MMF at any given moment. For the rate risk, on 30 September 2008, only one-‐third of the MMF analysed demonstrated an almost non-‐existent rate risk, while half showed a risk which we could describe as slight. Finally, two money market funds presented a marked interest rate risk. In actual fact, they turned out to be the least valid funds... and the best-‐performing ones! In terms of credit risk, half of the funds analysed presented no such risk on that date, while five of them revealed certain trends in relation to the EONIA and a strong risk. Lastly, we conducted a final study consisting of a dynamic analysis of three funds in order to test the model’s forecasting ability and the persistence of the risk factors. To do this, we selected a fund which had suffered a credit incident in September, and another which showed no particular risk on 30 September, and a third which had successfully passed the first two tests. We then measured the credit risk factors from the EONIA, which we compared to each of the funds at the start of each month (i.e. 9 comparisons), from the start of January to the start of September 2008. For the first fund, we noted that most of the measurements revealed high risks during the month before the fall in market value. In other words, the incident, in this case, was foreseeable. In the case of the second fund, we noted that in seven cases out of nine, there was a high credit risk, although it was low on 30 September. Finally, for the third fund, we observed regular and stable behaviour with no relative risk in relation to the EONIA.

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3.14.3 Money Market Fund does not mean no risk With money market funds, as with the other types of fund, there is a general, well-‐ respected rule: in the long term the manager cannot over-‐perform on his reference index without taking more risks than those with neutral exposure. As far as MMF are concerned, we saw that on most occasions, the risk run was not usually a interest rate risk, but a credit risk. The manager essentially tries to obtain a positive spread in relation to the EONIA, which he finds all the more easily if he sacrifices debtor quality. In extreme market conditions such as those we are currently experiencing, the risk of suffering a credit incident as a result of such a strategy is not a negligible one. A second conclusion we were able to draw is that rating, regardless of who performs it, and/or classification are no guarantee of security at this level. Our final conclusion relates to

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the fact that we were able to detect a certain degree of stability or recurrence in risk-‐ taking. In any case, for any investment in MMF, reliance on a multi-‐factor model now seems to offer the best security in terms of understanding relative risk. Tri-‐party Repo, another way of financing, but also of investing funds “Investors have to ask themselves two questions. How much can we grow our investments? And, can we afford our mistakes? (Mohamed El-‐Erian)

3.14.4 Collateral, a word that strikes fear into treasurers’ hearts!

When you talk about collateral, treasurers often bridle, worrying that they will be required to meet systematic margin calls. This discussion recently moved to OTC (Over-‐ the-‐Counter) derivatives, which we know will need to involve margin calls in the future, unless exemption is given to non-‐financial companies (which seems to be the case). This collateral market today represents hundreds of e EUR 10 billion under management. However, this market has a number of imperfections and a degree of inefficiency that are giving rise to operational problems. There are also market restrictions which prevent the banks, certainly, from making the best use of collateral. The idea we start from is, however, simple: why not use the assets that you hold to finance yourself or, in less favorable economic circumstances, accept them in order to bolster your own position? Collateral can be used for various reasons such as (1) margin calls on derivative product transactions; (2) as security for financing with market counterparties or central banks; (3) dealings with clearing houses or central counterparties (CCPs) and (4) for settling transactions.

3.14.5 Repo or not repo?

Repurchase agreements, often referred to as "repos", involve the sale of assets under an agreement or contract enabling the seller to subsequently buy them back. The buyback price will be higher than the initial price, with the difference representing interest calculated on the basis of the "repo rate”. The buyer of the securities is the lender ("giver") and the seller is the borrower ("receiver"). The collateral is reassurance for the lender and serves to safeguard its assets. It boils down to a cash transaction combined with a forward transaction and, at the end of the day, can be likened to a secured loan.

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REPO.

REVERSE REPO.

Participant

Borrower Seller Cash receiver

Lender Buyer Cash provider

Nearly

Sells securities

Buys securities

Farleg

Buys securities

Sells securities

The characteristic of a "tri-‐party repo" is that there is a custodian bank or an international clearing organization between the two parties. This third party plays the role of agent or intermediary, handling the transaction's administration, including the allocation of the assets pledged as security. Examples of these intermediaries are JPMorgan, Bank of NY Mellon and Clearstream in Luxembourg. In return for this tripartite agreement, the intermediary provides a management service including the profile of the eligible collateral. This enables the buyer to define its risk appetite and, to a greater or lesser extent, gives it the ability to sell its assets in the event of problems.

Tri-‐party Repo. Service (1)

Ca$h Provider

(collateral receiver)

CMSA (Collateral Management Service Agreement)

Trade details Currency Principal Repo Rate Collateral Basket Trade date

(2)

Ca$h Taker

(collateral giver)

Agent (3)

Ca$h

Tri-‐party Collateral Account

Securities

Custodian bank / Clearing organization (Example of services offered by Clearstream)

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3.14.6 Tri-‐party Repo: an alternative investment This way of investing has quite a few advantages in that it may provide access to more exotic counterparties or ones outside the usual round of the main corporate banks, but also to more risky counterparties or ones not rated by a rating agency. You lodge your funds with a third party custodian organization, after having agreed a deposit operation with the bank for a particular rate, amount, and term. Soon after, the custodian organization credits your account with a portfolio of securities defined with it in advance, on the basis of criteria that are exclusive and specific to each deal. For example, the business might want only investment-‐grade risk (with a credit quality floor) in its basket of collateral, less than XX% of risk on the same issuer, or a maximum of XXX million EUR per sovereign risk, or exclusion for the risk of certain countries or certain sectors, etc. The stricter and tighter your criteria, the lower the rate and the smaller the maximum portfolio will be. The concept of putting together a basket is very beneficial, as it enables you to achieve a very aggressive investment rate, perhaps with counterparty with no credit rating, and also with a pledge of a highly diversified basket of securities with a previously defined quality floor. Isn't that magic? The transfer of title of the securities therefore completely protects the company providing the cash. The portfolio can also be "over-‐collateralized". For instance, by demanding a portfolio of 110% for cash of 100%, the lending company gains additional security for itself. Should this basket of collateral lose value or in the event of any default in the underlying assets, the independent organization is authorized to draw directly on its client's (the borrower’s) stock of securities to balance the portfolio and bring it back up to 110% immediately. If it cannot do this within 24 hours, the borrower will be in default. The cash provider could then have the portfolio sold to recover its initial stake and the principal loaned. Furthermore, both the principal and the interest are protected by the existence of this collateral. Similarly, if it is the counterparty itself that defaults, the lender can utilize its portfolio as collateral to recover its initial stake. At a time when a bank failure is unfortunately no longer just theoretical, this product has the advantage of being threefold: (A) Diversification of investments and access to new and more risky counterparties; (B) Security for the investment via the basket pledged as collateral and finally; (C) Higher yield because of the counterparty's lower credit quality. Furthermore, there is nothing to stop the beneficiary of the collateral (i.e. the lender) using it for other purposes such as to cover margin calls for OTC transactions, to achieve a lower hedging cost on longer term transactions (long-‐term operations are by nature

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more expensive since they incorporate the cost of counterparty credit risk). It also receives a daily revaluation to market value from the independent custodian organization. The deposit granted can be treated as a "cash equivalent" type deposit (IAS 7) if it fulfills the criteria of a maximum term of three months. Even though the European Central Bank (ECB) is injecting massive funds into the market to bolster market and bank liquidity, this "tri-‐party repo" type of deal is still very common, unlike other products that are less attractive and less used at a time of an overabundance of cash.

3.14.7 Documentation

In terms of the documentation to be provided and signed, a single central basic document called a “CMSA" (Clearing Master Service Agreement) is needed with, an organization such as Clearstream, together with a GMRA (Global Master Repurchase Agreement) for each bank counterparty with which you are going to work (bilateral document for each counterparty). The client or the business then has an account opened with the agent to which the securities will be credited. These documents are, to all intents and purposes, framework agreements of the ISDA or GMSLA type, well-‐ known to international law firms. Using a third party, called the "tripartite agent", in the agreement (Clearstream in the example suggested above) provides some extra security for the lender. The approach using a basket of assets is also a good precautionary measure which gives the lender worthwhile protection in the event of default. Usually, "corporate" lenders do not want to invest directly in products issued by governments or other non-‐financial organizations. Furthermore, we should not forget that because of the future legislation on OTC derivatives, non-‐financial type companies will need to use what is called "trade repository" organizations to report on their derivative products. Selecting a tripartite agent that can carry out both types of operation gives you an independent counterparty as a partner and allows you to strengthen your relationship with it, while automating certain procedures and transaction flows. It is worthwhile bearing this point in mind when you need to select a third-‐party custodian organization. Finally, for those who do not have a custody an bank, this third party-‐agent organization can also play this role at the regulatory reporting level (for example, REGIS-‐TR) and can enable you to deal with other counterparties, particularly smaller money market funds, or to negotiate deposits with smaller banks.

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Advantages of using tri-‐party repo. Collateral givers:

Collateral receivers:

Ê New sources of financing Ê Automatic asset allocation and unlimited substitutions Ê Optimal collateral allocation across products Ê Finance a broader basket of assets

Ê Security of holding Ê Low cost and maintenance Ê Full re-‐hypothecation Ê Easy for users

3.14.8 Priceless protection For the meantime, this product is very simple yet little known and little used by corporate treasurers. It is also unknown to CFOs. The difficulty consists of "selling" the product in-‐house to management. Even if it seems somewhat bureaucratic and complex, third party management simplifies things and, at the end of the day, the cost is borne by the borrower. It allows you to you diversify your risks when you have large amounts of excess cash to invest and when in-‐house rules are too tight. Why not use somebody else's portfolio? Why not even use your own portfolio of securities if you have one (but not your own company’s shares). The operation obviously works both ways for companies that have good or reasonable collateral to offer. Even where the portfolio brings in a return (the coupon is still payable to the lender) it is often a bit "sleepy". Even if it bears interest or dividends, the securities portfolio does not do anything to the books. Giving it as collateral could be a way of "waking it up" and giving it a second, parallel, existence. We are talking about a simple and secure product that can meet several objectives at the same time. There seems to be very little doubt that this type of product is going to become more widespread within non-‐financial companies in the next few years. Why not go out and look for additional return while increasing security through diversifying collateral? Why not use the collateral lodged with us for many purposes, thereby killing two or even three birds with one stone. In the times we are living through, a wise treasurer cannot be too careful.

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4 Part IV IAS 39 and IFRS 9, Hedge Accounting Exception

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4.1 A revolution in accounting and moving to "fair value" "Nothing gets done without a little bit of enthusiasm" (Voltaire)

4.1.1

Transformation in accounting

Accounting has gone through a profound transformation since 2000. We have moved from the very traditional historical cost method to the concept of "fair value”. IAS 39 (and its American counterpart, FAS 133) are very good illustrations of this profound change in accounting. The initial purpose of accounting systems was to record cost prices. Since the time accounts first began to be kept, the costs borne were used as the value of all expense and fixed asset items for purposes of recording them in these accounts. These costs remained the references for comparison with any subsequent valuations of these same accounting lines. The concepts of inflation, changes in purchasing power and other similar concepts, were disregarded in this field even though of course they existed, particularly for making economic evaluations. In what is called "traditional" accountancy, the basic principle applicable to all expense lines was that of recording at cost price. The corresponding accounts in fact recorded a history of the expense. In accounting, the great double entry principle requires that firstly an entry should be made in the income statement and an equal and opposite entry should, at least temporarily, be made in the balance sheet. For example, the purchase of goods is recorded in the income statement, while the goods are temporarily entered as a balance sheet asset, under stocks, at the purchase price. The same rule applies to lines which remain on the year-‐end balance sheet, particularly capitalised assets. However, it is these balance sheet tracing methods that have been called into question by the new international accounting standards, when recording entries into the company's accounts for a certain length of time. If the items are to be held in the accounts for a long time, the historical cost principle no longer equates to the fair value that every accounting entry is supposed to reflect, for balance sheet dates after the date of recording.

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4.1.2

Reflecting the present and the future and reflecting them in the accounting system

Today, new accounting standards seek to capture the present as well as the future, and reflect them in the accounting system. In recent years, one idea has become more pressing. Why not reflect the potential resale price of an asset when valuing it in the accounts? In other words, in a large number of cases, to state the value of an asset, we tend to recognise future income rather than past expenses. This is a radical transformation in accounting practice. This approach has and will have major consequences for the yearly results posted by some companies. This change in the way of looking at accounts is at the root of what really resembles a sort of "accounting revolution" as some people have described it. This revolution is still partly in the future in some European countries. But the trend and mainstream is running that way, set on course by the two major international standards.

4.1.3

Origins of the transformation

Corrections have certainly been made for a very long time to amend, over time, the historical cost of assets (depreciation and impairment/write-‐downs). But these corrections seem somewhat artificial and rigid for depreciation, and are of rather limited application for impairment and write-‐downs. Another reason for questioning historical values arose in the context of inflation indexed accounting. This type of accounting used to be shown in a note to the accounts, in the 1980s, particularly in the USA. However, this involved revaluing the past based on the observed rise in prices. The view produced by this approach was therefore still linked to historical cost, as updated. Moreover, the rise of large stock markets and the growing influence of pension funds promoted the concept of shareholder value creation. Introducing this concept led naturally to the idea being transposed into accounting practice, and particularly into asset valuation. Similarly, at the same time the increasing number of company acquisitions, often at steep prices, contributed to putting this new concept into place. The acquisition price is in fact based on the future of the firm being bought, in other words on future cash flows (think of start-‐up companies in the internet sector which were sold at eye-‐watering multiples of assumed or hoped-‐for profits). Under such conditions, accounting values from the past, relating to the acquired assets (low, because they did not incorporate the future or this potential) were almost meaningless compared to the enormous purchase price paid for this same group of assets as a whole

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4.1.4

IAS 39 and FAS 133

In the USA, accounting standards that were moving towards fair value were introduced as the years went by, with most of the finishing touches being put in place by 1995. The IASB did the same in 1999. Then came the final touches or the cherry on the cake with the famous standards, FAS 133 and IAS 39. These are numbers that resound in the heads of treasurers and chief financial officers. These rules laid down the "accounting practice of the future". Governed by these new rules, accounting then started looking to the future, and economic reality prevailed over legal form. Globalisation was another factor giving impetus in that direction. It required an accounting system standardised at the world level, such as Michel Camdessus, the Director General of the IMF, called for. However, fair value is far more universally-‐ applicable in nature than historical cost. Historical costs always have peculiarities, particularly in local tax law, specific to each country in which the accounts are kept. In practice, plenty of companies switch to an international accounting system such as US GAAP or IFRS in order to obtain a listing on the world's biggest stock markets. In its 1998 annual report, Deutsche Bank disclosed that it used IFRS (formerly IAS), because, unlike German accounting principles, they were appropriate to the concept of creditor protection. This transparent and relevant information was considered preferable to valuation rules characterised by prudence. The latter tended to undervalue assets and permit hidden reserves. IFRS does not permit valuations arising purely from tax considerations. It might even be reasonable to think that in time all of a company's financial assets would have to be re-‐valued to market value (mark-‐to-‐market) or to fair value. That would be the aftermath of the accounting revolution, Full Fair Value which some people deplore.

4.1.5

The new basic standard

In historical cost accounting, derivative or hedging instruments remained "off-‐balance sheet". Indeed, before they matured they had no quantified or legal basis for being put in the accounts. In fact, before maturity, these hedging contracts involved almost no financial transactions between the contracting parties. It is therefore hard to record them in the accounts, since no cost will appear in the immediate future. Furthermore, sale of the underlying asset comes later and is sometimes even only conditional. The transfer of ownership has not (yet) actually been made. However, their absence from a company's accounts poses great dangers. Many major groups make increasing use of the derivative products market because of the great variability in the economic outlook and the high volatility in currencies and interest rates. As a result, many companies suffered massive and unforeseen losses as a result of very large and sometimes speculative commitments that turned out badly. In

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such cases, accounting recognition in successive stages would have brought out these phenomena gradually and perhaps even, in-‐house, have kept down the losses and stopped them becoming too large. Indeed, unfortunate speculation or the vicissitudes of highly leveraged instruments are sometimes the work of experts, who always hope to make up the difference and delay disclosing their under – or outperformance (still unrealised) – to their managers. The very technical aspect of these issues means that, in non-‐financial companies, management is not really able to understand the situation in this sphere, while the problems are still underlying ones. A systematic and regular check on the fair value of financial instruments by specialist auditors, made mandatory by being valued on the balance sheet, would avoid this risk of non-‐transparency. Unfortunately, it is very unusual to find auditors who are truly well versed in IAS 39 or FAS 133, even though things are changing slowly.

4.1.6

(New) IFRS rules

On the principles front, the important thing was to bring in a new IAS 39 standard to supplement IAS 32. IAS 39 was published in March 1999, applicable for periods starting on or after 1 January 2001. The first semi-‐annual and quarterly results of the pioneer companies were issued after the 2001 year end. Based on the mixed experience of companies that had been very early adopters of FAS 133, few or no companies adopted this standard early, as they could have done. IAS 39, a cousin or sister of FAS 133, was undoubtedly the most innovative standard, and the one that dealt with fair value in the greatest depth. It therefore contains an element of setting an example in this field. Furthermore, it extends the range of types of accounting entry. In the introduction to IAS 39, the IASB declared, "in application of this standard, all assets and liabilities must be recognised in the balance sheet, including all derivatives." The major innovation was, in effect, that financial instruments should appear with their values in the balance sheet, whereas by traditional rules, these instruments were accounted for off-‐balance sheet. It requires fair value to be used for most items and financial instruments, thereby changing existing practice. The standard nevertheless provides for exceptions to this principle by allowing hedge accounting treatment, providing you can demonstrate the link between the hedge and the underlying asset being hedged and provided you can demonstrate its effectiveness and document this relationship.

4.1.7

Revolution does not please everyone

IAS 39, then, is the new standard that best illustrates this revolution in accounting. It crystallises it, by making revaluation to market value the general rule. Its extreme

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complexity (not in its principles which are simple, but in its application), its ever-‐ changing nature and the technical complexity of the financial instruments that it is trying to govern make it the most innovative and the most difficult of all the standards. FAS 133 and IAS 39 were bestsellers at the start of 2000. Any number of things could be said about it. Like a law, the standard's text bears no relation to the many interpretations which caused and are still causing this standard to evolve. We could call it accounting "case law". It made only treasurers happy, because for many companies it was necessary and indeed crucial to research into hedge accounting treatment to keep down or eliminate a volatility that their shareholders and management could not tolerate. But to qualify for this accounting exemption from a market value that would hit the income statement directly, you have to document, test and explain the hedging relationship. Many groups overlooked or underestimated this great administrative difficulty. Based on the standard, the idea is laudable, readily understandable and makes good sense. But at the end of the day it looks as if the standard ran away with its initiators. The role of interpretation bodies (the DIG and IGC) came into their own with the need to interpret the standard and make it more flexible.

4.1.8

Goals achieved

We may well wonder whether those that the standard is trying to protect have succeeded in mastering it and transposing it in condensed form into their company accounts. The people preparing the standard took an immense amount of time to draw it up. Perhaps they were trying to do too much and made the mistake of going too far? It is also important and amusing to note that this standard is not without its impact on the behaviour of finance professionals. In fact, we note that many treasurers find that their hedging decisions and their use of this or that instrument are dictated by an accounting rule. It is the accounting rule that dictates the financial decision, which is to say the least paradoxical and astonishing.Most companies are conducting a complete review of their foreign exchange and interest rate hedging procedures on this occasion, to make them consistent and bring them into line with the standard and the way in which the company wishes to apply it internally. As with any revolution, not everyone will be happy with the new system. Many will have to put up with this new accounting approach even though they are not accountants. Others, such as financial analysts, rating agencies or even banks must try to grasp and understand the figures produced by the companies that apply it. It is a fair bet that not many of them could claim to understand these figures. Has the goal of providing better information been achieved? We rather think not. Nevertheless, IAS 39 has guarded against some of the past's excesses and unfortunate situations. It has created a strict discipline with burdensome consequences for

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treasurers. The standard allows or requires better risk management. It lays down an excessively rigid framework and delimits the boundaries of treasury management, of better treasury management. This is comparable to the principle of a bottle being half empty or half full. We can see positive aspects and understand that the purpose of breaking with the excesses of the past has at least very largely been achieved by the standard's developers.

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4.2 12 years under hedge accounting and IAS 39, for better or for worse? “It is better to err on the side of daring than on the side of caution” (Alvin Toffler)

4.2.1

The good and bad sides of IAS 39

Have you ever think about a simple question, but nevertheless somewhat a disconcerting one, "but when everything is considered, after so many years, has IAS 39 and the hedge accounting exception been beneficial for the profession of treasurer or not? IAS 39 has its good and its bad sides. Nevertheless, it has been relatively beneficial to the profession and to world finance. Its successors will be even better in ironing out a number of points that are often criticised by users. Even though it was resisted for a long time, then debated and each amendment challenged, even if it was listed as one of the reasons for the financial crisis (there was a need to find culprits other than just the ratings agencies which had taken too much of the blame) and even if it is still the most complex standard (IAS/IFRS), IAS 39 has done more good than harm. It paved the way for a complete revision of the approach to managing financial risk and hedging those risks. In particular, it brought more virtue and discipline back into hedging practices in non-‐financial corporations.

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The cruel "mark to market" sentence, a sort of wrecking bar of the P&L account, has obliged all companies to revisit their approach to risk management. Without it, there was a danger that these companies would have shown results that were unacceptably volatile for any reasonable and sensible CFO. Over a number of years an enormous additional workload was generated in learning, understanding, and implementing the standard. These same consultants now hope there will be sequels to IFRS 9 and IFRS 7 that are as complex and burdensome as possible (in the interests of their jobs) but they are also hoping for evermore numerous and tortuous regulations. On this last point they are unlikely to be disappointed.

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…from everything off B/S to everything on B/S…

Jan. 2001

Jan. 2015

No IAS / Local GAAP

IAS 39 IFRS9

No Fair Value

Fair Value

Financial Instruments not on B/S

∆ FV in P&L unless HA

Structured/ Sophisticated Financial Instruments

More basic Financial Instruments

No or flexible hedging policy

2020…

4.2.2

More formal hedging policy / more hedging

IFRS …

Full Fair Value ∆ FV in P&L no exception Very basic / Low volatility Financial Instruments Very formal hedging strategies / less hedging

"Hedge accounting", a temporary exception

Plenty of people seem to have forgotten that the hedge accounting exemption was supposed to be only temporary. The IASB's idea is, in due course, ultimately to move towards full fair value, thus attaining a sort of accountancy Holy Grail and eventually abandoning this IAS 39, which it inherited from the IASC (its predecessor). Is this ultimate goal desirable or not? We have often debated the question and warned against going to too great an extreme in transparency. It seems to us, instead, that this intermediate step, initially temporary, would be ideal when all is said and done. It would give transparency and wipe out the profit and loss impact where a position was hedged (Cash Flow Hedge or Fair Value Hedge). In the final analysis, would this intermediate step not be desirable in the longer term? Less can sometimes be more. Provided it is properly applied and its rules are adhered to, hedge accounting is an effective and virtuous model. It may be that a further step might turn out to be a step too far. In the long run, would it not be better to accept this situation, which is relatively satisfactory when all is said and done?

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4.2.3

For better or for worse?

At the end of the day, our assessment of these twelve years of hedge accounting is rather positive. This accounting standard made us codify and structure our corporate risk management more virtuously. IAS 39 made treasurers more aware of the volatility of hedging instruments and reminded them of their consequences. IAS 39, well before the sub-‐prime crisis and in everything that followed it, has averted many problems. Without IAS 39, many companies would have experienced, time and again, major losses due to current market volatility. It averted many consequences that would have affected their results, had they continued to use the financial products that they were using previously. This new virtue produced by IAS 39 prevented other disasters or financial losses that we could well do without in a period of crisis. So yes, I think that we can reasonably consider that IAS 39 was a good thing for the community of corporate treasurers.

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4.3 Overhaul of IAS 39: revolution or simplification? “A conservative is someone who believes in reform. But not now!” (Mort Sahl)

4.3.1

Fair value in the firing line after financial crisis

The butt of frequent criticism in recent years, fair value has been singled out by shareholders and banks alike as the perfect scapegoat for the financial crisis with which we have been confronted. But we know, of course, that the responsibility lies elsewhere, albeit shared rather than attributable to a single cause. Notwithstanding all the criticism, fair value is actually enshrined in what will be the future standard on financial instruments, the son of IAS 39. Like father like son, so they say, and this proverb might very well apply in this case too. Despite being divided into three separate phases, this overhaul of IAS 39 in relation to financial instruments is on the right track. The IASB (International Accounting Standard Board) had planned to publish three ED (Exposure Drafts) in the third and fourth quarter of 2009 and in the first quarter of 2010, a trilogy-‐type approach which does not exactly lend itself to being able to comment on the individual or successive draft(s) due to the lack of the necessary overview. Codenamed IFRS 9, the first part was published on 12 November 2009, thus completing their first phase of reform (www.iasb.org/News/). IFRS 9 makes use of a unique approach to establish whether an asset is to be measured in terms of its amortised cost or its fair value, thereby replacing the various rules from IAS 39. The approach adopted by IFRS 9 centres on the manner in which the company manages its financial instruments (its overall business model) and the contractual cash flows which characterise the financial assets. Also opting for a unique method to be used for impairments, the new measure’s effective date of entry into force will be 1 January 2015.

4.3.2

Need for in-‐depth reform of IAS 39

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reasons why some banks proved to be more resilient than others. Why have Spanish banks withstood the shockwaves relatively well, even though their economy has been suffering serious problems, most notably on the property market? Is it simply down to the practice of dynamic “provisioning”? IAS 39 is an accounting monster (we prefer to compare it to a sort of hydra) consisting of nearly 300 pages. According to Philippe Danjou, a French member of the IASB, “Overhauling IAS 39 is akin to renovating the Château of Versailles”. But is this really an appropriate comparison? Not really, as the classical spirit of this château, albeit adorned with some baroque touches, constitutes the zenith of French art and nobility, with a sundrenched aspect that, in our humble opinion, has little in common with the IAS 39. We would, however, concur with the view that it amounts to a colossal undertaking. The foundation stones of this renovation, on classification and measurement, were laid in the summer in the exposure draft (ED 14th of July, 2009) closed at the end of September 2009, through the 250 or so responses and comments submitted. The aim of Sir David and his acolytes was to, wherever possible, simplify the measures taken. The measurement of financial instruments has thus been reduced to two methods (amortised cost and fair value) and the number of classes has also been cut.

4.3.3

Convergence or divergence?

The United States appears to have opted to move towards what is known as “full fair value” for all financial instruments. In doing so, the FASB is deviating from the previous model and from the IASB’s guidelines. Nevertheless, both signed the Norwalk agreements in 2004 and, as recently as 5 November 2009, reaffirmed their MoU (Memorandum of Understanding). They even voiced the idea of intensifying their efforts in order to rapidly finalise the joint projects that are on the table (target date set: June 2011) and reiterated their desire to adopt measures in line with the wishes of the G20. But is there not cause for concern nonetheless? David Wright, from the European Commission DG Internal Market, has publicly expressed his concern regarding the risk of an absence of convergence between the two main global accounting standards, as neither the IASB nor the Commission intends to converge by simply aligning themselves with the new American model. The IASB is also highlighting the spirit of listening and consultation at the very heart of its due process, but there is cause to doubt the reality of these consultations. Listening is one thing and understanding is another, but finding a solution is trickier still when the concessions aspect and pragmatism are often notable by their absence within the IASB. In their defence, however, defining one perfect standard applicable to all is far from straightforward. It is like trying to square a circle as, whatever the board decides, some parties will be left dissatisfied. The fundamental remit and foundations of the IASB are based on the aim of meeting the needs of investors (users) by compelling the company’s concerned (preparers) to employ greater transparency and care. The banks’ insistence on returning to the single historic cost

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method (amortized cost) does not meet investors’ requirements and is therefore unconceivable from the outset. After all, the aim of the IASB, like that of many parties concerned, is to bring about or at least contribute to the increased stability of the financial markets and systems.

4.3.4

Hedge Accounting

The third tranche of the IAS 39’s renewal, which will determine the character of its successor, is scheduled for early 2010, contrary to what was initially planned. The initial discussions seem to be heading towards fair value measurement, with the resulting variations to be recorded as own capital and not solely in the profit and loss account. Nevertheless, this ED is inciting considerable fear within the financial community. At a juncture when the USA might be taking another route, there is good reason to be fearful. Numerous treasurers are hoping that the new standard will not be too different from the initial rule and that a good part will be left to the mixed model, thus permitting greater latitude and offering improved flexibility vis-‐à-‐vis the actual and practical needs of users. We may then need to modify and adjust our hedge strategies, and it will also be necessary to adapt our information and treasury management systems (TMS) in order to meet the new requirements and supply the information required. Like Saint Thomas, we will judge on the basis of the actual evidence when this third volume of the standard is actually put in place to complete this as yet still sketchy trilogy. In a recent presentation, we compared this eagerly awaited (and for good reason) third tranche to The Empire Strikes Back”, from George Lucas’s celebrated Star Wars trilogy. But instead of triggering a revolution, the newly simplified IAS 39 will hopefully be accepted by many without complaint. After all, its comprehensive makeover should facilitate the recording of results and the reading of annual reports. Having already likened IAS 39 to a chateau, it may be a step too far to compare the IASB to a galactic empire, but we do hope that this trilogy will be just as exciting.

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4.4 The 39 steps “Better late than never” (Proverb)

4.4.1

IAS 39, challenge or opportunity?

Like the famous Alfred Hitchcock movie, every step they took brought them closer to danger with the famous financial thriller: “the IAS 39 steps”. Like in thrillers, there are always unexpected developments, which keep us in suspense. IAS 39, somehow, changed every treasurer’s life, no doubt about that! It is a real challenge but also a fantastic opportunity to revisit and re-‐engineer risk management processes. The treasurer’s plate remains full of projects. A deeper focus on liquidity and risk management made his job more strategic than ever bringing him closer to CFO’s.

4.4.2

Position of ACT’s

Treasury Associations, including IGTA11 or EACT12 have had a keen interest in the development of the accounting standards for financial instruments and have been closely involved in reviewing and commenting publicly on them. Prior to IAS 39 it was a concern that the financial statements of companies could be misleading if significant financial positions were not disclosed in the annual accounts. Treasurers therefore have been supporters of new accounting rules including the principle of recording change of fair value of financial instruments in the accounts. Nevertheless they noticed that there exist some important remaining deficiencies. They hope that IASB will quickly introduce guidance or changes to address them.

4.4.3

Key deficiencies in the standard

4.4.3.1 Hedging The IASB has included very specific rules as to what will qualify as a hedge and by doing so disallows many normal transactions that should treated as hedges. There is a grave danger that companies will change their hedging policies so as to produce a favorable short term accounting treatment and this may be detrimental to the real economic needs of the company. Alternatively, companies will follow good economically justified practices and continue to use financial instruments, but because of the strict hedging criteria may end up with 11 IGTA -‐ International Group Treasurer Association 12

EACT -‐ European Corporate treasurer Association – www.eact-‐group.com

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reported results which are volatile and misleading and require lengthy management explanations and justifications. 4.4.3.2 Treasury center netting For large groups there are considerable administrative and dealing efficiencies to be gained by centralizing currency exposures, which is able to net off compensating exposures arising across the group. The treasury department then only needs to hedge the net amounts in the external financial market. Under IAS 39 this sort of activity is not effective in accounting terms because of the limitations on hedge accounting treatment that can be used.

4.4.3.2.1 Hedging of Intercompany Cash Flow Forecasts

Forecast intercompany transactions cannot be hedged items, although this matter is currently subject to review through an Exposure Draft (ED). The proposed solution is not practical and fully satisfactory for corporate who would prefer to be simply allowed to hedge such internal transactions.

4.4.4

Hedging of tender portfolios

For companies, whose tender periods are on several years basis (engineering, aircraft, defense…) and for which the FX rate used in the tender is a key element of the project, IAS 39 as it does not recognize macro hedging of a tender portfolio will lead to large swings in results.

4.4.5

Convergence with US GAAP

In drafting of IAS 39, there are several occasions where IFRS differ from the equivalent US standards. While it is not surprising to find small differences, treasurers regret that some seem to have little justification and introduce an unwelcome complexity into accounting procedures (absence of short-‐cut method, prohibition of hedge accounting for intercompany cash flow forecast or FX netting).

4.4.6

EU endorsement

The late EU endorsement of IAS 39 could be regretted. The involvement of the European Commission in amending IAS 39 for endorsement has created uncertainty for implementation in 2005 leaving too little time for corporations to finalize systems and procedures. Treasurers, in general, regret the decision of the ARC (Accounting Regulatory Committee) to recommend endorsement of an amended standard, which did not take into account corporate treasurers concerns. There are grounds for believing that IASB has given less attention to the submissions made by representatives of the corporate sector than has been the case for the financial sector. Furthermore by

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creating a cut-‐down standard, which is not the full IASB standard there is a risk that recognition of IFRS as an acceptable accounting standard for US regulatory purposes is lost. It could create more work for companies listed in Europe and in the USA because they would continue to prepare IFRS accounts. 4.4.6.1 Future of IAS 39 IAS 39 remains the most controversial standard ever. The Working Group on Financial Instruments (WGFI) (1) recently set up is aimed to discuss open issues and the after 39. Some influent IAS Board Members are in favor of the full fair value, which would be a real danger for corporations creating an intolerable volatility of P&L statements. The WGFI works could take a long time given number of issues, mainly raised by banks. The most realistic experts do not expect many changes. Nevertheless, the last ED related to the hedging of intercompany cash flow forecasts is maybe offering some opportunities. For a multinationals having activities in different countries, there is a real risk of translation of the results of the functional currency of the subsidiary into the functional currency of the parent company – on the basis of the average rate of the period concerned. As any company is evaluated on the basis of net incomes, it cannot be sensitive to the reduction of volatility of revenues associated with FX rates used for conversion of results. The hedging of translation risk is, thus, essential because it allows maximizing the shareholder value to which, more than ever, everyone is attentive. IASB is displaying its knack for surprising companies applying IFRS. It killed two birds with one stone by responding to a very logical request for allowing internal cash flow hedging but in a way, which goes well beyond what was initially asked. The IASB proposed solution is interesting and innovative by pushing the doors wide open to translation risk hedging, for lack of being given full satisfaction on a specific problem. FAS 133 solution allowing hedge accounting for intercompany transactions is easier to apply. It still remains a very complicated endeavor to understand the Byzantine logic pursued by IASB and the meanders of accounting for financial instruments. IAS 39 reminds us of the nursery rhymes of our childhood, "3 steps forward, 2 steps back". But in the end, it will at least be one step…forward. 4.4.6.2 Pandora box IAS 39 always has new surprises in store for the one who tries to open it. Some critical people will say that “39” hides many peculiarities. The complexity comes from its evolutionary character, which was pointed out time and again. Most people will think that alas, this is not its last mutation. The repeated amendments oblige adopters to frequently revise their copies and to adapt the way they have applied the standard.

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The difficulty will thus partly consist in being able to adapt to this shifting standard in order to better understand it. This undeniably requires a great deal of curiosity on behalf of treasurers. They can't expect anything of their colleagues from the financial world, who already "gave up" a long time ago. While some are still at the stage of discovery of IFRS through basic seminars or guided tours of the mysteries of the most whimsical of accounting standards, other early adopters are uncovering new surprising and irritating facets every day. The AG99 amendment was in this respect a true mine of technical revolutionary innovations although it has been criticized.

4.4.7

Every Cloud Has A Silver Lining

When thinking about IAS 39, we can see the "other side of it" and wonder if some won't take advantage of it. Banks, although having indulged in harsh criticism of this revolutionary accounting standard, as well as certain service providers are likely to benefit from certain induced positive effects of the prohibition of netting long and short foreign exchange positions. There has been quite a lot of frantic criticism of this accounting standard on which a great deal of ink has been spilled. Everyone has aired his respective grievances concerning this rule. It indeed turns upside down the classic approach based on the historic value, preferring to rely on fair valuation. Paradoxically, the least virulent and most constructive reactions came from corporate treasurers who had recognized the importance of adopting an accounting rule for financial instruments. They nevertheless recommended various practical amendments that were considered absolutely necessary. The netting prohibition, apparently insignificant, will, in practice, have important implications for all treasury centers. 4.4.7.1 Prohibition of netting It is no longer possible to offset long and short FX positions. Such offsetting nevertheless makes sense financially, because it allows reducing the basis of foreign exchange risk (cf. IAS 39 § 133 in contrast to FAS 138). This global basis of FX risk will thus increase. This inconsequential prohibition will generate an enormous inflation of number of hedging contracts. Indeed, the micro-‐hedge approach (one hedge per underlying risk) is almost inevitable in practice and the aggregation of positions, whether long or short, is more delicate. Likewise, for those wishing to mitigate to the maximum possible extent, the impact on their income statements, it is useful to adopt a strategy of the type "forward-‐to-‐ forward" revaluation by which the entire fair value change is taken into equity. This leads many treasurers to hedge in a individualized way and to slice-‐up FX hedges. It also forces them to hedge in a more precise manner, to enhance the cash flow forecasts or to hedge longer term. All these elements, contribute to an inflation of FX transactions. Such transition involves additional financial cost through the increasing number and reduced nominal value of deals, based on a micro-‐hedge model, but also greater

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operational risks, like error owing to an increased administrative burden in connection with FX contracts management (both internal and external) It inevitably leads to a more specific distribution of hedges. Certainly, aggregating long or short positions is still possible but it is limited in practice. 4.4.7.2 Direct and indirect beneficiaries The beneficiaries will no doubt be banks, which will see the number of FX transactions growing substantially in the future. It will also necessitate larger FX credit facilities. The extension of hedging terms – more dedicated – will also have a negative impact on pricing as banks overweight long maturities in term of price and utilization of lines. This could become, sometimes, a real problem for companies with tight financial structures or heavy borrowers. The bankers have found subject of comfort here. Thus not all is lost for them in this fierce accounting battle. This prohibition is also a strong argument for relying on e-‐trading FX platforms, which allow handling smaller amounts per transaction while benefiting from attractive prices and by diversifying the number of suppliers. Those adamant in their unwillingness to use this type of platforms will have to reconsider seriously this useful solution in the face of the new problem described here. Behind these Internet solutions, the reliance on providers of matching confirmations of transactions will become even more essential to every treasurer for ensuring more effectively smooth execution and settlement of hedging transactions. One of the responses to this technical multiplication of transactions will no doubt be the reliance on these reliable tools. The treasurer can thus benefit from relief of the administrative burden owing to greater automation of the processes and reduce risks of error inherent in the increasing number of contracts. It is in adversity that we learn how to react. We may wonder why things should be made simple when they can be made very complicated. As French author F. Rabelais said: “what could not be cured must be endured”.

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4.5 The third act of IFRS 9: revolution or simple reform of hedge accounting? “A short saying often contains much wisdom” (Sophocles)

4.5.1

Third and final part of IFRS 9

Is the third and last act of IAS 39 revamping a revolution or a simple reform of existing principles? Hedge accounting has always been a controversial topic. Are these new proposed measures acceptable for corporate treasurers? Sometimes, adjustments could be better than a complete reform of basic rules. The convergence with US GAAP should remain a critical issue for IASB in coming months. The corporate treasurers in Europe were impatiently waiting for the third part of IFRS 9 (www.iasb.org). Eventually, this long trilogy process of IFRS 9 was as long as an elephant gestation. The IASB based in London has recently issued this third Exposure Draft (E.D. – released on 9th December 2010 for comments by 9th of March 2011) on proposals to replace the hedge accounting requirements previously defined in the famous and controversial IAS 39 “Financial Instruments Recognition & Measurement”. Unquestionably no single treasurer could dare to pretend that IAS 39 is/was not highly complex and inaccurate on different items. It has long been an area of difficulties for both preparers (companies applying IFRS/IAS standards) and users (investors using these financial reports under IAS/IFRS). After G20 in London, IASB more than ever wanted to improve information available for investors. It explains why the decided to revisit in depth IAS 39. However, after this third part of IFRS 9 Exposure draft trilogy, we could doubt about the initial goal of completely revamping IAS 39. We could consider that IASB has proposed an interim consensual solution with amendments on existing rules, more than a comprehensive reform of financial instruments (hedge) accounting model. In short, hedge accounting rules concerns the reporting of derivative instruments used by a company to hedge its exposures to financial risks which could potentially affect its business. The general treatment of such derivative products is to measure it at fair value with changes being reported to gains and losses in the income statement, unless the hedge accounting exception applies. This exception is needed to faithfully represent the activity of the company which intended to protect and hedge a defined exposure. IASB has always considered the cost basis for derivatives would be inappropriate for measuring their (current) value.

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4.5.2

Struggle to understand IAS 39 reporting

For users, hedging and hedge accounting activities have always been an area of business where they often struggle to understand what is going on and how to interpret a company financial risk strategy. These rules have frustrated many preparers too, as the requirements have not been linked with common risk management practices. Hedge accounting has often been impossible or very costly, even when hedging was economically rational as risk management strategy. It has not been helped by the restrictions in which IAS 39 arguably limited the practical ability of companies to faithfully report their risk management activities. These exceptions and restrictions explain why some companies have refused to apply hedge accounting, while providing users with supplementary non-‐IFRS disclosures (un-‐audited) to explain their hedging approaches and strategies. It results into confusion and lack of comparability which is yet essential for investors, both Accounting Boards and even G20 members. Some complainers pretended also that use of different methods of hedge accounting created additional confusion. It is true and fair to say that often accounting rules created artificial restrictions which may negatively affect the way a business was managed. The critics towards IAS 39 are also related to its too prescriptive approach of what can and cannot qualify for hedge accounting, distinction between cash flow hedge and fair value hedge and eventually the disclosures to users not sufficient to understand risk management strategy of the company. The major idea of the IASB was to adopt a principle-‐based approach for aligning more closely hedge accounting measures to financial and non-‐financial risk exposures. IFRS 9 also proposes an enhanced presentation and new disclosure requirements for improving transparency (at least it is what IASB is convinced of).

4.5.3

Key measures proposed by IASB in third ED

Enhancement of disclosures: IASB proposes a comprehensive set of new disclosures supposed to better explain risks being hedged and how hedge accounting affects financial statements (rather than information on the hedging instrument itself which is covered by IFRS 7)

Removing of the artificial qualification criteria for effectiveness: we now have the “highly effectiveness” (a priori and a posteriori) approach and the 80-‐125% corridor which will be changed. The artificial bright line will be removed. The hedges should be determined in an unbiased manner in order to minimize ineffectiveness and in accordance to risk management policy. The ineffectiveness will continue to be reported in P&L. The effectiveness testing would then be quantitative as well as qualitative. Any ineffectiveness that arises will continue to be booked into P&L

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4.5.4

Changes to treatment of option premiums in order to prevent artificial volatility created by change in time value. The idea is to treat time value differently because it is irrelevant given the fact options generally run until maturity and make this time value changes lost Aggregated exposures of non-‐derivatives and derivatives instruments: Until now, a derivative cannot be part of the hedged item, causing problems for many risk management approaches and strategies (e.g. Hedging of commodities into USD fixed amount, then hedged against the functional currency of the company. The fixed amount of USD cannot be designated as the hedged item). The hedging of groups of items would be easier and more flexible, although it does not cover macro hedging. However these hedged net positions consist of forecasted transactions, which all have to relate to the same period (certainly too restrictive for corporates) Presentation of all hedges in OCI (Other Comprehensive Items – equity account) and not only the cash flow hedges A hedge of risk components of non-‐financial items was restricted in IAS 39 as hedging part of the hedged item was not authorized. This was a real problem for non-‐financial companies where the available hedging instrument does not match always the hedged item (e.g. hedging of jet fuel risk for airline companies with crude oil component). It is permitted providing the risk component can be separately identified

What should corporate treasurers do?

The corporate treasurers and their national or international associations should answer and comment the ED. All in, this third ED is not that bad. Eventually, IASB has understood we need to maintain hedge accounting exception, with some amendments to simplify it. Some users will certainly complain and ask for minimal changes. Some other (including users) could think simplification process is not satisfactory. EACT, as well as main national treasury associations, will prepare comment letters to underline the issues identified. For example, treasurers complain about the extended disclosures which could in some cases give competitive advantages to peers (however we quasi all need now to report under IFRS, and are therefore on an equal footing). We should also suggest refusing that the basis adjustment becomes compulsory for cash flow hedge accounting (maintaining of optionality would be better). The netting with forecasted transactions related to the same period also seems to be difficult and insufficient in practice. We should also welcome the option treatment more in line with US GAAP, while maintaining some slight divergences. At the end of the day, treasurers would be inspired in confirming to IASB all the positive elements addressed in the ED. In my

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opinion, it is a much better ED compared to some previous proposals made by IASB the last couple of years.

4.5.5

Next steps

The final standard, after amendments and comments received from users and preparers will be published in the course of 2013 and hopefully endorsed by EU. Once endorsed, it will be mandatory for accounting periods commencing on and after the first of January 2015; but corporates will be able to early adopt this new standard. Of course the third E.D., once agreed and adopted, will form part of the IFRS 9 and will include the other changes on classification and measurement of financial assets and financial liabilities (IFRS 9 part 1) and impairment of financial assets (IFRS 9 part 2). Then the financial instruments accounting standards trilogy will become IFRS 9 (which will replace IAS 39). Lots of treasurers are not convinced that all these changes and additional disclosures will effectively improve information delivered to users and investors. Even if we have major doubts about user’s general understanding of corporate risk management strategies under IFRS 9, it will not prevent IASB to try improving information, as requested by G20 after the financial crisis. More does not necessarily mean better in financial accounting. But who could contest need for more transparency.

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4.6 The son of IAS 39 “Better bread with water than cake with trouble” (Russian Proverb)

4.6.1

Celebration or funerals?

Lots of treasurers have forgotten that in January 2013 we have celebrated the 12th anniversary of IAS 39. Celebration or funerals? In last quarter of 2010, the IAS Board should publish its new hedge accounting standard on hedge accounting. It will be the third and last part of the IAS 39 complete revamping. IAS 39 has transformed our life of corporate treasurers. What has changed since the first of January 2001? It has revolutionized the whole hedging approach of corporates. Another question is to know whether the overhaul of IAS 39 is a revolution or a simplification.

4.6.2

Fair Value In The Firing Line After Financial Crisis

The butt of frequent criticism in recent months, fair value has been singled out by shareholders and banks alike as the perfect scapegoat for the financial crisis with which we have been confronted. But we know, of course, that the responsibility lies elsewhere, albeit shared rather than attributable to a single cause. Notwithstanding all the criticism, fair value is actually enshrined in what will be the future standard on financial instruments, the son of IAS 39. Like father like son, so they say, and this proverb might very well apply in this case too. Despite being divided into three separate phases, this overhaul of IAS 39 in relation to financial instruments is on the right track. The IASB (International Accounting Standard Board) had planned to publish its first and final ED (Exposure Draft) in the first quarter of 2010 (a trilogy-‐type approach codenamed IFRS 9, the first part was published on 12 November 2009 -‐ www.iasb.org/News/). IFRS 9 makes use of a unique approach to establish whether an asset is to be measured in terms of its amortized cost or its fair value, thereby replacing the various rules from IAS 39. The approach adopted by IFRS 9 centers on the manner in which the company manages its financial instruments (its overall business model) and the contractual cash flows which characterize the financial assets. Also opting for a unique method to be used for impairments, the new measure’s effective date of entry into force will be 1 January 2013, with early adoption possible from the end of 2009.

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4.6.3

Need for in-‐depth reform of IAS 39

Pushed by the European Commission to react to international pressure, the IASB had no choice but to agree to undertake a reform of its most controversial accounting standard. Sir David Tweedie acknowledged that it was necessary to rework it in order to tackle this recurring problem for once and for all. Regardless of the reform implemented, the one cast-‐iron certainty is that it will not totally satisfy anyone and will come in for plenty of criticism, an unfortunate fact for which the IAS board is fully prepared. The three phases cover classification and measurement; dynamic provisioning and hedge accounting. IAS 39 is an accounting monster (we prefer to compare it to a sort of hydra) consisting of nearly 300 pages. According to Philippe Danjou, a French member of the IASB, “Overhauling IAS 39 is akin to renovating the Château of Versailles”. But is this really an appropriate comparison? Not really, as the classical spirit of this château, albeit adorned with some baroque touches, constitutes the zenith of French art and nobility, with a sundrenched aspect that, in our humble opinion, has little in common with the IAS 39. We would, however, concur with the view that it amounts to a colossal undertaking. The aim of Sir David and his acolytes was to, wherever possible, simplify the measures taken. The measurement of financial instruments has thus been reduced to two methods (amortized cost and fair value) and the number of classes has also been cut.

4.6.4

Convergence or divergence?

The United States appears to have opted to move towards what is known as “full fair value” for all financial instruments. In doing so, the FASB is deviating from the previous model and from the IASB’s guidelines. Nevertheless, both signed the Norwalk agreements in 2004 and, as recently as 5 November 2009, reaffirmed their MoU (Memorandum of Understanding). They even voiced the idea of intensifying their efforts in order to rapidly finalize the joint projects that are on the table (target date set: June 2011) and reiterated their desire to adopt measures in line with the wishes of the G20. David Wright, from the European Commission DG Internal Market, publicly expressed his concern regarding the risk of an absence of convergence between the two main global accounting standards, as neither the IASB nor the Commission intends to converge by simply aligning themselves with the new American model. Listening is one thing and understanding is another, but finding a solution is trickier still when the concessions aspect and pragmatism are often notable by their absence within the IASB. In their defense, however, defining one perfect standard applicable to all is far from straightforward. It is like trying to square a circle as, whatever the board decides, some parties will be left dissatisfied. The fundamental remit and foundations of the IASB are based on the aim of meeting the needs of investors (users) by compelling the companies’ concerned (preparers) to employ greater transparency and care. After all, the aim of the IASB, like that of many parties concerned, is to bring about or at least contribute to the increased stability of the financial markets and systems.

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4.6.5

Hedge Accounting

The third tranche of the IAS 39’s renewal has determined the character of its successor. It was issued in 2010 and then reviewed. Eventually, the initial discussions seem to be heading towards fair value measurement, with the resulting variations to be recorded as own capital and not solely in the profit and loss account. Nevertheless, this ED was inciting considerable fear within the financial community. At a juncture when the USA wanted to take another route, there was good reason to be fearful. Numerous treasurers were hoping that the new standard will not be too different from the initial rule and that a good part will be left to the mixed model, thus permitting greater latitude and offering improved flexibility vis-‐à-‐vis the actual and practical needs of users. We still may then need to modify and adjust our hedge strategies, and it will also be necessary to adapt our information and treasury management systems (TMS) in order to meet the new requirements and supply the information required. Like Saint Thomas, we will judge on the basis of the actual evidence when the final IFRS 9 will be put in place to really analyze benefits of new provisions. It can be compared to “The Empire Strikes Back”, from George Lucas’s celebrated Star Wars trilogy. But instead of triggering a revolution, the newly simplified IAS 39 will hopefully be accepted by many without complaint. After all, its comprehensive makeover should facilitate the recording of results and the reading of annual reports.

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4.7 IAS 39: Every Cloud Has Silver Lining.… “That which does not kill us makes us stronger” (Friedrich Nietzsche)

4.7.1

IAS 39, the disdained rule…

When thinking about IAS 39, we can see the "other side of it" and wonder if some won't take advantage of it. Banks, although having indulged in harsh criticism of this revolutionary accounting standard, as well as certain service providers are likely to benefit from certain induced positive effects of the prohibition of netting long and short foreign exchange positions. There has been quite a lot of frantic criticism of this accounting standard on which a great deal of ink has been spilled since 1999. From bankers to insurers, to corporates, to auditors or even institutions in charge of accounting standards, all have aired their respective grievances concerning this new accounting rule. It indeed turns upside down the classic approach based on the historic value, preferring to rely on the "Fair Value" principle. Paradoxically, the least virulent and most constructive reactions came from corporate treasurers who had recognized the importance of adopting an accounting rule for financial instruments. They nevertheless recommended various amendments or practical corrections that were considered absolutely necessary. Most of these amendments were anyway adopted in two stages, with the exception of one, which is the most important: namely the "netting" of long and short positions to reduce foreign exchange risk (so called “Treasury Centre Netting”). Nevertheless, this apparently insignificant prohibition will, in practice, have important implications for all treasury centres. Because of this prohibition, the very essence of centralizing foreign exchange risks loses all its "raison d'être". It's as if the IASB were defying all practical common sense, which nonetheless is necessary. For other reasons, more particularly, because of frequent criticism from the banking world, the final adoption of the IFRS, including IAS 32 and 39, has been delayed. Maybe we will have to wait until autumn 2004 before the European Commission confirms the adoption of the global set of standards, without restriction, which is to be expected as things stand now.

4.7.2

Prohibition of netting

It is no longer possible to offset a long foreign exchange position, with another short position of the company for the same pair of currencies. Such offsetting nevertheless makes sense financially, because it allows reducing the basis of foreign exchange risk (cf. prohibition of IAS 39 § 133 in contrast to FAS 138 under US GAAP). This global basis of

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the foreign exchange risk will thus increase by the amount of the currency of the minor position (long or short), which the company used to deduct from the major position (short or long). Nevertheless, this apparently inconsequential prohibition of a current treasury practice, tolerated owing to the interpretations by the IGC, will sometimes generate an enormous inflation of the number of foreign currency hedging contracts. We can very well imagine that for certain companies, pursuing diversification; this number could increase and even been close to 100%. This will not fail to have consequences on the company's treasury management (1).

4.7.3

Management of foreign exchange risk, a real "grocery store"

But IAS 39 also means an increased number of hedging contracts. Indeed, the micro-‐ hedge approach (one hedge per underlying risk) is almost inevitable in practice and the aggregation of positions, whether long or short, is more delicate. Likewise, for those wishing to mitigate to the maximum possible extent, the impact on their income statements, it is useful to adopt a strategy of the type "forward-‐to-‐forward" revaluation by which the entire fair value ("Mark-‐to-‐Market") is taken into account in equity ("Equity Hedging Reserve" under IFRS). To adopt this strategy, it is obviously necessary to be able to justify the relevance of the hedge and the concomitance with the maturity of the underlying. This leads many treasurers to hedge in a dedicated, individualized way and "to slice-‐up like a salami " the foreign exchange hedges. It also forces them to hedge in a more precise manner, to enhance the cash flow forecasts and sometimes to hedge for a longer term. All these elements, moreover, contribute to an inflation of foreign exchange transactions. The application of IAS 39 to the management of financial instruments may in a way be compared to the backward evolution from a hypermarket to a grocery store. Such transition involves real financial cost through the increasing number of deals, the nominal value of which may in certain cases be very small (model of the "micro-‐hedging" type), and owing to the absence of netting, the greater risk of error as well as owing to an increased administrative burden in connection with the management of the exchange contracts, both at the internal (with affiliates) and the external level (with financial institutions). The very essence of IAS 39 and this absence of netting inevitably lead to an increase of the operating risks and financial costs for the company, which will be obliged to distribute in a more specific manner its FX hedges. Certainly, aggregating long or short positions is still possible but it is limited in practice. Furthermore, the prohibition to use cash flow hedges with longer maturities than the maturities of the underlying risks will also lead them to rely on dedicated micro-‐hedges.

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4.7.4

To whom it benefits ...

The big beneficiaries will no doubt be the banks that will see the number of deals on financial instruments grow substantially in the future. This increase will involve an increased number of foreign exchange credit lines as a consequence. The extension of the hedging terms – more dedicated – will also have a negative impact on the price (new trend that has been observed with major banks overweighing long maturities) and the utilization of credit lines. This could moreover become, sometimes, a real problem for certain companies with tight financial structures and which are furthermore heavy borrowers. The bankers who through their lamentations – which is certainly understandable – strongly weighed on the future of the IFRS in Europe, finally have found a subject of comfort here, thanks to IAS 39. Thus not all is lost for them in this fierce accounting battle.

4.7.5

Indirect beneficiaries

This prohibition is a strong argument for relying on on-‐line trading platforms ("e-‐ trading" such as Currenex or 360T, for example), which allow handling smaller amounts per transaction while benefiting from attractive prices and by diversifying the number of suppliers in terms of financial products available. Those adamant in their unwillingness to use this type of platforms will have to reconsider seriously this useful solution in the face of the new problem described here. Behind these internet trading solutions, the reliance on on-‐line service providers of matching confirmations of FX transactions, will become even more essential to every treasurer for ensuring more effectively smooth execution and settlement of his hedging transactions. One of the responses to this technical multiplication of hedging transactions for a treasury department will no doubt be the reliance on this type of on-‐ line tools, the performance and the reliability of which are henceforth recognized by all. The treasurer can thus benefit from relief of the administrative burden owing to greater automation of the processes of hedging foreign exchange risks and reduce risks of error inherent in the increasing number of negotiated contracts.

4.7.6

Not the end of the story

It is in adversity that we learn how to react. However, the intense lobbying of European Treasurers' Associations (EACT) has led to nothing. The prohibition Treasury Centre Netting remains a problem for any company exposed to exchange risks. The reliance on tools or solutions of the ASP type, more adequate for the management of financial instruments, is, in our view, necessary and even advisable. The IASB must undoubtedly have thought that corporate treasurers were getting bored. But alas, that was forgetting sound financial common sense. Finally, once again, as regards IAS 39, we may wonder

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why things should be made simple when they can be made very, very complicated. Fortunately with IFRS 9 and the work of the IASB we could expect positive changes in future and the provisions to be relaxed in order to better match real economy hedging practices.

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4.8 Fair Value could become very complicated to determine in volatile markets. “A reasonable probability is the only certainty” (Edgar Watson Howe)

4.8.1

Volatile markets

Nobody could dare contesting the current market volatility: gold; crude oil; commodities; USD/EUR, GBP/EUR; some emerging countries’ currencies or even interest rates. In such a complex market environment, we all understand why lots of European treasurers complain about financial reporting. We have entered into a credit crunch phase although there are huge liquidities on the market not suitably allocated because of a lack of confidence and absence of visibility. It is the current market paradox. Now these complains seem to focus on the Fair Value for reporting financial instruments. EACT has reported several times recommendations from its members for more guidance and also clearer rules to valuate financial instruments. It is particularly crucial when markets are under stress and when we face turmoil. In annual reports, there should appear better, clearer and more comprehensive disclosures on methodologies and (potential) uncertainties in valuations. We all heard these proposals made to IASB to make easier for preparers to possibly move their financial instruments from “Available-‐for-‐Sale” (AFS) category the “Held-‐ to-‐ Maturity” (HTM) one. As HtM does not require being fairly (re)-‐valued, its potential implied volatility can be parked. When markets have shacked, this could of course be comfortable until economy comes back to more normal market conditions. It obviously artificially hides an unpleasant economic reality at top management discretion. But who dares pretending what is normality in current market context? No one I guess. Furthermore as always, it would generate additional complexity and new rules complexifying an already complicate standard. The risk of inconsistent application of the rule could be negative in terms of clarity and understanding for users.

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4.8.2

The International Accounting Standard Board (IASB)*

IASB* has addressed in March 2008 the issue of complexity of the reporting of financial instruments. Everybody knows its long-‐term intention to apply the fair valuations to all instruments. Therefore, any attempt to set up an intermediary solution shaped towards a simplification of current rules could only be welcome. In this view, the reduction of financial instruments categories is a good idea the “group of 4” (at FIWG) has presented and defended When markets are illiquid or stretched, it becomes extremely difficult to assess the FV. On the other hand no one could reasonably expect IASB to come back to a reporting at cost. The Cornelian dilemma comes from the need for clearer guidance on valuation although it is highly complex to achieve. Everybody would prefer principle-‐based standards (even in the US) and not too detailed rules. But the more IASB issues guidance, the more standards become rule-‐based. We know that IASB refuses this tendency to inflate rules. We believe them when they desperately claim for simplification. What we refuse is a radical more towards full FV. Concise guidance is a sort of accounting Holy Grail for financial instruments. To impose one methodology would be over simplistic and simply impossible. Let’s remain realistic! Numerous users require more disclosures although others complain about current length of financial reports, which, in fine, reduces understanding and transparency. We have certainly (partly) missed the initial goal on IAS 39 and IFRS 7. We should not hide or try to disguise the economic reality, a fortiori in a troubled market. From the presentation of results it should be clear for users to understand from where volatility is coming from. To inundate reports with additional disclosures would be counterproductive. We all hope simplification will emerge from new IFRS 9.

See website www.iasb.org

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4.9 Ways of financing and hedging investments in volatile currencies “Little by little, one travels far” (J.R.R. Tolkien)

4.9.1

Introduction

For multinational companies, investing in countries with volatile currencies and high inflation rates could raise some classical issues very often faced but not always properly addressed. Usually, these issues are linked to future cash flow generation and consolidated EBITA contribution (in group functional currency), upstream of dividends (provided absence of restriction on dividend payments) and protection of asset translation on group balance sheet. Under IFRS, the choice of ways of financing and hedging the acquisition, depending on group strategic objectives are not neutral. Accounting and financial consequences need to be carefully contemplated before investing, especially when local currency of target is more volatile and interest rates higher than EUR or GBP.

4.9.2

Different approaches

Sometimes, some groups prefer to ignore these types of translation risks. Some others try to find ways to properly protect their exposures. But no perfect solution exists. Every strategy and approach imply accounting and/or financial consequences they better have to assess before being applied. In some other cases, a natural hedge and a matching between assets and liabilities in the risky currency could be a solution (an asset translation exposure offset by a bond issue in the same foreign currency). A dedicated hedging strategy is also foreseeable depending on objectives and concerns of the group.

4.9.3

Types of risks in case of acquisition in foreign currency

The group faces a currency exposure on dividends, which are sort of crystallization of net results of the subsidiary and on translation of both profit & loss statement and balance sheet of the subsidiary into the group functional currency. The IFRS consequences of each possible hedging approach should be contemplated or at least accepted. Under IAS 39, accounting consequences often drive financial decisions. Decisions could go beyond the pure financial logic. Treasurers are somehow forced to put the cart before the horses. It is therefore necessary to first define the objectives of hedging (if any) before determining the strategies to be applied. For example, the objective could be to limit the P&L or balance sheet volatility as far as possible or to

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protect future cash flows of dividends, or even, independently of potential accounting consequences, to hedge an identified risk.

4.9.4

Possible solutions

A group could be tempted by borrowing in the foreign currency to “hedge” the future dividend up streams. The loan repayment will be serviced by the dividends received (natural hedging). But the bank loan in local currency needs to be treated as net investment in a foreign entity in order to benefit from hedge accounting treatment. It means that the changes in spot value of the loan, calculated as under IAS 21 go into a separate component of equity named “CTA” (“Cumulative Translation Adjustment”) by American. This CTA will only be released into P&L upon disposal of the subsidiary. That solution, provided we apply hedge accounting, appears attractive for multinationals. Nevertheless, the other side of the picture is the cost of financing, which will be higher given the interest rate level of the foreign currency, consequences of a more volatile environment and higher inflation. Furthermore, the interest flows are not, a priori, hedged. The dividends are therefore economically hedged. Of course, it is essential to check that there are no restrictions on dividend payment to a foreign entity, which could sometimes be the case for high inflation countries.

4.9.5

Volatility mitigation

There is no volatility of the P&L generated by the loan revaluation as hedge accounting is applied. But there still is volatility of the P&L contribution of the subsidiary acquired into consolidated accounts of the group (upon consolidation method applied and depending on shareholding percentage). The P&L translation of the subsidiary will be based on the average exchange rate of the year. Lastly, there is no or little CTA volatility for the portion of the net assets covered by the loan (balance sheet translation movement) given the offset with CTA generated by hedge accountability of the loan in local currency. But this offset remains limited, as it will be reduced in proportion of the loan amortization. Therefore, it is not the perfect solution as the subsidiary P&L translation risk remains. Does a perfect solution exist? It does probably not exist. The solution to recommend depends on strategies adopted by the group and objectives in terms of risk management. Each one will try to find the most appropriate solution corresponding to its own constraints and views. The other approach very often adopted by groups is the purchase of the target by selling EUR or GBP and by buying the local currency. Accounting wise, there is no P&L impact at acquisition and on ongoing basis. There is no need for hedging instrument. But dividends remain economically un-‐hedged. The subsidiary P&L translation risk remains

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unprotected too. On top of that there still is balance sheet (CTA) volatility on the asset value, which is not hedged either.

4.9.6

Hedging of balance sheet translation risk

The idea of groups could be to hedge the asset potential devaluation by a financial instrument (sometimes without currency delivery but cash settlement– Non Delivery Forward type). Unless, they applied the strategy defined above for dividend hedging via local currency loan, they are equity exposed to currency devaluation. The recourse to NDF’s could partly offset translation change in value of asset. Without hedge accounting, such a strategy is not worthwhile, as it would generate P&L volatility on the derivatives. It is allowed, under IAS 39, to apply hedge accounting by hedge relating the financial instruments to the investment (“net investment in a foreign entity”). The effective portion of the change in fair value goes into a separate component of equity (CTA). When forward-‐to-‐forward method is applied, all changes (swap points and spot movements) go to equity, subject to effectiveness testing. There is no interim volatility of the P&L but, at rollovers, NDF’s will generate cash impacts (not P&L impacts). As the defined solution above described with local currency loan temporarily achieved translation risk hedging, it could be combined with such products for the remaining portion (which will increase upon loan amortization). In the first solution presented, we were trying to hedge dividend flows, which are a sort of part crystallization of net revenues. Unfortunately, the hedging of the P&L translation risk with hedge accounting treatment will not be possible, as we however thought with former proposed solution of IASB for inter-‐company cash flow forecasts (cf. former proposed amendment). Hedging a risk while creating an additional volatility besides would be a non-‐sense.

4.9.7

No perfect solutions

It appears that, depending on objectives followed, some solutions could be applied in order to (partly) mitigate foreign exchange exposure (translation and/or transaction risks). However, there are no perfect solutions to be applied in any situation. The approach of such FX risks should be dedicated, analyzed case by case, with deep look on potential accounting consequences and a full disclosure of them to the CFO, in light with market views. The strategy should take into consideration a realistic cash flow generation of the target to be acquired. A detailed cost benefit analysis should be run by the treasury department to assess potential advantages of a solution, in light with disadvantages and negative consequences. A dynamic approach and a close monitoring of open FX (translation) risks could also be applied or combined with dedicated strategies. Hedge accounting administrative burden should always be kept in mind before entering into similar hedging strategies. Decidedly, life is never simple under IFRS…

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4.10 How could an accounting standard setter respond to a credit crisis? “Close scrutiny will show most crisis situation are opportunities to either advance, or stay where you are” (Maxwell Maltz) This is a very complex question. Accounting rules are formal ways to translate financial operations. It is a sort of blood test. But, despite a blood test should not be considered as responsible for a disease, some keep considering IAS rules were somehow responsible for the crisis or at least have not helped to maintain financial stability. Because of these critics, demands from European Union (EU) and stakeholders pressures, IASB decided to react. The IAS Board decided end of 2008 to provide EU with an update of its response to the credit crisis and how they planned to address the various issues. IASB wanted to take number of significant steps to improve accounting guidance based on FSF (Financial Stability Forum). One of the main issues was the fair value measurement when markets are no longer active. Logically, the accounting translation of a financial instrument should not be responsible for its quality and current valuation. However, during such an economic crisis, people feared it could drive to further market deterioration. The first answer from the IASB was to organise round tables with experts to address issues (1). Both international Boards (IASB & FASB) were committed to urgently respond to this unprecedented situation facing financial markets. The IASB made an amendment to IAS 39 to permit certain reclassifications out of HfT (Held-‐for-‐Trading) and AfS (Available-‐for-‐Sale) categories. Many financial institutions have in Europe used the fair value option to eliminate or significantly reduce measurement mismatches. However, a virtual disappearance of some markets may have had an impact on the way instruments are managed. The problem comes if you opt for the fair value option and no subsequent change in the classification is permitted. The need for further guidance in application of the fair value in illiquid markets was identified by the EU, notably on the use of mark-‐to-‐model. Summarized, the EU issues were 4: 1. Ensuring that financial assets presently classified under FVO can be classified into other categories and not measured at FV; 2. Clarification whether CDO’ include embedded derivatives;

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3. Adjustments to impairment rules applicable for A-‐f-‐S assets; 4. Need for guidance on FV in illiquid markets

Actually, IASB has better defined guidance on application of FV when markets become inactive. It also published in December proposals to strengthen and improve accounting requirements for off balance-‐sheet items. Furthermore, it published new disclosure requirement related to impairment. The two major Accounting Boards seem to cooperate to accelerate efforts to harmonized positions and solutions. Eventually, IASB is considering some other key issues related to financial instruments, including the FVO, raised at recent round tables and by EU in its letters to the Chairman of IASB. This last issue is certainly more complex than what it seems and some specialists are not fully convinced that reclassification out of FVO would improve financial reporting and enhance investor’s confidence. EACT will have to keep following the solutions IASB will propose.

4.10.1 Crystal-‐Clear Transparency for Financial Instruments with IFRS 7

“All changes, even the most longed for, have their melancholy, for what we leave behind us is a part of ourselves; we must die to one life before we can enter another” (Anatole France)

4.10.2 IFRS 7, A New Accounting Standard for Financial Instruments Disclosures

The IASB created a new standard, known as IFRS 7, for the information that must be disclosed in regard to the use and management of financial instruments. This standard went into effect as of January 1, 2007. Sir David Tweedie, former President of the IASB, believed that this standard provides better information for investors, so that they can determine how to manage the risks taken by companies and thus make a more informed assessment of them.

4.10.3 Information Provided by the Treasury Department

The types of information that the Treasury Department must provide for the production of the annual report have been greatly diversified over the past few years. The quantity

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of information published did not stop increasing with IAS 39. It could be reasonably estimated that this information accounts for about 12 to 14% of the entire financial portion of the balance sheet. If we include the information pertaining to Enterprise Risk Management (ERM), for which the treasury is also sometimes (partially) responsible, this percentage can sometimes be 14 to 16%. With IFRS 7, this percentage may even reach 18% (based on estimates and a few rare examples of existing cases).

• Financial Risk Management • • • Treasury (incl. IFRS 7) 18%

• •

• Impairment of financial assets Enterprise Risk Management (ERM) * • Interest income/expense • Financial fees and commissions paid Interest (net) and financial results • Loans & bank overdraft Net debt/cash position • Currency translation reserve (CTA) Cash & Cash equivalents • Hedging reserve Own shares / Treasury shares • More disclosures on liquidity risk, credit

• Related party transactions /

Transactions with shareholders Others 82,0%

• Derivative financial instruments and hedging activities – FX / IR strategies and policies description

• Leases (Estimate based on RTL Group and companies early applying IFRS 7)

risk and market risks – Sensitivity analysis

• Hedge Accounting : more disclosures • Measurement of financial instruments by category

• Fair values of financial instruments

* Including ERM disclosures

Or course, the extreme, comprehensive nature of IFRS 7 can be explained by the fact that it must also be applicable to banks and financial institutions, whose business is, by definition, financial instruments. The goal is to require more details and greater uniformity of information provided, and to eliminate opportunities for concealing potentially corrupt or dangerous financial transactions. With these rigorous new accounting standards, the IASB hopes to force companies to become more virtuous. The famous IAS 32 (the corporate equivalent of IAS 30 for banks) defined the “disclosures” and other information that companies had to report under IFRS. In the summer of 2005, the IASB published IFRS 7 “Financial Instruments: Disclosures,” which maintains the IAS 32 reporting principles, while adding significant new and supplementary information for inclusion.

4.10.4 Yet Another Major Project for Treasurers?

It may be a relevant question to ask whether this new standard will be the next major project for treasurers. Won’t it be another nightmare for treasurers who are already overworked by the infamous IAS 39?

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IFRS 7

IFRS 7 will specifically require disclosure on: 1. The materiality of financial instruments and financial position, as well as their performance 2. The nature and extent of the risks of managing these products, as well as the way in which they are managed and used 3. The information will be both qualitative and quantitative.

4.10.5 Following the Trend of Improving Internal Controls

The all-‐too-‐famous Sarbanes-‐Oxley Act, which was established in the U.S. and which, sooner or later, we can expect to see translated into European law, instilled an increased need for internal controls. These regulations gave rise to greater virtue and a concern for transparency that was too often lacking. In any event, the most philosophical among us may say that every cloud has its silver lining. This may be true, but others may respond that it is better to leave well enough alone. Enterprise Risk Management (ERM), accounting transparency, the establishment of internal procedures and regulations, as well as ad hoc controls, the clear segregation of tasks, uniform accounting standards and increasingly strict European regulations are all contributing to this new, more virtuous approach. These requirements naturally imply more discipline and rigor, more simplicity and more connections between IT systems in order to avoid redundant data entry and the risk of manual errors. Fear of the authorities, strict rules, formalities and increased transparency have put us in a completely new environment, far removed from the deviance, blunders and other scandals of the past. In this respect, the IFRS falls in line with the various local regulations that are the European equivalents of Sarbox, such as the German Kontrag, the French Loi de Sécurité Financière (LSF) or Dutch Tabaksblat Code. This is just one of many reasons that justify the central role that the treasury must play in establishing the Risk Management process and a Risk Committee.

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4.10.6 How To Deliver This Information Clearly, a well-‐managed Treasury Center will be able to provide the key information required by IFRS 7. In one form or another, the information exists. Of course, the TMS (Treasury Management Systems) or the ERP do not provide much of the information required by this new accounting standard. We should expect that the treasury will continue to use the traditional calculation sheets for a long time to come. Information systems will have to undergo many developments over the next few years before they can be in complete compliance with the new standard. IFRS 7 is the consolidation of the IAS 39 requirements for qualifying hedge accounting. It defines the guidelines to be followed and the format, which is now compulsory, in which the information must be published, including procedures, policies, reports, management strategies, objectives pursued, risks incurred, potential impact evaluations, and others. Many companies began by drafting procedures that they do not yet have, or verify, rethink and secure existing ones in innovative ways. IT tool and its content were subject to regular, precise, specific reviews. The fluidity of the information chain from the operational mechanism (the source of underlying risk), to the management controller (the interface between company headquarters and the operational subsidiary) to the group treasurer had to be completely revamped. This confirms that IAS offered an opportunity to review all of the internal procedures and the information chain so that they can be streamlined.

4.10.7 Mission Accomplished?

Will this accounting standard enable readers to understand the potentially significant role of financial instruments in evaluating the performance of a company, and the nature and extent of the risk that would result from the financial instruments to which the company is exposed (even if they are intended to cover risks)? The extent of the information that must be published, compared to the prior IAS 32, is indeed much greater. For example, it will be mandatory to disclose information on loans and credits to be received (maximum exposure, related credit derivatives), the fair value of collaterals granted as well as their terms and conditions, and details on defaults and breaches of financial agreements that might call for immediate repayment and whether or not they have been settled. It will also be necessary to publish details on the way in which the company manages risks, the average exposure amounts by risk type and their concentration. Liquidity risk analysis is also required (maturities, unexpected flows) as well as market risks (sensitivity, for example, on a 100-‐base point change in interest rates with the impact on the balance sheet and on the income statement or even credit risk (maximum exposure, collateral, analysis of financial assets due or impairments).

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4.10.8 Fundamental Shift in Mentality In the end, isn’t the overall objective to change mentalities and increase the safety of shareholders and company employees? Of course, the cost of attaining this goal is high for financiers. However, it would be reasonable to think that mentalities have already begun to change and that a new generation of treasurers has come into being. These new financiers are gradually accepting this significant “reporting” portion of their duties. The prestige aspect of “front office” duties has completely disappeared. They are accepting the more rigid, restrictive framework in which they must perform their duties without flinching too much, as if it were natural. After all, isn’t that the best proof of a profound shift in mentality?

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4.11 IFRS 7, a new nightmare for corporate treasurers? “To win without risk is to triumph without glory” (Pierre Corneille)

4.11.1 “7, red, uneven and lacking”

One of the main goals of international accounting standards and of the IFRS in particular, was clearly to improve the level of information contained in companies’ annual reports, as well as transparency. The IASC (which has since become the IASB) wanted to improve financial transparency by increasing the quantified data to be disclosed in a more uniform, standardized manner, while limiting the accounting latitudes of the past. Through new accounting rigor, the IASB wanted to force companies to become more virtuous. The famous IAS 32 (for corporates and IAS 30 for banks) defined the disclosures and other information that companies were supposed to report under IFRS. In the summer of 2005, the IASB published IFRS 7, “Financial Instruments: Disclosures”, which maintains the presentation principles of IAS 32 while adding a great deal of new, additional information to be provided.

4.11.2 New nightmare for treasurers?

It may be interesting to wonder if this new standard will be the next big area of focus for treasurers. This new accounting standard is applied as from 1 January 2007. Treasurers’ lotto card is starting to slowly fill up: the “1”; the “21”; the “32”; the “39”; the “7”. What will the next number be? IFRS 7 will make it necessary to specify: 1. Relative importance of the portfolio of financial instruments held in position, as well as the overall performance of the envisaged entity 2. Quantitative information on market risks, liquidity risks and credit risks, as well as the more traditional risks of raw materials, equities, foreign exchange and interest rates 3. Qualitative elements describing the management and treasury goals pursued and fixed by senior management, the overall financial risk management policy, existing procedures, relative performance and the adequacy of results vis-‐à-‐vis the scope of the risks incurred

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4. Foundations and assessment of the information provided to senior management

To the quantitative and enumerative criteria, IFRS 7 adds more modern qualitative analytical and measurement criteria to risk management (sensitivity approaches, V@R / Value at Risk and models close to the third pillar of Basle II).

4.11.3 New information or disclosure now obligatory

Clearly, a well-‐managed treasury department is capable of providing most of the information required by IFRS 7. The information exists, in one form or another. Naturally, TMS (Treasury Management Systems) or ERPs cannot provide much of the information required by the accounting spread sheets for a long time to come. Information systems will still undergo many developments in the coming years in order to be in full conformity and compliant to IFRS 7. IFRS 7 is the crystallization of IAS 39 requirements for the qualification of hedge accounting. It defines the types of guidance to follow and the format, now compulsory, of the information to be published: procedures, policies, reports, management strategies, objectives pursued, risks incurred, measurements of potential impact and others. Many companies will begin by drawing up procedures that they still do not have or they will check them, rethink them and make them dynamically secure. IT media and their contents must be reviewed -‐-‐ regularly, precisely and specifically. The validity of the information feedback chain between operational (the source of the underlying risk), the management controller (the interface between headquarters and the operating subsidiary) and group treasury must be completely revisited. This confirms that IAS offers an opportunity to revisit all of one’s internal procedures and the information feedback chain with a view to optimizing them.

4.11.4 IFRS in line with regulations on risk control and management

The IFRS are consistent on this point with various local European regulations, the counterparts of Sarbox, such as Germany’s Kontrag and France’s Financial Security Law. This is one of the reasons, among others, that justify the central role that the treasurer must play in setting up risk management processes and a Risk Committee. For all of these various regulations, the treasurer will have the delicate task of demonstrating – regularly and constantly-‐-‐ the adaptation of procedures and systems to operational changes. The tracking and feedback of information and risk, and checking and appropriate covering must be demonstrated on a regular basis. Accordingly, we see

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that the demands are high and the treasurer must equip himself with appropriate, solid and powerful information systems to fulfil his obligations and to carry out his mission. “Treasury” is less and less a “do-‐it-‐yourself” kind of job. The position has become extremely technical and deliverables have become complex and precise. Treasury Financial Reporting & Related Controls

4.11.5 Objectives and measures stipulated by IFRS 7 This new accounting opus will apply to all companies, regardless of their size. The now “traditional” idea is to enable users to assess the potentially significant nature of the financial instruments in assessing their performance and the nature and scope of the risks that result from the financial instruments to which the company is exposed (even if they are intended to hedge risks). The scope of the information to be published is much larger than the previous IAS 32. For example, it will be necessary to disclose information on loans and receivables (maximum exposure, credit linked derivatives), the fair value of the collateral granted, as well as their terms and conditions, details on defaults, breaches of financial covenants that could lead to immediate reimbursement, and whether or not this situation has been remedied. It will also be necessary to publish details on how the company manages risk and the average exposure amounts by type of risk and their concentration. It is also necessary to analyze liquidity risk (maturities, non-‐discounted flows), market risk (for example, sensitivity to a movement of 100 basis

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points on interest rates with the impact on the balance sheet or profit and loss account, or credit risk (maximum exposure, collateral, credit enhancements, analysis of financial assets due or impairments).

4.11.6 Information provided by the treasury

For a few years now, it can be said that the treasury department produces more and more financial information for the presentation of the annual report. The scheme describes the type of information provided by the treasury and its share of the financial data. IFRS 7 contributes in accruing this important treasury contribution. It can be estimated that 15 to 18% of the financial information is now produced by the treasurer (under IFRS 7). This information takes on the shape of tables, numbered data, analyses, notably of sensitivity or text comments, destined to explain strategies, coverage policies and the profile of group risk.

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4.11.7 How does one implement IFRS 7? To implement IFRS 7 a company starts with a complete review of procedures and risk management policies in order to define the adjustments that need to be made. Then, one must establish a gap analysis by reviewing IFRS 7 paragraph by paragraph. The ideal situation is then to suggest a solution, a table or a text comment in order to conform to the rules of the new measure. This information, as much from a formal than a content point of view, will be qualitative and quantitative. It is necessary to define the means of collecting the information required. This could require developments in the information or consolidation systems. The sensitivity analyses can imply recourse to ‘pricer’ type IT tools of or financial application software. Once the approach and format have been determined, it is best to have the financial statements to be published and divulged approved by internal audit, the auditing committee and the statutory auditor.

4.11.8 Too much is too much!

According to the popular saying, too much is too much. In accounting matters, there is a risk that it will be necessary to produce formatted information for which one may honestly wonder if it will be read and understood. That is the extent to which it is becoming dense. Doesn’t too much information kill the information? It certainly does! The IASB is still convinced that everything it does improves the standard on and understanding of financial instruments. Yet who would dare criticize those who demand greater virtue in managing financial risks? Is it not indecent to disapprove what is requested, even if accounting requirements are becoming extremely burdensome? To be more optimistic, perhaps we can envisage compliance as the possibility to metamorphose an apparent handicap into a genuine economic and operational advantage? To be in conformity, especially with IFRS 7, it is not too early to launch the complete, in-‐ depth review of financial management. In the near future, we can be sure that treasury will be the most transparent of all financial management departments.

4.11.9 Bankers call for review of financial rules

Bankers recently criticized and blamed accounting rules for having deepened the financial crisis. Can an accounting standard be responsible for a credit crisis? How can IASB respond to this situation? The CESR has its own view on these IFRS issues and surveyed top European companies.

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The Chairman of HSBC, Stephen Green said in Davos, in January 2009, that the current financial rules must be “fundamentally revised”, as they had deepened the financial crisis. He pretends that the capital adequacy regulations and fair value accounting were “well intentioned” but had proved to be inadequate. Some even said that these rules encourage banks to build up their capital instead of lend money to their customers. He thinks, as many bank fellows that “FV accounting has added considerable volatility to results, only part of which is economic…” many banks keep saying that financial rules worsened crisis. FV accounting would be used to determine the value of assets whose market price cannot be determined. Although these positions could be understood, it is too easy to only blame an accounting rule when bankers obviously manipulated instruments they were not understanding, not estimating risks and potential volatility. It seems too easy to designate a sole responsible to the current chaos. In the meanwhile, SEC head said accounting rules must be neutral. He pretended “accounting rules should not be bent to help soothe the battered US economy. “Accounting rules must be neutral and aren’t just another financial rudder to be pulled when the economy ship drifts in the wrong direction”. He added they are “instead the rivets in the hull and you risk the integrity of the entire economy by removing them”. Mr. Cos indicated that constructive revisions could be made to improve a rule that the banking industry had been pressing be suspended in the crisis. A SEC study has found most investors agree the rules provide a meaningful way to measure assets. He conducted saying: the more serious the stresses on the market, the more important it is to maintain investor confidence with neutral, independent accounting standards”. The standard setters must endeavor to continue developing robust best practice guidance for auditors and preparers – particularly for FV measurements of securities traded in inactive markets.

4.11.10 How could an accounting standard setter respond to a credit crisis?

“Close scrutiny will show that most “crisis situations” are opportunities to either advance, or stay where you are”. (Dr. Maxwell Maltz) This is a very complex question. Accounting rules are formal ways to translate financial operations. It is a sort of blood test. But, despite a blood test should not be considered as responsible for a disease, some keep considering IAS rules were somehow responsible for the crisis or at least have not helped to maintain financial stability. Because of these critics, demands from European Union (EU) and stakeholders pressures, IASB decided to react.

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The IAS Board decided end of 2008 to provide EU with an update of its response to the credit crisis and how they planned to address the various issues. IASB wanted to take number of significant steps to improve accounting guidance based on FSF (Financial Stability Forum). One of the main issues was the fair value measurement when markets are no longer active. Logically, the accounting translation of a financial instrument should not be responsible for its quality and current valuation. However, during such an economic crisis, people feared it could drive to further market deterioration. The first answer from the IASB was to organise round tables with experts to address issues (1)13. Both international Boards (IASB & FASB) were committed to urgently respond to this unprecedented situation facing financial markets. The IASB made an amendment to IAS 39 to permit certain reclassifications out of HfT (Held-‐for-‐Trading) and AfS (Available-‐for-‐Sale) categories. Many financial institutions have in Europe used the fair value option to eliminate or significantly reduce measurement mismatches. However, a virtual disappearance of some markets may have had an impact on the way instruments are managed. The problem comes if you opt for the fair value option and no subsequent change in the classification is permitted. The need for further guidance in application of the fair value in illiquid markets was identified by the EU, notably on the use of mark-‐to-‐model. Summarized, the EU issues were 4: Ensuring that financial assets presently classified under FVO can be classified into other categories and not measured at FV; Clarification whether CDO’ include embedded derivatives; Adjustments to impairment rules applicable for A-‐f-‐S assets; Need for guidance on FV in illiquid markets Actually, IASB has better defined guidance on application of FV when markets become inactive. It also published in December proposals to strengthen and improve accounting requirements for off balance-‐sheet items. Furthermore, it published new disclosure requirement related to impairment. The two major Accounting Boards seem to cooperate to accelerate efforts to harmonized positions and solutions. Eventually, IASB is considering some other key issues related to financial instruments, including the FVO, raised at recent round tables and by EU in its letters to the Chairman of IASB. This last issue is certainly more complex than what it seems and some specialists are not fully convinced that reclassification out of FVO would improve financial reporting and enhance investor’s confidence. EACT will have to keep following the solutions IASB will propose. 13 see www.iasb.org – letters from Sir David Tweedie to Jorgen Holmquist 14/11/08

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4.11.11 CESR statement of the reclassification of financial instruments CESR (Committee of European Securities Regulators) has closely monitored the amendments proposed by IASB regarding accounting for financial instruments. It has especially followed the discussions on fair value accounting. The review followed the approval by IASB, in October 2008, to amend IAS 39 and IFRS 7 concerning the so-‐called “reclassification between categories of some financial instruments”. This “crisis amendment” was endorsed at the same time by the European Union to be used in all country members. CESR has expressed its support for the initiative taken by the IAS Board, which eventually avoided another EU carve out. IASB and CESR were requested by the European Commission to start working on appropriate solutions specifically on FV option, embedded derivatives and insurance issues. The EU Commission stressed the urgency of finding good solutions to the identified issues as they needed to be resolved before end of 2008 (to be applied to 2008 figures and results)14. IASB answered in December 2008 to comment and explain how it intended to move forward. CESR considered three issues as matters of importance and to be solved rapidly: (1) FV option, (2) Embedded Derivatives, (3) Impairment of A-‐f-‐S items. CESR’s views on main IAS issues With latest amendment It is now possible to reclassify some financial instruments out of a category of instruments through P&L to other categories. However the new option does apply if the financial instrument has been classified into this category using the “FVO”. The EU Commission clearly stated that it should be possible. CESR has therefore urged the IASB to re-‐examine as a matter of priority the effects of the use of FVO in more details. The EU Commission also re-‐insisted on the issue of standards convergence (IFRS & US GAAP) in the area of embedded derivatives more specifically CESR is also concerned with the possible reclassification of the host contract (once split) to H-‐t-‐M category (not the derivative des-‐embedded). CESR welcomed the publication of the E.D. on amendments to IFRIC 9 and IAS 39. It encourages both accounting Boards to work closely together and FASB has recently expressed its agreement to work on ensuring US GAAP are applied in the same way as IFRS. 14 See ECOFIN – 2 Dec 2008 : “… it reminds the IASB of the issues recently revised by the Commission and urges the standard-‐setter to give urgent consideration to these and, when appropriate, to come forward with the technical solutions as requested in time the publication of year-‐end results”….

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Eventually, CESR is concerned by EU Commission issues raised of A-‐f-‐S. For A-‐f-‐S debt items, if impairment is identified, unrealized reduction of FV is treated as impairment and for A-‐f-‐S equity items; any impairment cannot subsequently be reversed. EU contemplates the appropriateness of these above measures. IASB answered to CESR that it is a complex issue. It will be included in recommending that IASB, in specific circumstances, should develop due process procedures with public hearings and consultation to enable to amend standards, when necessary in response to emergency circumstances.

4.11.12 Review of top European companies

CESR ran a survey to analyze 100 top EU financial companies (22 financial from FTSE Euro Top 100 + 78 other financial companies). The issue was to check whether other amendment or not, and if so the related disclosures (according to IFRS7). More than 50% did not apply the reclassification of instruments CESR is somehow more concerned by the disclosures on the reclassifications, which should be transparent, clear and comprehensive. CESR will continue to closely monitor future IFRS developments in the highly sensitive area of financial instruments and FV accounting. It is particularly cautious on IFRS 7 developments and transparency of disclosures to protect users. By simply reading available public financial information, a user (professional or not) should understand reasons for reclassification and how it impacts accounts It is extremely difficult to say whether or not an accounting standard setter can respond to the current credit crisis. It would also be unfair to condemn IFRS as being the sole responsible for such a financial chaos. On the contrary, without Fair Value, bank accounts would have been nuclear bombs nobody would even know about.

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4.12 Commodity Hedging in Europe “In the midst of writer, I found there was, within me, an invincible summer” (Albert Camus)

4.12.1 Commodity blues

Among other things, the second half of 2008 was marked, from a market point of view, by the steep drop in the price of raw materials, which peaked. We all knew that the prices were over-‐evaluated. The global economic growth supported the price of commodities for a long time. Yet, this market is characterized by its great adaptability. When the demand drops, the producers adjust their offer little by little (for non-‐ agricultural matters that are subjected to possible climatic contingencies). The relative gap between the spot price and the future price has currently hit record levels. The spot price, which we noticed the most, is decidedly that of petrol (almost divided in four as compared to its highest level in 2008!). But for the prices to stabilize, the balance must be made between offer (production to be deducted), demand (dropping) and that the intrinsic elements influencing the price do not interact (i.e. cold or warm weather, storms, floods, etc.). On the short term, no one predicts a real rebound of raw material prices. In fact, the adjustment of the production is never immediate and the increase in production requires an activation period. The elasticity has a certain technical or seasonal inertia. On the long term, an increase is expected. However, 2008 will not be forgotten. Even at USD 30 a barrel, everyone would like to pollute less, consume less, recycle what can be recycled and use more renewable energy.

4.12.2 Commodity hedging: tough task but necessary

The extreme volatility of raw material markets has pushed a number of businesses to cover their exposure even more. The turning of the markets disturbed them; some were even over covered. As always, it is in a period of crisis that we feel compelled to review one’s coverage strategies of raw materials. Some have covered more and more in a growth market context. Today, they are puzzled and questioning their entire coverage strategy. Yet, the strategy must be independent of the fluctuations of the raw materials demanded, which are big. The strategy is certainly not static, but requires a certain permanence to be useful. Today, the groups have been burnt: first not covered enough then very covered, then again too covered. And what should they do now?

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One must add to this dimension of commodity volatility, the volatility of the US dollar, which adds a layer of difficulty to any treasurer’s job. Any strategy must be harmoniously articulated. Besides the price risk, the risk of change (for a European), there remains the risk of illiquidity for certain raw materials. The last factor of complexity could come from the absence of an organized identical market. One must then make use of the coverage of similar underlying (highly) correlated stocks (ammonia and natural gas; jet fuel and Brent; Arabica and Colombian coffee, etc.) Too often the buyer cannot reflect the cost overrun on their sales, nor negotiate the agreements with their suppliers in order to ‘cap’ the purchase price.

4.12.3 Trading and coverage

Besides the coverage of the flows linked to buying raw materials, there are the purely speculative operations, which have been mushrooming. It is in fact useful to give volume and liquidity to the markets. The top managements and purchasing services have greatly involved themselves in these coverage processes, notably by readjusting the frame of the group’s strategy by way of the purchase committees of raw materials (a kind of organ of collegial decision-‐making). In general, policies are set for six months, as the markets move more quickly than before. Today, the climate factors (with temperature changes and much pollution), policies (i.e. Russia and the Ukraine for the transit of gas to Europe, conflict in the Middle East, etc.) and economics (less demand in a recession period) strongly influenced the price of commodities, and not always in a controllable way,

4.12.4 Common sense principles to be implemented

It is clear that as much as possible, the company exposed to the price of raw materials will (1) implement a common management framework between the purchasing department and financial department. From now on, the treasurer is directly involved in this type of coverage. (2) The company will generalize as much as it can the indexation of the purchase prices of raw materials on the indexes of liquid markets susceptible to allow the coverage. (3) It will improve its forecasts to more precisely determine the needs, and by doing so, avoid over covering. This implies active monitoring and constant updates of forecasts to adjust the resources to the demand. (4) Finally, it will apply a coverage strategy allowing for smoothing over time the impact of these variations. Sometime, this needs the help of a consultant and certainly a new organization and coordination between departments. An appropriate reporting must also be implemented for a regular follow-‐up of the open positions. The strategy and financial products to be used will also be well-‐defined in a policy validated by top management.

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In certain cases, since raw materials are the most often labeled and quoted in USD, the European company will add to the risk component on raw materials, the risk of the exchange rate USD/EUR. This rate can mitigate (like in 2008) a rise in the value of the underlying stocks bought, or worse, increase the risk. The correlation of the two impacts can make the European company less competitive than its American competitor (when the dollar is strong). Therefore, we see that the risk is linked to the underlying stocks or even sometimes the closest and most correlated underlying stocks and the quoted currency, without mentioning the political risks that can sometimes dry up a market if the production is highly concentrated on a geographic area.

4.12.5 Difficulty in covering properly and efficiency test issue

The efficiency test and the 80-‐125% corridor explained that sometimes coverage is inefficient from the start since the closest and most correlated underlying stocks are different. The risk of inefficiency was greater from the start than for the coverage of a rate or exchange, for example. This explains why certain treasurers have suggested removing this restriction so at least the efficient part, as weak as it may be, can be recognized as such and not impact the income statement. This proposed measure, notably by the ‘group of the four corporations’ within the FIWG (Financial Instrument Working Group within the IASB), takes on all its meaning here. It is one of the rare measures for which we could reasonably expect obtaining its removal. One must finally equip themselves with the appropriate tools or solutions to promote coverage, transmit the rapports planned for IAS 39 and IFRS 7, and test the efficiency and sensibilities of the coverage. It is far from being a simple task technically.

4.12.6 Communication on coverage strategies

The communication of the strategy used is always delicate. One must talk about it without talking about it too much or risk giving an advantage to a competitor. Some do not even dare address this point or do so in extremely vague and brief terms. Yet, any shareholder has the right to know how the group is covered, even more so in a highly volatile period. This exercise in transparency is very delicate and highly sensitive for a number of CFOs. Here again, the quoted company is penalized by a more organized and more formal publication or by the use of more restrictive IFRS accounting standards.

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4.13 Specific commodity hedgers, the forgotten… “No problem is so formidable that you can’t walk away from it” (Charles Schultz)

4.13.1 Specific issue of some commodity hedgers

So far (before IFRS 9), the IASB has forgotten some commodity hedgers. The hedge accounting for commodity works when underlying are listed or when futures exist on regulated markets. The use of ratio or differential techniques, although classical, often does not qualify for hedge accounting. The preparers involved in commodity hedging have tried to address several times a specific issue to the IASB without any success so far. It is (was) a real issue for lots of companies, which want to hedge specific commodity purchases. Usually commodities quoted on dedicated market places like Chicago are per definition of “common” quality and rather standard. But some companies look for protecting their purchases of commodities, which are not necessarily listed as futures or which are not basic in quality. For example, when a coffee manufacturer wants to hedge its Columbian coffee needs when Arabica hedging exists, what could he do? When an air freight company wants to hedge jet fuel purchases, what could it do apart from buying crude oil hedge instruments? 4.13.1.1 Differential technique To obtain the desired quality of commodity, a company would pay a differential (also called “ratio”) to obtain the required quality or type of commodity. Differentials and ratios are not derivatives instruments but are execution contracts. Although they only try to compensate the potential price difference between basic quality quoted and specific quality targeted. There are correlations between underlying commodities but not necessarily always a close one. Accounting wise, the problem comes from IAS 39 § 82 stating that when the hedged item is a non-‐financial asset or non-‐financial liability, it shall be designated as a hedged item (a) for foreign currency risks, or (b) in its entirety for all risks, because of the difficulty of isolating and measuring the appropriate portion of the cash flows or fair value changes attributable to specific risks other than foreign currency risks. In the previous version of IAS 39, a company could take the differentials and futures when determining effectiveness of commodity hedges. Depending on the price, the differential may render the hedge ineffective and inefficient as defined in IAS 39. The future hedge should be considered as partial hedge of the specific commodity

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requested. The difficulty of isolating and measuring fair value changes attributable to specific risks should not be a reason for preventing hedging of specific commodity risks. The ratio and differential techniques used for cocoa, coffee and other defined commodities are well known on the market and usually used by companies to hedge commodity risks. Futures only cover average quality and not specific ones. It corresponds to usual and best practice risk management policies applied by corporates for ages. These differentials have been invented centuries ago for offering such protections to purchasers of commodities. It is a partial hedge of a final commodity need. It is possible for credit risks and not for commodity risks. The spread is also a differential, which could vary independently from the underlying interest rate. 4.13.1.2 Solutions? Not really The regression analysis models are potential solutions. But these models are very complicate to run and imply sophisticated IT tools to be set up. Provided it is highly correlated and the best “known” hedging strategy or product available on the market, it should be tolerated. The differential should really be considered as a credit spread and should be excluded in the effectiveness testing and calculation. Weather elements, political conflicts, etc… could affect pricing of some products in certain areas and not in others, creating a certain de-‐correlation.

4.13.2 Removal of effectiveness corridor

The Working Group on Financial Instruments (WGFI) has addressed the idea of removing completely the band of 80 to 125% for the effectiveness testing. By excluding the effectiveness corridor to be respected at inception and throughout the life of the hedging instrument, IASB could give indirectly support to commodity hedgers when hedging of non-‐listed raw materials. At least when non efficient as defined by IAS 39, the whole hedging will not be ineffective but only a portion of it. The solution is certainly unsatisfactory for commodity hedgers. But we have experienced with IASB situations where half solution is better than no solution at all. It does not prevent us from keeping lobbying in favor of these specific hedgers. Fortunately, IFRS 9, once finalized, will remove the corridor of effectiveness testing.

4.13.3 EACT lobbying

EACT, as for tender portfolios hedging, tries to defend its member’s position each time it detects potential issues and practical problems while applying classical risk management strategies. As always with the IASB, no one can predict its reaction. The recent easing of its position on intragroup cash flow forecast hedge accounting opens doors to further

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necessary and logical amendments. When EACT Board members met the European Commissioner McCreevy, it reiterated its recommendation to adapt sound accounting rules matching best practices in terms of risk management. The position of the Commissioner, clearly stated in newspapers, proves that he did not intend to accept everything issued by the IASB. He promised EACT to keep requiring changes in IAS 39 where necessary. He was very sympathetic towards positions defended by our European Association of Corporate Treasurers. He understood treasurers act to eliminate as far as possible P&L volatility. The coming IFRS 9 will be the proof of his concerns. 4.13.3.1 Putting the cart before the horses An accounting rule should never prevent companies to keep using proved risk management techniques, used for decades. If so, it means financial decisions are sometimes driven by accounting rules. The IASB has often assumed, too easily, that in general risk management techniques used by preparers are speculative. If accounting was a science, as said by E.B. Titchner, we could sometimes think that common sense is the very antipodes of it.

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4.14 What is the True (Re)valuation of a Forward Contract? „The chief value of money lies in the fact that one lives in a world in which it is overestimated“ (H.L. Mencken)

4.14.1 Revaluation, divergence depending on the counterparty calculating it

The revaluation of a forward contract (absolutely basic contract) can come up with plenty of surprises when you compare the results provided by Treasury Management Software (TMS) with the revaluation produced by your banker. The "Mark-‐to-‐Model" method can differ from the "Mark-‐to-‐Market" method and low interest rates can in certain cases give rise, with long maturities, to significant divergences that are worrying for treasury managers and external auditors when they review the accounts. Forward contracts, (commonly called "forward outright” contracts), on revaluating a portfolio to market value for a quarterly accounts close, can give rise to strange results when compared to those obtained from the bank with which you are dealing. The treasury manager may be alarmed at this astonishing fact, given both the mathematical simplicity and the apparently basic nature of the calculations used. Certainly Treasury Management Systems (TMS), in general, use the same logical and long-‐established methodology. They all have very similar models which take account of the structure of the software application itself, of the way it works and also of its own logic. The calculations are based on yield curves and on the prices fed into the application by a reliable external source such as Bloomberg, for example. At first sight, we might expect the revaluations to produce similar results even if, perchance, the reference rates used were not exactly the same. A significant difference, relative or even absolute, may be a worry to the treasurer manager and give rise to questions from the auditors. For several technical reasons, this risk of divergence is greater than ever. Depending on the source of the revaluation, it can vary as we are going to demonstrate

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4.14.2 Method for calculating a forward foreign-‐exchange contract Here are the formulae used for revaluing a forward foreign exchange contract. Forward outright rate = spot rate x (1 + variable currency interest rate x days of settlement/days in year) (1 + base currency interest rate x days to settlement/days in year) NB: a further convention is that, for foreign exchange purposes, most countries deem the year to have 360 days Net Present Value (NPV) or discounting a future result NPV = C o + C 1 / (1+r) + C2 / (1+r)² + C3 / (1+r)3 … Where: R = discount rate which corresponds to: Rt / (1+i)t If you know these two basic concepts, all you have to do is follow the method generally suggested by treasury software applications. APPROACH: 1st step is calculation of the NPV for both legs of the forward deal 2nd step is the conversion of both legs of the FX deal in local functional currency at closing date Difference between buying currency NPV and selling currency NPV into functional currency equals the Mark-‐to-‐Market valuation of the forward deal NPVs are calculated by using Zero Bond Discounting Factors (ZBDF) Systems usually then use the linear interpolation method to calculate the ZBDF linked to an interest rate specific maturity, which is different from those loaded into the system (which are the classical 1, 2,3,etc months rates) The zero-‐coupon yield curve measures the relationship between a future value and its present value. In principle, the yield curves used should be consistent. Market prices ought therefore to be in line with theoretical prices. Based on market prices (i.e. swap points), we can calculate the implicit interest rate. Unfortunately, the results can sometimes turn out to be different. The "zero-‐ coupon" yield curve therefore often remains theoretical. The problems can arise from a number of sources. The methodologies used can explain some slight differences. But the main source of divergence comes from the prices and rates used. For instance, interpolation may be linear or cubic, the rate used may be implicit or market rate, it may be the “bid” or “ask” rate or yet again mid-‐rate, or the closing spot rate (but which closing? New York or Frankfurt?), etc.

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These various elements can explain divergences, especially when interest rates are at record lows and interest rate differentials are very slight. A small difference may thus translate in absolute terms into a significantly different amount on revaluation, giving rise to questions as to the method used, which the auditors may challenge. When we understand that the results can vary depending on the method and reference prices used, we are in a position to explain the variations by comparison to the revaluation done by this or that bank. The problem gets knottier when we realize that the banks themselves use different methods and rates. Where the divergences from a particular bank are large, they could perhaps be reduced by using rates that are closer to "market rates" (the Mark-‐to-‐Market" against the Mark-‐to-‐Model" approaches). On the other hand, there is a danger that these same differences may even increase with another bank with which our results had previously been closer. All banks have their own methodologies and reference rates and prices. The use of market rates is not possible for treasury software applications. They cannot use market rates. As we saw when there was extreme volatility and the EUR and USD, for instance, were under pressure, market arbitrages could exist and create differences between theoretical rates and actual market rates. For instance, we saw swap points of 2.1124 (implied) and 2.5250 (market) (source Bloomberg FXFA -‐ August 2011). It is clear that with such differences, the revalued amount can come out different from the one calculated by the bank, and worry a vigilant auditor. Furthermore, with historically low rates, the impact and the relative differences are larger. This explains why some differences had perhaps never struck treasury managers and their auditors before. Forward contract revaluation practice The customary way of revaluing forward contracts (FX Forward Contracts) is based on the CIRP (Covered Interest Rate Parity) which calculates the forward price of the exchange at interest rate differentials between the two currencies. This ("Mark-‐to-‐ Model" or "Replicating Model") in a supposedly transparent and efficient market, using the same figures, should give a valuation very close to that of market value. For quarterly valuation, a "Mark-‐to-‐Market” type valuation must be provided. However, we have recently been able to observe a rather significant deviation between these two models. This deviation is more marked and important for portfolios with a maturity of over one year. Over a short period, the reference rates are usually closer together or even identical. The problems get worse as the portfolio's maturity gets longer, because for maturities of over one year the reference rates vary significantly. However, semantically it would be wrong to talk of invoking "market prices" since this price is supplied by the counterparty that we are dealing with. These counterparties quote an unwinding price for the contract as if they actually had to unwind it right now. This price is made up of various factors and is not completely "neutral" and unbiased. This is the reason why it is current practice to "calibrate" one of the two interest rates to achieve the same forward rate with the model. This is what we call the "implied interest rate" which can be used for reconciling revaluations. The "implied forward interest rate" is particularly used for valuing or pricing NDFs ("Non Deliverable Forwards"), for which the applicable interest rate is to some extent purely "notional" or somewhat artificial. This is no less

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problematic for calibration given the technical problems involved, such as obtaining rates which are sometimes negative.

Example Source FinMetrics (www.finmetrics.com)

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4.14.3 Reconciling the un-‐reconcilable This is a "top-‐down" approach, used because we don't know exactly how future supply and demand could be skewed by other considerations. We therefore have to make the model use calibrated data. It is no use trying to reconcile the un-‐reconcilable. This is taking things too far. Even if the market price would appear to be the most "fair", the most tangible and the most correct from an accounting point of view (under IFRS/US GAAP), there is no clear reason for claiming that the valuation made by the bank that we initially dealt with is any better than that produced by a treasury software application. Even if we change the interest rate assumptions used, we would obtain other valuations that would not necessarily be much closer than those of the banks. They all in fact use different methods and interest rates. The goal is not to review or price all current transactions with each bank. The goal is to be able to give a clear explanation of major variances, methodology divergences and most crucially distortions in the sets of market data used. One bank's price is different to another's for the simplest FX (foreign exchange) products. For instance, the cost of money varies greatly from one bank to another, even more so under Basel III. This price must be, and is, incorporated into the evaluation. We have to understand that since these foreign exchange contracts are effective hedges intended to be held until final maturity, it is acceptable to keep on using the "classic" methodologies applied by the TMS producers. The main thing is to be able to explain them, to substantiate the revaluations to the auditors. Additional software may prove necessary, along with mastery of the mathematical revaluation technique being used. TMS software does not cater for all the subtleties and all possible valuations, or specific counterparty valuations. For reasons of accounting consistency, only one methodology must be applied. However, understanding the valuation differences and equipping yourself with additional software may prove to be a big advantage. Reporting on differences To be able to substantiate the differences, we have to identify the problems, to have set out the main points of them – ideally by means of an independent and reliable external opinion – and then special comparison revaluation reports must be prepared. By exporting data from TMS software ("Mark-‐to-‐Model" classic methodology) and from revaluation software ("Mark-‐to-‐Market" in an application such as REVAL for example – www.reval.com) to an Excel spreadsheet, we can compare the values and calculate the differences. External revaluation tools have the advantage of obviating use of information requests sent to the bank and of having to do a manual upload of this valuation. If the application is robust and neutral, it will facilitate automated reporting in Excel. However, if differences still remain between valuations done by the bank, the TMS and the additional revaluation application (which obviously can happen), this will yet again tend to prove – should that be necessary – that valuations are relative, and it will vindicate the cross checking approach. It is advisable to attach a copy of the tables of interest rates used to this report. They will by themselves give a clear illustration of the

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differences. Having many ways of checking and several software applications is not without advantages in the present case. The use of third parties, such as a big four firm, is possible but is also hugely expensive and increases reliance on third parties. Transparency in methods and an understanding of the problems will usually be enough to satisfy your auditors, who will be all too happy to see that you have got a grip on this tricky point. The final advantage of third-‐party checking software is also the speed of production of a comparison report after the accounts close or simply when the auditors ask for it. This is an example of a standard internal control, an example of the way in which treasury managers can strengthen the internal control environment and its effectiveness.

4.14.4 Recommendations

It would seem that the first thing we have to recommend is that you should have a good understanding of the methodology used by the software producer. Few treasurers have this. Secondly you have to check, bank by bank, that the revaluation that it has provided is close to your own, currency by currency, with a focus by product if possible. If that is not the case, by overriding your system rates with market rates (for example Bloomberg market rates on the "FXFA" page), you can see if it comes significantly closer. The same has to be done with each bank to try to work out the methodology it uses more precisely. If there are still divergences, it is a good bet that just the choice of data – “bid” or “ask” rates/New York or London closing rates, the interpolation method selected (linear or cubic) or even the discount rate (Net Present Value/NPV at EUR/GBP or USD rates), etc. could easily substantiate and explain it. If even forward contracts are producing differences, think what you might find with more sophisticated, more highly leveraged derivative products with more specific revaluation methods. It is even more necessary, for products of this type, to have main or complementary software applications such as REVAL or an adviser such as FINMETRICS, which are specialized in this type of revaluation to market value, to check and substantiate the revaluations put forward by bank counterparties, and ensures they are objective. However in our basic example, the question arose from the apparent simplicity of the matter and from the preconceived notion that nothing resembles a forward contract more closely than another forward contract and that their valuation is always identical. After you have carried out the exercise and demonstrated to your auditors the reconciliation difficulties generated by the divergence in methods and reference data, you just have to repeat the exercise from time to time on a test basis on one bank or the other, focusing on the portfolio with the most significant divergences in terms of revaluation.

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4.15 IFRS 13, or when counterparty risk hits your bottom line The counterparty risk was not taken into account when revaluing financial instruments “Be wary of a man who urges an action in which he himself incurs no risk” (Joaquin Setanti)

4.15.1 IFRS 13, the one we forgot?

Through focusing on the future IFRS 9 (which will not become effective until January 2015), we might almost forget IFRS 13 coming into force, and one of its major impacts on treasurers (yet another one). Treasurers sometimes focus on certain problems, such as OTC derivatives and the risk of being required to post cash as collateral, to the point of forgetting others. They are so obsessed with certain measures that they see as unfair (rightly) that they forget the mandatory aspect of reporting to ESMA via trade repositories. This latter measure will nevertheless come into force as of 2013. It seems to us that we should first focus on current priorities and ensures we can fulfill our obligations as soon as they come into force. IFRS 13 is the next on our list of reports to be provided, to comply with all the new accounting regulations and standards. This accounting standard demands a minimum of thought to assess the scope of information to be provided, how to produce it and extract it from the computer systems and finally to understand the potential impact on the company's balance sheet and income statement. This is a good time to carry out an evaluation of this type, so as to be ready for that hour. IFRS 13 was published in November 2006 (that long ago). It is largely inspired by its US cousin SFAS 157 in the measurement principles that it adopts.

4.15.2 Dealing in financial instruments

When we deal in OTC type financial instruments for hedging purposes, for example, in IFRS we have to revalue them at every accounting period close. But what is the "fair" value of such an instrument? The "fair value" is the financial and mathematical value calculated by the difference between the NPV (Net Present Value) of the instrument and the NPV of a perceived identical and opposite contract that cancels it out. In short it is the difference between the first instrument and the instrument that needs to be traded to unwind the deal, discounted to present value. Any Treasury Management System (TMS) worthy of the name should do that with no problem. However, this "fair" value – estimated on the basis of market data (mark-‐to-‐market) – does not take account of counterparty risk or counterparty default.

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If the counterparty defaults you will not receive delivery of the currency or commodity or interest rate that was the subject of the original deal. The idea was therefore additionally to incorporate the concept of the risk of default of the other contracting party. This risk was not taken into account when revaluing the financial instrument portfolio. For 12 years (for the IAS 39 pioneers), treasurers have been revaluing their financial instruments in a partial and ultimately incomplete manner. IFRS 13 is intended to put that right. "Risk-‐free" interest rates or yield curves are taken as the basis for assessing whether the present value of the instrument is positive (an asset) or negative (a liability). To this value we would therefore apply a CVA (Credit Value Adjustment), depressing the instrument's value for counterparty risk and conversely we would reduce (because it is negative) the negative value of a liability to recognize and record our own credit risk (Debit Value Adjustment).

4.15.3 Measurement at "fair value"

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This is an exit price. Fair value takes into account the characteristics of an asset or liability. IFRS 13 takes up the much-‐heralded hierarchy of data to be used in measuring fair value. The IASB has set down three input levels in its hierarchy. The data to be used must be that which a market participant would itself take into consideration. The techniques used must also be noted in the disclosures and annual reports.

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4.15.4 Methodology to be applied Turning to the methodology to be applied, we have to ensure that we can gather all the necessary information and apply the appropriate calculations and simulations to it. The financial literature, as is often the case with new accounting standards, is somewhat laconic. So we have to make up our own religion, testing it with the external auditors. That is no easy job. We therefore suggest the following approach: 1. Identify the type of ISDA agreement signed and who it is signed with to understand any payment netting agreements (generally for a single currency and a single transaction). 2. Identify whether any CSA (Credit Support Annex) type agreements exist, requiring collateral to be posted which would have the effect of removing all counterparty risk. There may be other types of agreement which would further reduce counterparty risk and its potential impact. 3. We must check the technical capabilities of the software application being used (in general the TMS itself) or another peripheral application such as REVAL or consider whether some auxiliary facility could carry out the calculations or provide the financial data. Depending on the methods adopted, which may be very sophisticated or based on probabilities – as in financial organizations for example – we have to equip ourselves with more or less powerful software applications. 4. When the method and the software able to provide the data have been decided upon, in principle we have to export the data to spread sheets to apply the calculations for measuring the impacts that might potentially reduce the theoretical mark-‐to-‐market value. 5. We could then run simulations or stress tests, using assumptions of sharp counterparty deterioration. 6. We would then have to produce special reports for audit purposes and for disclosure in the annual report. Here again, we are in uncharted territory.

4.15.5 A subject that is more complex than it seems. IFRS 13, a subject that is more complex than it seems at first glance. An impact study and prior tests are a must. Depending on the volumes, the number of portfolio transactions, and the types of hedges used (e.g. interest rate, FX, commodities, equity, etc.) and the complexity of the derivatives being dealt in, these calculations can be relatively unwieldy, especially if we do not have an IT application that is suitable and able to export to spread sheets. Even with a sophisticated TMS, you have to extract the

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data, format it and add what is needed for line by line calculations, to produce the required reports. The effectiveness test may be impacted by this CVA/DVA adjustment. We therefore need to estimate it, simulate it and understand it to anticipate any potential ineffectiveness that might affect the P&L and the hedge accounting strategy. As so often, the complexity arises from the lack of clarity in the standards and the lack of practical examples and comparisons. With the new measures, you always have to start with a relatively clean sheet and the pioneers have to forge the approach and produce the documents without detailed existing guidelines. We also have to try to keep the approach we adopt simple, to keep down the time that needs to be devoted to this new accounting requirement.

4.15.6 Suggested methodology

Other types of approach of course exist, sometimes more complex or more mathematical, but not necessarily more correct or accurate for that. Any approach, whatever it may be, must be approved in advance by the independent auditors. The

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sophistication of the transactions and the software used, together with the size of the transactions, may justify use of more specific or more complex methods. Credit risk based on their CDS levels can be calculated easily. We can work on an averaging basis or by period (the latter approach being more painstaking). If we use a detailed approach, line by line, applying the impact of credit risk (as a plus or minus depending on the NPV) we will arrive at a combined overall result that can be recognized in the accounting records. COUNTERPARTY CREDIT RISK BASED ON CDS Banks # Bk1 Bk2 Bk3 etc…

CDS 1Y

CDS 2-3Y

CDS >3Y

etc..

average

90 130 112 …

125 150 123 …

150 170 146 …

XXX YYY ZZZ … 3,00%

Corporate own CDS CORP 75

130

1,20%

Proportionate Gross Fair Value Approach we propose this method although there are some others

POSITIVE M-t-M Trade / OTC # Deal 1 Deal 2 Deal 3 Deal 4 NET

M-t-M in m € 1250 -1000 -750 2500 2000

Scaling in %

CVA allocation

Adjusted NPV

assuming 60 as CVA

62,50% -50,00% -37,50% 125,00%

37,5 -30 -22,5 75 60

1212,5 -970 -727,5 2425 1940

Scaling in %

CVA allocation

Adjusted NPV

NEGATIVE M-t-M Trade / OTC # Deal 1 Deal 2 Deal 3 Deal 4 NET

M-t-M in m € 1000 -2500 -900 900 -1500

assuming 60 as CVA

-66,67% 166,67% 60,00% -60,00%

12 -30 -10,8 10,8 -18

1012 -2530 -910,8 910,8 -1518

In the two examples given, we have calculated the negative impact on the discounted (NPV) portfolios, whether positive or negative, in valuing them at the date of the accounts close in question. The method is simple and quite easy to use. However, it

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comes as no surprise that almost no treasury software publisher has proactively offered solutions and anticipated the needs of its users. But here they have a wonderful opportunity to demonstrate the quality and power of their software. These reports will be built up a little by little, as users demand them, over time. Once again, the pioneers are to a certain extent suffering from a lack of support and vision. It is up to them to devise an appropriate report suited to their treasury work environment. We also note there is no requirement for comparatives in the first year. This should make the treasurers' jobs easier. If they are well organized and have been able to test the report before its implementation date, we may even see those providing comparatives for the 2012 year end. In this counterparty risk valuation aspect, IFRS 13 is not as complex as it might be. It is simply a constraint and one more report to be disclosed. The new valuation, however, is even more "fair" than the one that preceded it, through incorporating (more or less satisfactorily) this concept of bilateral counterparty risk. We have to sing IFRS 13’s praises once again for at least providing early clarification of what needs to be done and stating which measurement techniques need to be adopted, depending on the specific circumstances. Life in IFRS accounting is a long river, which is far from being calm. What we have to do now, therefore, is to comply with this new requirement.

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4.16 Alternative FX Coverage Solutions under IAS 39 “If you’re in a bad situation, don’t worry, it’ll change. If you’re in a good situation, don’t worry it’ll change”. (John A. Simone Jr.)

4.16.1 Volatility Control and Improved Financial Results

When a company begins focusing on controlling the volatility of its results under IFRS, it starts to think about how to diversify the type of coverage it might use as an alternative to traditional “plain vanilla” products such as foreign exchange forward contracts or even interest rate swaps (IRS). Treasurers are seeking a magic solution that will give them a position of coverage on their account statements while offering leverage, however moderate, to improve financial results. But does this ideal strategy exist in reality? It is truly a Cornelian dilemma, as it is necessary to sacrifice a lack of volatility in order to potentially amplify the results through the leverage created by an option-‐ or derivative-‐ based coverage instrument. This difficult choice must be made so as to ensure that volatility will be limited to an acceptable degree while offering a means of enhancing financial results, even slightly. Isn’t that the true essence of risk management? It might be described as risks that can be managed dynamically while limiting their potential negative impact. It is in this type of strategy that the treasurer truly has his work cut out for him.

4.16.2 Alternative Strategies

There are many alternative strategies that involve combining approaches. This combined strategy is indispensable if the objective is to optimize results. We will have to accept the non-‐qualifiable portion in coverage accounting. This portion will directly affect the income statement because it is neither effective nor qualifiable under IAS 39. If we look at the example of foreign exchange risk (FX), one strategy that has become classic consists of splitting the product into two components, which are themselves coverage instruments, one of which will be qualifiable and the other will not. The idea is based on the synthetic creation of a foreign exchange forward contract with a lower price and a derivative product. The derivative component that is synthetically created in this way must not generate too much volatility (time value and/or intrinsic value). However, it is true that strictly applying the principle of substance over form can mean ruling out this type of strategy. The IASB was specific on this point. Nevertheless, we

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believe that it is difficult or even impossible for an Auditor, even if well-‐informed; to develop a strategy that combines these two product types. In the example we will describe below, the rate of the foreign exchange forward contract is decreased so slightly that it is even more difficult to isolate and identify it as such. Consequently, there is no use being too orthodox. The separation trick should ideally materialize in the form of two separate confirmations. If the two separate contracts are established with two different banks, with slightly differing dates or amounts, it becomes completely impossible to identify them, even for a financial products expert. Example of the “Extra” Type Foreign Exchange Forward Contract(*) Let’s look at the example of a company that is in a “short” USD position. In order to benefit from the weakness of the USD with respect to the current spot over a period of time, the company decides to enter into an “extra” foreign exchange contract, which is participatory based on a drop in the USD. The advantage of this contract consists of a rate guarantee over a minimum period. The treasury center can, in turn, return this “forward extra” contract to its subsidiary, which is exposed, or give it a simple forward exchange rate. The idea behind the “extra” type contract is that if the deactivating barrier is not reached (because it is positioned high enough and the USD/EUR does not reach that barrier at any point throughout the period), the spot exchange rate will apply. The treasury will then fully benefit from the weakness of the USD. Inversely, if the barrier is reached, it is deactivating and the rate becomes the “strike price” (decreased with respect to a normal “dry” period). The simplicity and efficacy of this product reside in the guarantee that it offers, while providing a view over fluctuations in the exchange rate. The example in the graph below shows an evaluation of this type of product.

4.16.3 “Forward Extra” – Accounting Impact*

The contract can be subdivided into two components: a foreign exchange forward contract that can be qualified for coverage accounting, and the purchase of a “Reverse Knock-‐Out option EUR call USD put,” which cannot be qualified for hedge accounting. This second component will be reevaluated as “Mark-‐to-‐Market” at closing of each quarter. The value change in this reevaluation will have a direct impact on the income statement. However, it is possible to measure, if not contain, the volatility of the secondary product. The most commercially dynamic banks offer this analysis to their customers. Of course, volatility may exceed the initial intrinsic price of the option over a given quarter, but the analysis should define a comfort level with which the treasurer can live, even if often, the worst-‐case scenario is correctly priced in only 5% of cases. The V@R is obviously not an absolute guarantee of containing quarterly volatility. It is

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only a reasonable and acceptable indication. This limited risk is the price to be paid for benefiting from the up side. Some banks even offer guaranteed maximum volatility products. Such guaranteed volatility caps should have a real success in future. We believe that this type of product offers a real advantage for treasurers, to diversify their financial coverage instruments and to improve their performance without taking unreasonable risks. The overall equilibrium of the portfolio thus created will make it possible to positively smooth over the overall results and to make the use of derivative products a little more attractive, without becoming aggressive or complex. This type of product, for the first component, is managed using a TMS (Treasury Management System). The second component may pose a problem and in the worst-‐case scenario, could require management using a calculation sheet.

4.16.4 Dynamic management of FX risks

In the example described above, if unfortunately (or fortunately, rather), the company sees the USD weaken(*), it runs the risk of having to return to the strike price of its initial contract, but on the other hand, it will see its natural “short” position become more favorable for the future and it will reap the benefits. In the opposite situation, if it chose reasonable barriers, then it managed to protect itself against a rise in the USD with respect to the EUR. Dynamic management can also consist of reselling the option, known as “profit taking,” provided that the price obtained (largely) compensates for the decrease in the initial period. Consequently, it appears to be helpful to adapt simple, effective strategies rather than easily, but too prudently, adopting the foreign exchange forward contract. In the end, a combination product offers greater security and less risk than a 100% qualifiable product with a high risk of inefficiency and therefore of volatility. Simplicity can ultimately turn out to be very effective and viable when speculative risks and aggressive strategies are not an option.

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4.17 What services are expected from a trading floor and what has changed since the onset of the financial crisis? “Price is what you pay, value is what you get” (Warren Buffet)

4.17.1 1. Services expected of a trading floor Is there such a thing as a customer satisfaction model for a trading floor? What’s the best way to serve corporate treasurers with regard to financial products? These are the questions we aim to answer, as the crisis and new regulations have changed and will continue to change the behaviour and expectations of financial managers. Generally speaking, irrespective of the country where corporate treasurers deal with a trading floor, they are becoming more and more demanding in terms of the services provided. These demands can be explained by the complexity of the operations as well as the technological and regulatory developments. These days, due to the centralisation of banking activities, financial managers are making increasing use of trading floors based abroad, most often dealing directly with Frankfurt, Paris or London. This maximised centralisation of trading floors’ activities has now been compounded by a fundamental technological change enabling banks’ relations with operators to be conceived in a manner that is new and more efficient, but also much more direct. Treasurers expect high-‐quality services, efficiency and also general proactivity. This might seem self-‐evident but, in practice, it sometimes turns out quite differently. Proximity is no longer an absolute must, but merely a simple advantage that is losing its lustre by the day. Nevertheless, it’s important not to dismiss the benefit that it continues to bring and the preference of some financial managers for local human contact. Very frequently, the approach to relations is also a question of style, age or generation. It’s vital for bankers to always try to make the difference through the service, as in a world of products that have become true commodities and are all interchangeable, the service (including, of course, price) can become the trump card, the USP and the means of securing loyalty among the treasurer clientele. The internal banking relations policy of a multinational group is often such that treasurers seek to adequately and impartially spread the operations entrusted to banks in order to comply with their established commitments, increasingly contractual ones. However, the sole fact of being considered a core bank is not enough to justify high prices and/or poor services. Bankers should

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always merit the flow of operations entrusted to them. Treasurers often loathe change, as departing from their habits always carries a risk. They look for specific and advanced services and when they find them, they become attached. Treasurers are sedentary by nature, even if the new generation are more volatile and less loyal than their predecessors. Automation has become an absolute key that many seek in order to install STP (Straight Through Processing), all the more so as the new regulations, including the notorious 8th Directive, require the reinforcement of internal auditing. Both internal and external audits are designed to strengthen chains of financial operations by integrating and automating them from their negotiation stage right through to their eventual settlement. However, a high degree of automation does not negate the benefit of possessing a high-‐quality back office, which is always an added ace for a banker to have up his sleeve. Even though automation reduces the risk of error, it is rarely total, complete or infallible. Having high-‐quality internal support available at one’s broker then becomes more than a mere advantage or a service. Having a back office located in India, dealing with operations carried out from Vienna with a trading floor situated in London is far from straightforward, and when the incorrect operation has been performed via an electronic trading platform (such as the FX dealing platform), the situation is further exacerbated. Prudent treasurers will have already put in place an upstream system for the instantaneous control of operation confirmations in order to prevent problems downstream. Such systems are numerous (e.g. Misys Cross Matching Settlement system CMS). Treasurers expect their broker to provide a rapid and clear response, within the deadlines set. When it comes to financial management, the course of business simply won’t wait and a speedy quote process is a real competitive advantage for a trading floor. Treasurers want to have high-‐quality information on the markets and the prices charged, as well as views of changes in prices and rates. Certain more proactive trading floor operators call clients to inform them of a significant development or a major fluctuation on the market. In tune with the needs and expectations of their clients, they are able to empathise with them. This amounts to an art, which, ideally, the banker adapts to each client and each style in order to serve them properly, as clients want appropriate advice at an increasingly competitive price, particularly on the revaluation of a portfolio or their IFRS or US GAAP accounts processing. Treasurers need to be able to benefit from sufficient FX or other credit lines to be able to deal at all times. There’s nothing more frustrating for a dealer than refusing an operation due to not having enough lines, and today’s lines need to be longer and longer. Admittedly, these lines are going to build in a concept of duration and the cost of the company’s credit risk is going to be passed on in the quotes for the products dealt. The banks are trying to reduce the maximum duration of hedges in order to limit their risks and the consumption of own funds. Ideally, treasurers need lines at least equal to or greater than 5 years, as they want to avoid all collateralisation, as much as

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possible. Here too, the regulations may play a key role and affect the way of working and the hedging cost (cf. OTC derivatives reform project). Treasurers love it when no ISDA (International Swap and Derivative Agreement)-‐type agreement is requested. Alas, in this day and age, this is also an unavoidable necessity for each and everyone. The banks quite rightly want to govern the framework of the trading floor operations. It’s difficult and tiresome to negotiate but, at the end of the day, it protects both parties. The use of online trading platforms constitutes a best practice that is becoming widespread within all major companies, due to their ease of use and infallibility (e.g. 360T, FXall, Currennex, etc.). Even though operations are becoming virtualised in this way, a contact person is still required on the trading floor, together with a stand-‐in when necessary. A low dealer turnover rate is often an advantage for retaining a treasurer’s business, and when these dealers are professional and efficient, the business follows naturally. The use of an online platform does not preclude the “old-‐fashioned” method of dealing by telephone. In terms of reporting and information, the requests are becoming ever more demanding. Today’s treasurers expect greater exhaustiveness on the part of their banker. Advice and strategy are the two cornerstones of the service expected today and these strategies need to be specially tailored to each individual’s requirements. The tools to aid decision-‐making exist and the banks can help treasurers to choose the strategy best suited to the circumstances. The added value is then such that loyalty follows automatically. The battle is generally won here, rather than at the level of prices that are often too squeezed and tight to hope to make a profit without colossal volumes. When it comes to a trading floor’s financial products and services, innovation amounts to a decisive strength. Treasurers expect a purchase/sale service that functions 24 hours a day, via a powerful, reliable and efficient network. Orders have to follow the sun and be left or placed regardless of the time of day or night.

4.17.2 Changes observed since the start of financial crisis

The volatility of the markets is greater than ever. The recent example of the dollar against the euro and the fluctuation of certain raw materials has been enough to concern the professionals who have to hedge them. In such a situation, shrewd advice becomes a must. If a client is well advised, he/she will return. The markets are still evolving but what have definitively changed are the extents of the fluctuations and the speeds of reaction of the markets. The possible and feared reform of over-‐the-‐counter derivatives is, in this regard, worrying and alarming for all corporate treasurers, who have been hit by the (over)reaction of the regulators following the systemic risks that

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have arisen in recent months. But were they responsible? Aren’t the guilty parties and the victims all being lumped in together by introducing (overly) radical solutions? The longer-‐term weighting of lines, their reduction due to merger or restructuring and change of focus and the increase in costs to compensate for the effects of the successively adopted Basel regulations are undeniable facts. Hedging costs money and will become ever costlier, whatever comes out of the OTC reform. For example, longer-‐ term hedging now comes at a cost linked to the intrinsic corporate credit risk. “The longer you hedge, the more it’s going to cost you”. The situation is further complicated by accounting rules which continue to evolve and which are set to change radically with the advent in the coming months of the “son of IAS 39” (successor to the accounting standard for financial products). What does it have in store for us in terms of hedge accounting? It’s still too early to say. With each IFRS reform, the sophistication of the products used by a company is reduced. Treasurers want to be able to characterise the financial operation for hedge accounting, a sort of accounting Holy Grail and sign of neutrality of the profit and loss account. The banks are often thinking more of their own development and their specific regulations before considering their clients. The example of the reform of OTC derivatives proposed by the USA and the European Union is enlightening on this point, and the same applies to the IAS 39 or IFRS 7 accounting standard. The world has changed and continues to do so at an ever-‐increasing pace. In this process of evolution and this conquest of markets, the power to react is a major advantage. Rather than having finished their transformation, the banks still need to adapt further. Often, they adapt themselves and then, in a second phase, have to follow their clients, as the service is still not correctly tailored to the clients or their needs. In fact, the total lack of understanding on the part of some bankers regarding the activities of corporate treasurers can be nothing short of mind-‐boggling. It is this lack of empathy which explains a good number of the problems and mismatches between the offers and services proposed. There are no two ways about it: you have to get to know your clients in order to adapt to them more adequately. Sensibly, certain banking lobby groups have now enshrined KYC (Know Your Customer) in their charters and other codes of conduct in order to encourage their members to have more empathy towards and knowledge of the needs of their clients. This same model should be applied to all services provided by a bank.

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4.18 Deciding to hedge “If you look at life one way, there is always cause for alarm” (Elizabeth Bowen)

4.18.1 To Hedge Or Not To Hedge, That's The Question

If we refer to the comments of Merton Miller, winner of the Nobel Prize in Economics in 1990 for his pioneering work in the theory of financial economics, we might conclude that hedging serves no purpose: “The most value-‐maximizing firms do not hedge”. But can we as treasurers accept this statement at face value? Wouldn’t that amount to the negation of our profession? Even if we take into account the context of his words and even if we accept that hedging means taking a decision and making a choice that could lead to a possible loss of opportunity, it strikes us as inadvisable to adhere purely and simply to Merton Miller’s theory, with due respect to the man and his work, as well as to his sidekick Franco Modigiani. The academic issue here is whether hedging “creates value”. In certain cases, hedging is an obligation (contractual in the context of credits) and, in imperfect markets, sometimes makes it possible to continue to borrow. Hedging also enables treasurers to concentrate on the operational and management sides, and can create value when it sustains the company’s activity and ensures the continuity of its main aim and corporate purpose. Non-‐financial companies don’t like speculating at all and remaining completely unhedged. Imagine the totality of exposure to one or more risks, such as all of the exposure to the USD, and apply to it a stress-‐testing factor of 20%, for example. While the CFO could live with such an impact (even if, in part, the accounting P&L result would not be affected by off-‐balance sheet underlying commitments), there is a high likelihood that it would not accept or tolerate such an impact, even a potential one. Just think of the amount recorded in OCI/EHR (Equity Hedging Reserve) to find out what we avoid entering in our profit and loss accounts. Thank God that the IASB invented hedge accounting, to reduce the valuation to the correct level. Once you have got past the question of whether or not you are going to hedge, the next issue is to what extent you are going to protect your financial risks. 100% hedging of all balance sheet or off-‐balance sheet risks strikes us as foolish and inadvisable. Essentially, the treasury is a function of management and this management needs to be applied to hedge part of its exposure and control the remainder, often according to principles and a strategy that have been clearly defined in the internal hedging policy. Hedging without applying hedge accounting would seem to be suicidal, as it would amount to not hedging but also taking all the impact in the accounts through the “mark-‐to-‐market” revaluation of the financial instrument portfolio. Consequently, the issue is how far should hedge accounting be applied? Here too, the treasurer needs to define an

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intelligent compromise strategy between what is required in terms of hedge accounting and what can, due to its size or lesser impact, remain hedged and re-‐valued without offsetting to compensate for the accounting impact recorded. The treasurers have also a duty of education of Boards and CFOs in order to make them sensitive to risks of inappropriate hedging strategies.

4.18.2 Adaptive Hedging Strategy

So-‐called hedging strategy must always be the subject of written rules and principles that have been clearly transmitted to subsidiaries. However, it needs to remain adaptable in order to respond to changes in the markets and the economic situation. But there is no single “one-‐size-‐fits-‐all” solution. Every policy is different and specific to the company concerned. It needs to be validated by the Audit Committee and reviewed regularly. It should also take the accounting aspect (IFRS) into consideration, based on the hotly contested and unnatural principle initiated by IAS 39 of “putting the cart before the horse”. The strategy also needs to determine the precise type of instruments authorized, and this must be done in accordance with the IFRS strategy adopted in order to always remain “on the right side”. Finally, it defines the counterparties to be used, as this credit risk is no longer theoretical at all. The company’s hedging strategy will depend on its general culture, its approach to and appetite for risk, and lastly the CFO’s tolerance for the volatility of the financial result. It is dependent on external factors (geography of the group, currencies, long or short positions, profile, natural or economic hedging, etc...), as well as on internal factors as described above. These factors will shape and define the hedging policy. What currencies to sell in? Should the translation risk be covered? Fixing the debt or not? Etc.

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Financial Exposure Hedging

Tolerance to P&L volatility  No Hedge Accounting (HA)

Not Hedging

Exposed to financial risk and P&L impact at maturity No interim volatility issue unless when exposure on balance sheet

No tolerance to P&L volatility Hedge Accounting  at least partly

Full HA Final financial exposure protected but P&L impacts during instruments life

Part HA limited P&L vol. Less admin.

No P&L vol.

Easier accounting management and disclosures under IFRS

Admin. burden to qualify for HA

• No need for IT tools for revaluation and HA management

• Portfolio valuation (M-‐t-‐M) management issue • IT tools required (incl. for HA management and IFRS reporting)

4.18.3 What To Do And What Not To Do When It Comes To Hedging Where hedging is concerned, there are a series of pitfalls and errors that must be avoided at all costs in order for it to be effective and appropriate. We are going to try to list some of these in a non-‐exhaustive fashion. To be effective, you need to design an appropriate hedging policy and to precisely know what it intends to accomplish. It is not as straight forward as it seems. Obviously, everyone wants to protect the business from the P&L volatility. The objectives should be aligned to the overall business strategy and be specific as well as quantifiable. The flexibility should not be used to justify the reluctance of corporate to document a sound hedging strategy. A formal policy is paramount even if viewed as cumbersome and also rather bureaucratic. Without formal rules, there are risks of absence of discipline, transparency in communication to stakeholders and continuity when facing staff turnover. The performance benchmark need to be measured to determine whether it is effective or not. It also has to be aligned and adapted to strategic objectives targeted. For this metrics, treasurers needs to use appropriate IT tools like REVAL, for example, or state-‐to-‐the-‐art TMS (e.g. eTC -‐ City Financial WSS). The simulations are also important for monitoring closely open positions (e.g. currencies with high differential of interest making hedging “expensive”; floating IR portfolio).

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Despite the usefulness of FX and IR forecasts issued by invest banks; it can be dangerous to rely too much on simple market views or predictions even from well-‐known gurus. Hedging process should remain adaptive and gradual to weight possible wrong assumptions. Forecasts are more useful for short term hedging. The strategy needs solid foundation and principles rather than market “changing” views. The art resides in defining the appropriate ratio level. Another risk is to use too complex instruments in order to reduce hedging costs. Some features are designed with knock-‐outs, barriers, corridors, etc… to create the so-‐called “zero-‐cost” products. Treasurers have to use powerful IT tools to revalue these types of products, if dealt. Furthermore, treasurers should have the expertise to de-‐structure the products in order to well price them. The more complex a product is, the less transparent it is in terms of pricing. It is essential to align time horizon of underlying and financial instruments. By hedging short term, the roll-‐over of hedging instruments could be expensive and create cash shortfalls. Mismatches are not to be advised. However, (too) long term hedges could also be expensive (e.g. because of interest rate differential). Treasurers should always consider cash-‐flow impacts, especially when hedging non-‐cash items (e.g. translation risks) or uncertain future exposures. The most complex issue is correlation between exposures and underlying items. When identified, it can reduce the global hedged position, even if not fully perfectly hedged (e.g. CAD and aluminum price, USD and crude oil). When treasurers rely too much on proxy hedges, it can become very dangerous. The hedging strategy needs to be coordinated across the group to avoid potential inefficiencies.

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Major Pitfalls and Risks to be avoided fro FX Hedging Strategy Definition

! ! ! ! ! ! ! !

Use of complex derivatives structure to hedge (w/o Hedge Accounting qualification) Embedded derivatives (by use of third currency/different from customer/supplier functional currency) Natural hedging and opportunities for offsetting risks  when analysis is not made on a global basis Correlation factors not addressed and contemplated (e.g. commodities and $, $ & £, IR & FX, equity and IR, etc.) Failure to produce reliable cash-flow forecasts on foreign exposures and wrong timing on cash-in/outs Oversimplification of FX approaches Absence of sound FX/treasury tools for HA and valuations (e.g. Wall Street Systems, REVAL, eTC, …) Absence or insufficient price for FX (e.g. TMS, dedicated pricing tool, FX platform, …)

! ! ! ! !

No clear rules understandable by affiliates and group wide (Idem if objectives of risk management not clearly defined)

Too strict approach of FX hedging rules (e.g. hedging HUF/EUR forward at 3 years is extremely expensive  better sometimes to closely monitor “open” positions

No hedging accounting strategy to mitigate not P&L volatility Inappropriate (or absence) of FX consolidated net reporting (incl. KPI’s benchmark No open door or room for “market view”’ and opportunity hedging strategies Ineffectiveness testing not met  extra volatility created

4.18.4 Advantage Of Using The Trading Platforms and new technologies These days, for reasons of efficiency, comparability and internal controls, not making use of trading platforms would be a big mistake. Using this type of tool, such as 360T or FXall and ICD or STN, for example, is now established as best practice. These tools permit an STP (Straight Through Processing) approach and the automation of trade in financial instruments from their initial trading until their final settlement at maturity, including the accounting entries during the life of the product and the ad hoc transfer instructions. They offer the opportunity to obtain the best prices (real trading market prices on line and even better than the indicative pricing displayed on Reuters), but also to obtain a number of reports and statistics that can be useful for internal controls and KPI's/KAI's. They allow operational risks to be significantly reduced, especially when supplemented by a transaction confirmation matching service via MT 300 or Misys CMS. Lastly, they provide a means of putting all one’s banks in open and simultaneous competition in order to correctly allocate the side-‐business.

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IAS 39 Specific Tools – RTL Group IT Architecture

Banks

Connection

Feeding With Market Data Reporting, Testing, etc.

Trading Platform Interface Dealing & Capture of Deals

eTC

Interface

Input

Mirroring

eTC Cash pooler

Connection Mirroring I/c dealing

Settlements & Transfers

Payment Factory

MT300 exchange

Group Affiliates

Dealing

TMS

ERP

TMS

Cross matching Settlement/ Confirmation checking on line (via TMS & Cashpooler)

Confirmation

Posting

Reporting/ Valuation

Settlement

4.18.5 Keys Factors Impacting Hedging Strategies The design and the implementation of an effective group FX risk management strategy and policy can be a real challenge for many corporate treasurers. The extreme volatility level experienced on FX markets (especially EUR/USD) over the past couple of months has highlighted the need for carefully considering the FX and interest rates hedging requirements. Then, the question is how sufficient these hedging strategies are to meet their risk management objectives.

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Key Factors Impacting Hedging Strategies Market Volatility (extremely high given current economic context, crisis Economic on sovereigns and EUR) External

Factor IFRS Rules e.g. IAS 32 & 39 + IFRS 9 + New Hedge Accounting Standard (to be released in Q4 2010)

Corporate Hedging Strategy

Accounting Factor

Legal Factor Developments of company business (e.g. exports, natural hedging, dependency on commodities and USD, production abroad to offset some risk on some currencies)

O.T.C Derivatives Reform (if applied without exemption for corporates) + Basel III indirect Impact on O.T.C derivatives weighting

Market Internal Factor

4.18.6 Are We Facing More Expensive FX Pricing In The Coming Years? One of the unexpected or unsuspected consequences of the current financial crisis could be a significant increase of FX pricing on longer periods. Dealers are beginning to think more seriously about credit-‐adjusting the prices quoted on FX derivatives in general. The pressure on banks may force them to adjust pricing up on longer period FX transactions to include the credit risk element. It means that leaving aside swap points and interest differentials, the longer a forward deal the more expensive it will be. This evolution we have noticed the last years seems crystallizing now. This is rather surprising for some corporates although it was inevitable, especially after such a deep credit and faith crisis we faced. The solution to reduce the extra cost adjustment applied to FX transactions is to sign an agreement like CSA type (Credit Support Agreement) to collateralize bilaterally amounts corresponding to changes in mark-‐to-‐market valuation of portfolio of FX transactions made with the bank. The idea, like for margin calls, is to secure the potential (unrealized) loss on portfolio of FX deals revaluation. If the portfolio has a negative change in fair value (lower value compared to inception value), the customer would have to secure this amount with a cash collateral deposit. In the case of a positive change in fair value, the deposit in cash would be made by the bank. Both deposits are remunerated at EONIA rate. Of course, the larger and the more diversified the portfolio, the less collateral would be potentially required. It is obvious that in case of default (e.g. Lehman or Kaupthing bank) the customer can recuperate and compensate, via the deposit, the loss incurred. The bargain would therefore be: does it make sense to reduce cost of hedging FX transactions by

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collateralization or not? The more FX transactions dealt, the more the banks used for dealing, the more collateral would have to be possibly immobilized and locked. It could not be considered as cash and cash equivalent according to IAS 7 as pledged to the bank. The return offered will not be as good as the one potentially achieved now with money market funds of prime quality. The CSA will imply review by lawyers and extra legal costs, at least for first contracts to be signed (similar to ISDA schedules). Fortunately, limits and margin calls will be managed by the bank back-‐offices. Nevertheless, it will create extra administration for treasury teams. For companies which are cash poor, it has an additional cost, especially when spreads are extremely high, as today. The corporate treasurers could also decide to have recourse to shorter FX transactions rolled-‐over over time. Again, it will generate extra administration and interim volatility at roll-‐over dates. That is the price to pay for this type of solution.

4.18.7 OTC Derivatives Reform, Challenges

The Obama Administration has announced in June 2009 a sweeping reform of the financial markets, including a brand new approach of the OTC (Over-‐The-‐Counter) derivative markets (“Financial Regulatory R: A New Foundation” published on June 17, 2009). In the meanwhile, the European Commission has issued a “Consultation document on possible initiatives to enhance the resilience of OTC Derivatives Markets” (Brussels – Commission staff working paper 3/7/9 SEC 2009-‐ 914 / “Ensuring efficient, safe and sound derivatives markets” – COM 2009-‐332). The major issue with this reform is the scope it includes. It does not only cover the trading of CDS and CDOs but also the plain vanilla hedging instruments (e.g. IRS, currency swaps, etc…). We will be all impacted by such a reform. The aim is to apply new rules to all derivatives, no matter what type of them is traded or priced, regardless of whether they are standardized or customized and it also includes the derivatives to be invented in future. There are no exceptions for simplifying the rules application. Are the “standard and classical” OTC products victims of the excesses of a bunch of them (e.g. CDS and CDOs)? In general, the companies use derivatives to reduce exposures and risks and not to trade speculatively. The direct impact for corporate end-‐users is obviously the increase of cost of hedging because of margining system, the increased P&L volatility given potential ineffective hedging strategies and unwanted transparency on hedging strategies applied. The OTC reform would lead to higher costs and therefore to increased borrowing and possibly to additional capital requirements. The use of derivative products is essential and legitimate for a sound risk management. They are aimed to stabilize prices and mitigate risks. More transparency is certainly a recommended and praiseworthy goal, which can prevent future systemic risks. However, we do not want to negatively impact basic plain vanilla products which use could become ultimately impossible. As always, the excesses

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from a limited number of persons will penalize the whole derivative user community. The misuses of couple of sophisticated and complex instruments by traders, together with the weakness of controls by regulators and supervision bodies will eventually impact the vast majority of the users. The cost for repairing the damage to financial system is extremely high. To avoid some of the impacts for treasurers and not to be counterproductive, few financial professional organizations and service providers have recommended excluding the derivatives or at least to be exempted from this reform. We have noticed a real simplification and cleaning of derivative products used compared to couple of years ago, before IAS 39 stringent provisions on financial instruments. The risk is, if no exemptions are planned, that corporations will decrease the use of OTC derivatives, even basic ones. The cost of margining and reporting would be too high compared to benefits. Corporations would need to arrange committed credit facilities to meet central counterparty margin calls, reducing accordingly their total debt capacity. Corporations could suddenly decide not to hedge anymore some financial exposures. The result would be to have un-‐hedged risks and bigger exposures in a period of time where operations are already affected by the world economic crisis. With IAS 39, some financial hedging decisions were driven by accounting considerations. With the OTC derivative regulations, hedging strategies would be driven by cost and administrative considerations. We should admit that so far, corporate treasurers are relatively immune from any financial regulation. The idea with the OTC derivatives regulation would be to standardize derivative instruments (sensu lato) and to require them to be dealt through an exchange with settlement handled through a clearing house or a Central Counter Party (CCP). Interposing a CCP with rules on margining and collateral is designed to reduce counterparty risk (what seems to be an important and useful objective). It also aims to promote fungibility of products and full transparency of markets, to increase legal certainty and to reduce legal risks. Eventually, it enhances operational efficiency by enabling electronic confirmation services and more standardized collateral management processes. However, after recent bail-‐outs, we could reasonably accept that large multinational banks default is rather limited (although not excluded). Furthermore, it remains a delivery risk (which is at the end of the day smaller than a pure credit risk). It should facilitate offsetting and netting down of operations or, if necessary, the wind-‐down. If derivatives (including FX forward and plain vanilla IRS) are quasi “burned” because of administration burden and costs they would create, the risk management by non-‐ financial corporations would become extremely difficult. The risk would be to avoid hedging to minimize related costs.

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All treasurers would support all regulation measures dedicated to improve controls on financial counterparties and dealers. The better way to reduce risk in banking sector is certainly not the transfer of constraints and costs to corporations and users. The last thing one could wish is to make hedging impossible, too complicate or expensive for normal business exposures. As usual with such proposed reforms, it impacts several activities and professions, including blue-‐chip companies, which may suffer for crimes they did not commit. In modern economy, the banks provide the fuel and corporations are the engines. The risk is to try to purify the fuel while altering the engine.

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4.19 To collateralize or not to collateralize the hedging process, that is the question “A worried man could borrow a lot of trouble with practically no collateral” (Helen Nielsen)

4.19.1 And what if you use margin calls for hedging your FX?

Whether we like it or not, in future the hedging of financial risks may never be the same again. As we have often pointed out, since the first decisions after the London and Pittsburgh G20 summits, the great and the good of this world have decided on better regulation of finance in the broad sense, by adopting a series of restrictive and preventative measures designed to protect businesses, banks, governments and of course private individuals. One thing seems certain: nothing will ever be the same again. For “OTC” (Over-‐The-‐Counter) type derivatives, for example, the idea was to require the use of central counterparty clearing houses (CCPs). This would involve the need to put up cash collateral (a sort of safety reserve to cover the risk of counterparty default – CVA, and for the bank the potential pre-‐financing of the value receivable on a downward revaluation – FVA. This collateral is also called a "margin call". The European Commission's objective is also to use organizations to record and report on outstanding trades (organizations called "trade repositories"). A powerful lobby of treasurer associations will no doubt put a stop to this obligation to give collateral. This exemption will apply below a certain threshold, to be defined. However, we should not be too quick to rejoice over this short-‐term respite. Even if we happen to be under the exemption limit, we should still fear the perverse and insidious effects of Basel III and MiFID II, which indirectly oblige banks to use margin calls for their clients. The thing that we are trying to avoid springs back into our faces, like a boomerang. However, for some people this need for a margin call in the form of cash to be provided throughout the life of a financial product is perhaps an opportunity to gain a competitive advantage or benefit from more favorable prices. It is by no means certain that a company with a cash surplus, which is prudent in managing its cash and that, has an average rating would find it beneficial, whatever the outcome of political and technical debates, to use margin calls to fine-‐tune its hedging cost or its return on short-‐term investments. This is what we shall try to demonstrate

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4.19.2 Whether or not to resist the requirement to post collateral It seems hard to be really critical of the regulators' ideas and objectives, particularly in Europe. When we look at the iBOXX index and the 7-‐year spread, for example, and its movements – or bank 5-‐year CDS – we will be alarmed to find that volatility has become extreme. Even if spreads are narrowing, they are still at incredibly high levels. Counterparty risk is truly not a myth or a mirage away in the middle of the desert. We believe that the market itself must impose its own standards and conditions. The regulator should still lay down rules, provided: (1) That they are harmonized throughout the world, (2) That they provide effective and complete exemptions, not ones cancelled out by other rules, and (3) That they leave end-‐users the option of deciding how they want to cover themselves. This is a major challenge. Bank ratings have been downgraded sharply. Neither the worries over the euro nor over sovereign debt provide any grounds for holding back. Regulators must now act and the trick will be in how best to adapt to these new obligations. Of course, companies with borrowings will be worse off and will probably have to adapt their strategies for hedging financial risks. The challenge will be to know whether you should hedge at a higher cost with no collateral, or at a lower cost with collateral. The calculation will be purely financial. Conversely, others could perhaps derive much benefit from certain market opportunities.

4.19.3 Questions to ask yourself

Non-‐financial companies should ask themselves whether collateral might not sharply reduce the cost of hedging. Since the Basel III principles are not likely to change, we may assume that the cost of hedging will rise as the hedging period gets longer. We may assume that the longer the hedging period, the dearer the derivative instrument will be. This being the case, we need to ask ourselves how much "dearer"? We have carried out this exercise on theoretical examples (purely indicative examples quoted by major institutions). The answer varies from one institution to another because the bank's CDS matters, as does that of the counterparty. The assessment and the exercise are therefore complicated. However, one thing is clear: derivatives will become more expansive overtime. If the company, with a cash surplus, having opted for a conservative investment policy (S.T./under 3 months), puts part of this surplus up as

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collateral, it will be remunerated at a rate comparable to that given by a bank for an ordinary deposit. It will not suffer any real loss of income. The calculation then becomes interesting. A company with a cash surplus, and therefore with no liquidity risk, can in this way remove the credit risk. By putting up collateral it in fact frees itself from the risk of counterparty failure where the revaluation of the portfolio is positive. In case on top of that, the hedging gain is important; it is all profit for the company. This is not the case for a company with borrowings. It would be swapping credit risk for liquidity risk – at the end of the day it would gain nothing in terms of risk. Furthermore, the cost of borrowing (depending on spreads) can be even higher than hedging cost savings.

4.19.4 Possible solutions

There are several possible solutions: (1) Do nothing and do not agree to margin calls (at the risk of paying more for your hedging) (2) Sign a CSA (Credit Support Annex) type bilateral agreement (with margin calls with or without "threshold" or "daily" terms) (3) Sign an agreement with a central counterparty clearing house (CCP) (with daily margin calls, with no materiality threshold, with an initial margin on top, hiking the total cost) (4) Use an "ISDA deposit" (to avoid margin calls and also to boost the return on investment)

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The dilemma is in choosing between (1) significantly better hedging or trading terms, but with potential cash volatility and higher administrative cost in exchange, and (2) poorer hedging terms, with no cash volatility or additional administrative cost. An opportunistic strategy could also be chosen to vary with market conditions. Initially, we might think that short term hedging could be done without collateral, while longer term hedging would have collateral, to reduce cost. We may question whether it is realistic to use a clearing house since the price of the entry ticket is so high (initial margin and initial fee in addition to variation margins), and whether the implicit administrative cost is acceptable and manageable for the treasurer of a medium-‐sized company. We might think that CCPs would be restricted to (very) big companies with large volumes. The final option referred to above (i.e. the ISDA deposit) is very attractive because it keeps down the cost of the hedge or improves return on the deposit. The other advantage of an ISDA deposit is being able to decide the term of the deposit, without necessarily aligning it to the duration of the collateral (as in the example referred to). Obviously, this deposit is at risk for the company in the event of failure of the counterparty bank.

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4.19.5 So what would be advisable? It would seem obvious that "cash rich" companies with an average rating (of between BBB+ and BBB-‐), that have adopted a conservative and short-‐term investment strategy for their surplus cash, would find it beneficial – selectively at first – to use bilateral agreements of the CSA or ISDA deposit type to improve the cost of the hedge or to boost the return on the deposit (for the longest foreign exchange hedging terms, where the difference is most material). The principles referred to for foreign exchange apply equally to interest rate hedges. Bilateral agreements seem to us to be more flexible and easier to use. This would enable the company to avoid the impact of the bank's credit charge and pre-‐financing cost (i.e. the Credit Valuation Adjustment and Funding Valuation Adjustment). By using the "Value at Risk" ("V@R") on fluctuations in the derivative, it is easy to estimate the gain to be obtained on the cover or the investment. The situation is still pretty hazy. Not all banks know how they are going to pass the costs on to their clients. Furthermore, the bank's credit standing and that of its counterparty (as evidenced by the cost of their CDS) will affect the cost of cover, amongst other things. It is therefore advisable to use an opportunist approach, and to gradually favour a few quality banks for longer and potentially more costly hedges, without collateral. It is obvious that a well-‐designed strategy could give the company a non-‐negligible competitive advantage over the competition, particularly if the competition has borrowings. Hedging strategy will change, the writing is on the wall; but it will not necessarily have only adverse effects for the "richest" and most prudent companies.

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4.20 Financial Information Provided by Treasury Department “There cannot be a crisis next week. My schedule is already full”. (Henry Kissinger)

4.20.1 Information provided by the treasury

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4.20.2 How does one implement IFRS 7? To implement IFRS 7 a company starts with a complete review of procedures and risk management policies in order to define the adjustments that need to be made. Then, one must establish a gap analysis by reviewing IFRS 7 paragraph by paragraph. The ideal situation is then to suggest a solution, a table or a text comment in order to conform to the rules of the new measure. This information, as much from a formal than a content point of view, will be qualitative and quantitative. It is necessary to define the means of collecting the information required. This could require developments in the information or consolidation systems.

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The sensitivity analyses can imply recourse to ‘pricer’ type IT tools of or financial application software. Once the approach and format have been determined, it is best to have the financial statements to be published and divulged approved by internal audit, the auditing committee and the statutory auditor. Here you will find two examples of tables taken from an annual report of Deutsche Telekom, which was one of the first companies along with Vodafone to apply IFRS 7 by anticipation, when it became applicable.

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4.21 Fairness of Fair Value “It is better withering to be silent, or to say things of more value than silence. Sooner throw a pearl at hazard than an idle or useless word; and do not say a little in many words, but a great deal in few.” (Pythagoras)

4.21.1 Fairness of Fair Market Value

From now on the IASB has very clear intentions of introducing the concept of fair value as a primary basis for measuring the amounts reported in the annual financial statements of companies. Gradually, companies have been asked to continue recording assets and liabilities in their balance sheet, taking fair value into account. Although the IFRS’s notion of fair value is essentially based on the market value, many people wonder whether this notion of fair value could be applied in a practical way to assets and liabilities that have no contractual market value available. In these particular cases, is the objectivity and reliability of the IFRS accounting standards and the product accounts of this authoritative accounting literature a guarantee? We should ask ourselves the question. The IASB has decided to adopt what is first of all a definition of market value for the Fair Value (FV). The IFRS mentions an amount for which an asset can be exchanged or a liability can be liquidated or unwound between identifiable or identified parties who wish to proceed with this transaction at acceptable conditions, or ‘at arm’s length’. This market value approach is reflected in the prioritization pyramid of the FV established and developed by the American counterpart of the IASB, the FASB (Financial Accounting Standards Board) and published in the United States in an ‘exposure draft’ (ED) dated June 2004. (1) The price defined by the market value must therefore be adjusted by the removal of transaction costs (estimated). However, transport costs must be incorporated into the fair valuation calculated. The fair value is in fact a realistic exit value. But according to the level of hierarchy proposed by the IASB, a part of this valuation is based on a value judgement, with everything that this entails in the way of uncertainty and error. In the IAS 39 standard, it is stipulated that the ‘bid’ is used for assets and the ‘ask’ for liabilities. However, the ‘mid-‐price’ is also a possibility. The coherence of the method used is recommended to statutory auditors. At Level III (5 in the IASB table), the combination of valuations is also possible. When we talk to buyers and sellers, it is (cf. chart attached) obvious that it regards an uncommitted and independent counterpart.

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IASB’s Hierarchy of Fair Value

Using prices or quotations for identical assets or liabilities in active markets

Level I When the information is available

Level II Level III

If it is not available, recourse to quoted market prices for similar assets or liabilities If it is still not available, use other available valuation techniques

4.21.2 Practice and Reality of Fair Value Sadly enough, the practical reality is quite different. For many assets and liabilities that should be appreciated and evaluated at their fair value, there is no Level I or Level II valuation or evaluation available (according to the scheme proposed for the IASB/FASB). On the contrary, the fair values have to be determined hypothetically by figuring out what the market price should be if this market or a similar one actually existed. This estimation is often based on hypotheses and elements provided by management. These future hypotheses and the valuation model used will therefore be partially subjective. For example, these hypotheses and models will apply to provisions, the costs related to pensions or assets whose value must be reduced (“asset impairment”). This raises the essential question of knowing whether the hypotheses of the fair value at Level III are sufficiently understandable, reliable, pertinent and comparable to be used for financial reporting.

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4.21.3 Subjectivity of the Fair Value Notion Is it not somewhat subjective to call the value that we give to an annual account asset or liability ‘fair’? Within the idea of fair value itself an important element of subjectivity seems to be assumed in many cases. When we read the documents presented by the IASB, inspired by their overseas colleagues, we wonder if the terms ‘market value’ or ’marketable value’ or ‘trade value’ would not have been better choices. Even when we adopt elements at Level II or especially at Level III, incorporating the notions of value judgement, notions of estimation (or openings to valuation techniques not listed in their entirety), we can ask ourselves whether the word ‘fair’ is the most appropriate term. If we begin with a notion that even in its name incorporates the idea of subjective judgement and appreciation, we can only doubt that it is what we really want it to be. One of the initial problems lies in the term fair value, which evokes or implies expectations from readers of the annual report that cannot be met. In accounting, even if it is sometimes a delicate issue, one must avoid any interpretation, judgemental approach or use of vague methods as much as possible. Ideally, accounting, as seen by its practitioners, must be precise, square and transparent. The vagueness linked to the initial notion of fair value will ensure a risk of dissatisfaction regarding the result and/or method. We should not qualify of ‘fair’ what we cannot prove is really fair. We should have used a more adequate term for this ‘valuation’ and give it an adjective more in line with the reality of the proposed methodology. Fair Value Hierarchy (source IASB)

Level 1 (=price*quantity) P*Q After Markets Inputs Entity Inputs

Level 2-4 (incl. OTC transactions)

Level 5

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4.21.4 Reliability of the Information Reported By spending much energy assuming whether information is pertinent or not, the IASB has forgotten to pay enough attention to the reliability of this information. If the valuation methodology is not entirely reliable, how can the result lead to anything else but variances and the removal of the comparative nature highly proclaimed by the IASB itself, when it boasted its standards regarding various accounting legislations, national and domestic? The statutory auditor and specialists ponder this fundamental point. No one doubts that the finality of the accounts is to provide quality information that is reliable, transparent, precise and comparable. This essential and preliminary objective must remain a main theme of the elaboration process of any IFRS standard. It is generally accepted by everyone that the accounting information has to be “un-‐der-‐stan-‐ da-‐ble” to readers. These same readers must then be able to take rational economic and financial decisions, based on the accounting reports it produces. If instead of giving readers precise information based on a methodology strictly defined and with a highly predictive value they are provided with information that gives the impression of being based on random predictions and subjective elements (Levels II and III), we cannot be surprised if they are somewhat perplexed. The target set by the IASB itself should not be missed. In practice, everyone easily understands that Level I is ideal, even ‘fair’, but limited to a certain class of assets and liabilities of which there are few. From there, an enormous amount of literature has been deployed to define two other, more random levels. Level III, suggested by the accounting setters, relies on mathematical models based on predictions, hypotheses and postulates from management. The question is, will the valuations defined this way be ‘fair’ or not?

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4.21.5 Cornelian Dilemma The IASB will once again be confronted with a Cornelian dilemma. Will the international accounting constituent be able to continue the valuation approach of assets and liabilities using measurement models (approach mark-‐to-‐model to asset/liability measurement) and at the same time promulgate accounting standards that allow investors to evaluate management performances, the value of the company and take the appropriate financial investment decisions? This is doubtful. Do we have to then resort to the proper method of historical cost? Obviously not! This would be the same as going backwards in accounting. Few people would defend the idea of going back to the past and resorting to a method that was labelled unfair and obsolete because it did little or nothing to reflect the economic reality. The IASB should ideally promulgate and promote practical methods that are solid, transparent and objective, which could be properly used to support investors making future predictions. The IASB could also distinguish the primary and quite certain valuation methods to be integrated into the annual financial statements (balance sheet and P&L sheets) and the secondary valuation methods that are less precise, exact or ‘fair’ to be incorporated in the annexes of the annual financial statements. This secondary information will be additional and complement the first.

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Following what IFRS 7 will impose, we could imagine using these accessory valuations in sensitivity analyses. The IASB has opted for the periodical revaluation of assets and liabilities at fair value. Some say this approach implies a volatility of results. Therefore it is logical that the investors should be informed of the figures reported and their nature. We must therefore distinguish the results achieved or not, the losses and gains resulting from the evolution of a real market price from those resulting from calculations based on simple hypotheses.

4.21.6 The Best Is the Good’s Enemy

Like in many other sectors, the best is often the good’s enemy in accounting. By having placed overly exaggerated emphasis on what the IASB believes is useful and necessary information, it has forgotten to pay enough attention to the reliability of the information to be delivered. Is this information still understandable? Is it interesting for the reader of an annual report? We must seriously ask ourselves this. Moreover, if the convergence between US GAAP and IAS/IFRS has been defended and maintained by the company treasurers and the EACT (*) with regard to the IAS 39 standard, they nevertheless believe that everything that comes from the United Stated must not necessarily be adopted as is. The ‘made in US GAAP’ is far from being a sufficient label to be incorporated as is! In conclusion, before adoption we must make sure that such a complex and partially subjective notion, with all its advantages and disadvantages, does not mislead the so-‐called ‘users’ or investors as to the true nature of the economic reality of the underlying element. It is not clear whether the IASB has the will or the intention of making sure of this fact prior to generally adopting the notion of fair value.

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4.22 The IAS 39 Effectiveness Testing – What If the 80-‐125% Range Was Eliminated? “What I dream of is an art of balance” (Henry Matisse)

4.22.1 Double Effectiveness Testing

The effectiveness tests stipulated in IAS 39 are far from being a straightforward formality. Yet, when test results fall outside of the 80 – 125% range and are considered “ineffective,” the consequences can be drastic and onerous. Wouldn’t it be better to simplify? Why maintain a range, outside of which the sanctions are arbitrarily drastic? Many people argue that these effectiveness limits should be eliminated. IAS 39 stipulates two effectiveness tests; one is prospective, the other is retrospective. According to the first precept, a hedge must be highly effective as soon as it is put in place and negotiated with the banking institution. However, according to the second precept, the company must verify this effectiveness afterward. In order to be highly effective, the coverage must fall within an effectiveness range of between 80 and 125%. Fortunately, as a result of the lobbying done by treasurers, these pre-‐hedge and post-‐ hedge percentages have been aligned. This consistency, which already existed under US GAAP, was requested by European corporate treasurers and was obtained in the best interest of everyone involved; this effectiveness measurement is not easy to determine.

4.22.2 Testing Methodology

Existing methodologies for performing the required effectiveness evaluation vary widely. The methodology can be both qualitative and quantitative. In addition to determining that the critical terms of the hedging contract are aligned and coordinated with the terms of the underlying asset, the treasurer must put a number on the quality of the hedge. There are various methodologies, such as the famous “dollar offset method” (which is intended to determine the change in the fair value of the hedge with respect to that of its underlying asset), or the “hypothetical derivative method” based on an assumption of perfect hedging and an analysis of the deviation from said perfect hedge. However, there are even more statistical methods, such as “regression analysis” or the “volatility reduction” method. These statistical methods can be cumulative (from the time it is designated as “hedge accounting”) or periodic (period-‐by-‐period analysis). In addition to calculating

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prospective and retrospective effectiveness, these methods can be used to determine ineffectiveness, as well as which accounting entries to apply. The choice of methodology must be made from the outset and be applied consistently, constantly and definitively, and it must be documented and explained.

4.22.3 Prospective Effectiveness

There is no specific methodology defined for this test; however, you can apply good common sense. If all the critical terms of the hedging contract are aligned with the terms of the hedged underlying asset, it can be concluded that the hedge will be effective. You will still have to check the effectiveness throughout the lifespan of the hedging instrument. For example, for an IRS, the critical terms can be considered aligned if the following criteria are met: the nominal amount of the hedging contract is identical to the principal for the entire life of the underlying asset, the expiration dates are the same, the interest payment dates are the same, the basis for determining the interest is the same for the underlying asset as it is for the hedge, the re-‐pricing dates for both are identical, the interest-‐bearing asset is not impaired, and the fair value of the instrument at the time it is designated is zero euros, or, if it has a value, this value must be completely offset by the fair value of the hedged asset. This example shows that the pre-‐hedge effectiveness evaluation can be determined based on factual information. One could therefore conclude that a foreign exchange forward contract, for which the maturity date is the same as that of the hedged underlying asset, is highly effective from the outset.

4.22.4 Retrospective Effectiveness

The treasurer must prove that his hedge remained effective within certain limits (80-‐ 125%), or otherwise the hedge will be declared completely ineffective. This range creates difficulties that some people would like to see eliminated. With the “fair value hedge” method, effectiveness is proven by comparing the current numbers, and with the “cash flow hedge” model, it is done using methods such as the hypothetical deviation method mentioned above. Although effectiveness can be calculated either by individual period or cumulatively, it is important to remember that the first approach is riskier in terms of ineffectiveness than the second approach, which tends to smooth over the potential ineffectiveness in question.

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Change in FV of underlying

Change in FV of hedging instrument

100

(90)

(100-90)

(65)

(5)

(60-65)

(40)

120

(120)

Period

Hedge ineffectiveness in P&L

(20) (-40+20) -

(120-120)

Effectiveness ratio Period by period

Cumulative

90% (90/100)

108% 97% (65/60) (155/160) 50% (20/40)

113% 135/120)

100% 106% (120/120) (255/240)

4.22.5 Ineffective Portion The ineffective portion of the hedge will have to be recognized directly on the income statement. Consequently, it is advantageous to have the greatest possible effectiveness, in order to limit impact on the P&L and to post as much as possible in the “equity hedging reserve.”

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Retrospective Effectiveness Test for CFH Hedge item

Floating rate debt refixed

15/3, 15/6, 15/9, 15/12

Hedging

IRS (some amount) refixed 31/3, 30/6, 30/9, 31/12 15 days of time mismatch generating potential ineffectiveness

MTM hypothetical “perfect” hedge MTM of IRS

-762.760 -684.163

-762.700 -851.132

-762.760 -963.815

Recorded in Equity Recorded in P&L

-684.163 -

-762.760 -88.372

-963.815

112%

126%

% effectiveness

90%

out of range

4.22.6 Practical Aspects of the Test to Consider Shouldn’t we establish minimum thresholds under which the changes would be considered immaterial and negligible? Some treasurers have suggested that the IASB adopt a more flexible attitude when assessing effectiveness. In fact, isn’t a foreign exchange forward contract the most effective instrument for hedging exchange risk? We truly believe so. Is it necessary to prove its effectiveness even when a “forward-‐to-‐ forward” method is applied? Just like we do with an IRS, we could adopt a series of criteria to be met from the outset, to avoid these effectiveness tests and make life easier. When dealing with small numbers (“law of small numbers”), the “dollar offset” method can be dangerous. It can determine ineffectiveness by the low correlation existing from small changes in fair value with respect to the total amounts of the hedges. This is the case when the periods being studied or analyzed are short (i.e. the first or last period in question). However, this situation is paradoxical when it pertains to an IRS or a future contract that appears to be perfectly aligned with the underlying asset. When a company has adopted a “spot-‐to-‐spot” method, for example because it cannot define the time of payment or deposit with any accuracy, it avoids the retrospective test. The downside to this administrative advantage is that the ineffective portion must be recorded on the income statement. This is also the predicament when using options. It is a Cornelian dilemma; you can either keep the “intrinsic value” and the “time value”

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attached, and be forced to test the effectiveness at the risk of being totally ineffective (IAS 39), or you can separate them and avoid the effectiveness test, but automatically generate ineffectiveness with the change in the time value (which will automatically be posted in the P&L). This second approach is permitted under US GAAP (DIG 20) and creates contained volatility until maturity, but it avoids the risk of complete ineffectiveness and does not require testing it.

4.22.7 Testing Tools

Tools are necessary for testing effectiveness (IAS 39) or even sensitivity (IFRS 7). The traditional tools can be provided by the Treasury Management System (TMS), or by third party tools and specialized external service providers, such as REVAL, for example (see www.reval.com ). It all depends on the degree of sophistication of the instruments used. The most complex mathematical methods, the “Value at Risks” (VaR) approaches or the “regression methods” require adequate technical support, which some service providers do offer. The choice of method applied is therefore not arbitrary and can result in additional costs for the company.

4.22.8 Proposed Simplification

The corporate members of the IASB Working Group on Financial Instruments (WGFI) have proposed a complete removal the 80-‐125% effectiveness range. This is a true simplification desired by the “commodity hedgers.” It would make it possible to keep the effective portion in an “equity hedging reserve,” even when it is low, while taking into account the results of the ineffective portion. It is infuriating to see that, because you are 79% effective (under-‐effective) or 126% (over-‐effective), all of the hedging is considered as such. Often, a commodity hedge is ineffective from the outset, because the instrument covers a related, but slightly different underlying asset (for example Brent to cover jet fuel, or Arabica to cover Columbian coffee). Isn’t a little bit better than nothing at all? Isn’t this limit arbitrary? Why not set the range at 70-‐135% or even 50-‐ 150%? IASB seems to be swayed that there may be room for simplification. Eliminating this effectiveness range and allowing a qualitative test for the most effective basic instruments is not an entirely ridiculous idea. These two ideas would make life a lot easier for treasurers applying hedge accounting. We think it would be easy for companies to come to a consensus on this point, since it seems so obvious and logical. However, in the IFRS, logic is sometimes forgotten or neglected in favor of old habits. Has anyone ever wondered how these effectiveness percentages were determined? Perhaps not. What if we simplified things for once?

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5 Part V Regulations

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5.1 Might too much regulation kill off regulation? “It isn’t so much that hard times are coming; the change observed is mostly soft times going” (Groucho Marx)

5.1.1

There is only so much that you can achieve

You can have too much of a good thing, as the popular saying goes. But does this apply to financial regulation? Will too much legislation not be counter-‐productive? We should ask ourselves if, by trying to do things too well and to seek absolutely crystal clear transparency, we might not end up with a surfeit of financial reporting material to be disclosed publicly. Are we perhaps going too far in terms of financial legislation and supervision? The financial crisis is over. It has left a few scars still visible. The sovereign debt crisis is still simmering away. The G20 London summit decided to put the emphasis on absolute transparency. This is a laudable goal. However, the road to heaven is paved with good intentions. Are these good intentions enough to achieve the absolute target that the G20 has set itself? Even though the great and good of this world may be aiming at this target, which is certainly praiseworthy, the means of getting there and the methods used may vary and may potentially create disparities from continent to continent. This would give rise to unacceptable competitive advantages and disadvantages. Regulation makes no sense unless it is applied similarly to everybody. Globalisation, too, affects the new regulations that apply or are to be applied. However, the paradox is the temptation towards a rise in nationalism and protectionism at a time when we have to standardise and harmonise laws in force at the worldwide level. This is indeed a threat that the G20 intends to combat. The "Dodd-‐Frank Act" must not and cannot be fundamentally different from the European Directives or the ESMA rulings. Globalisation must also be regulated and harmonised and above all must be consistent. Here we see globalisation operating at the political level and not just, as we are often led to believe, at the economic level.

5.1.2

If you want more rules, you want more supervision

Supervision inevitably goes hand-‐in-‐hand with a surfeit of regulation. Rules are only meaningful if they are intended to correct a potential deviation and if they are implemented and monitored by specialist bodies authorised to do so. Here again we see

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a myriad of "supervisors" operating not only at the national level (AMF, FSA, CSSF, SEC etc.) but also at the supranational level (ESMA, EMIR, CESR, EU Commission, IOSCO etc.). These divergences in roles make proper structuring of supervision more complex. We also need to bear in mind the developing countries which are changing the game from the economic point of view. They are arriving bright-‐eyed and bushy-‐tailed, with little in the way of organisation or regulations. This being the case, they are likely to generate unfair competition, with a complete absence of control and particularly scruple as regards major powers. For example, China has time and again demonstrated that it will not always follow the demands made by Europe or the USA. It does exactly as it sees fit, without bothering about the rest of the world.

5.1.3

The costs and burgeoning on costs of the free-‐market paradox

Here again, we have a major economic paradox because the world of the free-‐market, through its excesses, is becoming ever more closely controlled and ever less… "free” – the victim of its own aberrations and the abuses of its greedy and thoughtless operators. Excesses call for restrictive rules, which call for oversight bodies, which inevitably lead to huge compliance costs. Let us take the example of banks. The finger is often pointed at them and they are subjected to thousands of rules, including the famous "Basel III” regulations. It is they who inevitably will have to pay through the nose to meet the bill for the much stricter liquidity and solvency ratios. At the end of the day, this bill will be passed down the line to their corporate customers. Basel III will have major indirect repercussions on access to credit. It will become even scarcer and even more expensive (or to be more accurate it will increasingly be billed at a fairer price). A switch toward something closer to the US model should be expected in Europe, with more capital markets transactions to make up for shrinking bank lending. This also means that (when borrowing) we will have to work with an ever-‐greater number of banks. Syndicated credits will involve an ever-‐greater number of banks that, in addition, will change more often during the life of the credit, regularly transferring their exposures to other banks. The new regulations will have indisputable effects, direct or indirect, on non-‐financial companies. The welfare state will become less and less the model of choice and governments themselves will have to tighten their belts. It will turn into a vicious circle. If you want less expenditure, you want less economic recovery. This is the cruel dilemma facing European governments and the difficult balancing act to which some have no answer, as happened recently in Portugal. Here again, emerging countries do not play an appropriate role, manipulating their currencies for their own ends to boost their exports. A strong EUR is a mixed blessing and makes the role of governments much more complicated.

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5.1.4

More regulation or less regulation?

This is indeed a crucial question. It would seem that there is nothing we can to stop the heavy load of new regulations. However, as stated above, excess can be negative and even counter-‐productive. A happy medium must be found to balance out the forces in play, to cut down the risk of a crisis and to ensure that the economy keeps on working. This is one of the challenges facing the members of the G20. The concept of having better overall risk management underlies it. Without better risk management, no prevention is possible. Companies must stress and promote a risk culture. But risk management must also become a proactive (forward-‐looking) management tool rather than a compliance tool (backward-‐looking/passive). Compliance does not always guarantee effective forward-‐looking management. Here again, governments must change mind-‐sets towards higher quality in management generally, not just in the financial industry. It is a fair bet that we will have more legislation, regulations and mandatory reports to produce to certify compliance and adherence to laws and basic financial principles. However, in contrast to IFRS which aims at being principles-‐based, the trend is ever-‐more toward rule-‐based approaches, which have little flexibility or adaptability. It is the very principles of the free-‐market and laissez-‐faire philosophies that are now hanging in the balance, since governments intend to (must, in some people's view) regulate financial activities. The danger is still that the majority will have to pay for misdeeds of a minority.

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5.2 Regulate finance the same way as controlling air traffic to avoid crashes in mid-‐air “You have no control over what the other guy does. You only have control over what you do” (A.J. Kitt)

5.2.1

The economic volcano

We should regulate worldwide finance the same way as we control air traffic: in a completely coordinated way. If it works in the skies, why wouldn’t work on land? In financial matters, is it really so difficult to finish the job of coordinating regulations? The air traffic model could be a source of information that could help to converge towards the ultimate goal: financial legislation applicable to everyone without location providing any competitive advantage. Ash thrown up by the worldwide economic crisis that first appeared in 2007 then took shape in autumn 2008 has fallen back down to earth in spite of the volcano re-‐erupting several times. The challenge for world leaders (i.e. the G20) is to define effective preventive regulations to limit the risk of systematic impact on the worldwide economy. Today we realize that a specific crisis, located on one continent ends up polluting the whole world, even though certain patients may be more affected by the disease than others. We are always seeking the remedy or the vaccine, but it is hard to recover from such an illness with the current economic climate in such poor shape. Convalescence is not taking place under the best conditions. The stigmata are such that it is much more important than ever before that we act and legislate. However, the state of the world economy is a much greater worry for politicians than financial regulation. It is now almost five years after the start of the sub-‐prime crisis, and not all the Dodd-‐Frank measures and European regulations are yet fully finalized, deployed or implemented. This timeframe seems extraordinary and shows how difficult the task is. Should inspiration not be drawn from other industries to decide how to do it better?

5.2.2

The dilemma: international regulator or no international regulator

Some people are advocating or have advocated a worldwide regulator. Others advocated international rules or at least coordinated and harmonized rules. The state of the worldwide economy, depressed yet again for several months or more, does not help governments and the other people involved to get their act together. The focus is more on profitability and survival than the means of avoiding any future systemic risk. The idea of a parallel between worldwide financial regulation and international air traffic

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control is valuable and educational in our view. The air traffic control structure ccould be an inspiration to the G20 and to national and international regulators. We need to think of defining responsibilities, roles, minimum safety standards, procedure and real-‐ time management. The task is certainly complex, but not impossible to achieve.

5.2.3

Responsibilities and allocation of roles

Each country controls its own airspace in accordance with international criteria and rules. Air traffic control operates very pragmatically. Every pilot knows exactly what they have to do and who to listen to without needing any worldwide regulatory authority. Therefore, there is no worldwide regulator in the air traffic sector properly speaking, but it nevertheless works very well. It seems to us that it is not a worldwide regulator that is needed, but instead standards that are harmonized and coordinated up to a certain point. These standards and practices or procedures must be internationally recognized and applied, and adhered to and supervised even at a more local or regional level.

5.2.4

Minimum safety standards

Before taking off, you know that the plane you are on today has undergone a rigorous inspection in accordance with applicable civil aviation rules. If the plane does not have the necessary certificates and papers, it will not take off. Any malpractice is rooted out and the slightest suspicion or failing is penalized by grounding, which is extremely expensive in aeronautical terms. Here again, regulators could nail an institution to the ground if it failed to comply. A strict freeze would force them to act fast. Small penalties applied after the event is often ineffective. The size of the penalty must be large for the rules to be followed. The penalties announced in the case of the recent Libor scandal may seem quite low to ordinary mortals given the scale of the fraud. Why not be more dissuasive and harsher? There is a level at which risk is no longer bearable, so action should be immediate and preventive, even if considered very harsh. If the penalties are too low, the thief will try and chance it. If it is dissuasive, they will think twice. Territorial jurisdiction and airspace have an effect in air traffic matters because countries can decide not to allow planes to fly over their airspace. Have countries lost this option or have they delegated it to the European Union? The economy has been globalized, but not the financial rules. They have been regionalized (for example US, EU, China, etc).

5.2.5

Common language

To establish effective procedures, we need to speak a common language. In the aviation industry this language (English) exists and is understood by everybody, applied by everybody and disputed by nobody. They even use a special alphabet, certainly a bit out of date, militaristic and peculiar, to avoid any misunderstandings or mistakes. The transmission of information by the operators and the regulators must be coordinated, perfectly and faultlessly. Is that not what the IASB is trying to do with IFRS? Clearly, FASB

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with its US GAAP sometimes diverges. However, we are on the road to convergence and everyone will end up speaking an Esperanto-‐type accounting language, a mixture of principles from both sides of the Atlantic. Basel is another example of this initiative. Here again, rules that are not applicable or applied to everyone make no sense and are potentially damaging in creating major competitive disadvantages under certain circumstances. ISDA is a technical language coordinator and defines market practices, as is the IASB through its IFRS and interpretations (i.e. IFRICs). All too often we have the impression that we're not all speaking the same language. So how do we ensure we understand each other to avoid crashes?

5.2.6

Local controls at the point of departure

In air travel, when traffic is congested, the plane cannot take off. In finance as well, where a market looks ‘congested’, why not bar or limit access? Of course, sometimes it will automatically limit itself, like money market funds since the summer of 2012 as a result of short-‐term interest rates hitting the floor. Access to certain asset categories or markets should be prohibited as it is to certain airports. An AIRBUS 380XXX cannot land at London City Airport for obvious reasons. In contrast, any number of brokers, bankers or non-‐financial companies can access any type of market. Access to markets needs to be better defined to avoid incidents due to lack of professionalism. For example, the MiFID I & II rules, which are certainly onerous, are trying to meet this objective in Europe, although not only in Europe. Effectiveness would be achieved by coordination which all of us think the G20 would allow. As in Rio on another subject, we talk, but at the end of the day, we do not all act together when we should all be rowing in the same direction at the same rhythm.

5.2.7

Financial radar

Time management is crucial in air traffic management in skies full of enormous flying machines. Radar is the real-‐time control tool. In finance, we have no radar system. Everything is done with a time lag after the event. There is no room for anticipation or proactive action. Could we not build financial radar? It would be enough for investment funds, hedge funds and banks to declaree their position in real-‐time. Clearly, this would not be so easy for non-‐financial companies. However, reporting to trade repositories for OTC (Over-‐the-‐Counter) derivative products shows what could and ought to be done. The portrait of the OTC financial skies would then be complete and the whole family would be in the picture. This snapshot of the financial skies by the national or international regulators would be confidential with the public and competitors having no access to the information in the same way that access to an air traffic control room is restricted and secured.

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Radar, even a rudimentary one, would be better than no complete view of the OTC markets, to take this specific example. With a comprehensive map of these risks the regulators could supervise and coach the participants through recommendations, instructions or penalties to prevent any risk of a mid-‐flight crash. By targeted action, the ‘financial controllers’ could, like their EUROCONTROL air traffic counterparts, adjust risks and take effective preventive action or provide useful support to avoid any potentially destabilizing failure, such as that of Lehman Brothers in 2008. We think of air transport as one of the safest methods of transport in the world, but when an accident happens, it hits the collective unconsciousness through its seriousness. Prevention, however, statistically limits the crash ratio (victims/flights). There are relatively few air transport accidents because they do not suffer from ‘fat tails’ unlike the financial markets. Regulators and governments must speed up reforms so that worldwide financial regulation can be finalized as fast as possible. All this has been going on for far too long now, and the uncertainty is still a source of risk. Enthusiasm has perhaps tailed off, which is regrettable. We need to act to quickly to win back the four gold stripes of the pilot in charge of financial vehicles.

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5.3 Reforming OTC Derivatives, a new challenge for Corporate Treasurers “No problem is so formidable that you can’t walk away from it” (Charles Schultz)

5.3.1

New regulation for OTC derivatives?

The Obama Administration announced in June 2009 a sweeping reform of the financial markets, including a brand new approach of the OTC (Over-‐The-‐Counter) derivative markets (“Financial Regulatory R: A New Foundation” published on June 17, 2009). In the meanwhile, the European Commission issued a “Consultation document on possible initiatives to enhance the resilience of OTC Derivatives Markets” (Brussels – Commission staff working paper 3/7/9 SEC 2009-‐ 914 / “Ensuring efficient, safe and sound derivatives markets” – COM 2009-‐332). Some corporate treasury associations (e.g. AFP and ACT) and IT service providers (e.g. REVAL – see: www.savemyswaps.com ) have expressed their views on such a radical change on the way derivative products in a broad sense are dealt and negotiated. Beside these initiatives other corporate treasurer groups or specialized institutions, like Greenwich Associates, have launched surveys about this planned reform. EACT has addressed its concerns and main issues about a reform which does not consider how it would affect the corporate users of financial markets. The major issue with this reform is the scope it includes. It does not only cover the trading of CDS and CDOs but also the plain vanilla hedging instruments (e.g. IRS, currency swaps, etc…). We will be all impacted by such a reform. The aim is to apply new rules to all derivatives, no matter what type of them is traded or priced, regardless of whether they are standardized or customized and it also includes the derivatives to be invented in future. There are no exceptions for simplifying the rules application. Are the “standard and classical” OTC products victims of the excesses of a bunch of them (e.g. CDS and CDOs)? In general, the companies use derivatives to reduce exposures and risks and not to trade speculatively.

5.3.2

Direct impact for Corporate Treasurers

The direct impact for corporate end-‐users (i.e. treasurers) is obviously the increase of cost of hedging because of margining system, the increased P&L volatility given potential ineffective hedging strategies and unwanted transparency on hedging strategies applied. The OTC reform would lead to higher costs and therefore to increased borrowing and possibly to additional capital requirements. The use of

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derivative products is essential and legitimate for a sound risk management. They are aimed to stabilize prices and mitigate risks. More transparency is certainly a recommended and praiseworthy goal, which can prevent future systemic risks. However, we do not want to negatively impact basic plain vanilla products which use could become ultimately impossible. Some treasurers in the USA are concern by the conflict between mandatory contract rules and US GAAP (i.e. FAS 133) and ability to demonstrate hedge effectiveness (see: www.afponline.org ). As always, the excesses from a limited number of persons will penalize the whole derivative user community. The misuses of couple of sophisticated and complex instruments by traders, together with the weakness of controls by regulators and supervision bodies will eventually impact the vast majority of the users. The cost for repairing the damage to financial system is extremely high.

5.3.3

Alternative solutions

To avoid some of the impacts for treasurers and not to be counterproductive, few financial professional organisations and service providers have recommended excluding the derivatives (as defined under IAS 39 definition) which qualify for hedge accounting treatment under FAS 133 or IAS 39 from the regulatory reform envisaged. According to Jiro Okochi from REVAL it could even help encouraging sound risk management, promoting transparency and reducing costs and administrative burden. The financial instruments accounting standards (i.e. IAS 39 and FAS 133) were implemented in order to make sure corporations that speculate using derivatives will book changes in fair value of hedging instruments into profit & loss statement. The aim was to improve transparency and to better reflect the financial reality of operations formerly booked off-‐balance sheet. The corporations that use basic hedge accounting qualified instruments would be penalized by the generalisation of rules to all derivatives. The obvious consequence of the current accounting rules was to enable end-‐users of derivatives that have deployed fairly conservative hedging strategies to benefit from hedge accounting compliance in mitigating Profit and Loss (P&L) impacts. We have noticed a real simplification and cleaning of derivative products used compared to couple of years ago, before IAS 39 stringent provisions on financial instruments. The accounting treatment and qualification could be a better criterion than the non-‐ standardized versus standardized trades distinction. Some treasurers have proposed to exclude basic plain vanilla instruments from the scope of the reform. For example, a straight forward FX contract or a plain vanilla Interest Rate Swap (IRS) will not be regulated by the OTC provisions. The major problem would be then the definition of the scope and the instruments to be removed from the OTC products.

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5.3.4

Risks if applied as is

The risk is, if no exemptions are planned, that corporations will decrease the use of OTC derivatives, even basic ones. The cost of margining and reporting would be too high compared to benefits. Corporations would need to arrange committed credit facilities to meet central counterparty margin calls, reducing accordingly their total debt capacity. Corporations could suddenly decide not to hedge anymore some financial exposures. The result would be to have un-‐hedged risks and bigger exposures in a period of time where operations are already affected by the world economic crisis. With IAS 39, some financial hedging decisions were driven by accounting considerations. With the OTC derivative regulations, hedging strategies would be driven by cost and administrative considerations. We do know at this stage how it would be applied in practice. The management of numerous call margin lines would inevitably be complicate. The return on these potential time deposits (as margins) would also certainly be inefficient. Who knows how the clearing house system will function in practice? If we use several houses for clearing operations, it will create additional complexities. We should admit that so far, corporate treasurers are relatively immune from any financial regulation. Unfortunately, one consequence of the crisis and these set of coming regulations is the indirect effect on pricing and / or operational impacts (e.g. incorporation of credit risk on FX products; OTC derivatives planned regulation). The idea with the OTC derivatives regulation would be to standardize derivative instruments (sensu lato) and to require them to be dealt through an exchange with settlement handled through a clearing house or a Central Counter Party (CCP). Interposing a CCP with rules on margining and collateral is designed to reduce counterparty risk (what seems to be an important and useful objective). It also aims to promote fungibility of products and full transparency of markets, to increase legal certainty and to reduce legal risks. Eventually, it enhances operational efficiency by enabling electronic affirmation and confirmation services and more standardized collateral management processes. However, after recent bail-‐outs, we could reasonably accept that large multinational banks default is rather limited (although not excluded). Furthermore, it remains a delivery risk (which is at the end of the day smaller than a pure credit risk). It should facilitate offsetting and netting down of operations or, if necessary, the wind-‐down. If derivatives (including FX forward and plain vanilla IRS) are quasi “burned” because of administration burden and costs they would create, the risk management by non-‐financial corporations would become extremely difficult. The risk would be to avoid hedging to minimize related costs. All treasurers would support all regulation measures dedicated to improve controls on financial counterparties and dealers. The better way to reduce risk in banking sector is certainly not the transfer of constraints and costs to corporations and users. The last

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thing one could wish is to make hedging impossible, too complex or too expensive for normal business exposures.

5.3.5

Coordination of all actors on stage

As usual with such proposed reforms, it impacts several activities and professions, including blue-‐chip companies, which may suffer for crimes they did not commit. In modern economy, the banks provide the fuel and corporations are the engines. The risk is to try to purify the fuel while altering the engine. All the professions that could be impacted by the OTC derivative reform are not always represented in the discussions, round tables or workshops. The corporate treasurers should be represented by EACT and their national treasury association(s). EACT has recently decided to react and to address the issues and concerns of treasurers ( www.eact.eu ). The systemic risk the EU intends to avoid or to mitigate arises within the financial sector and not elsewhere in the economy. The failure of some non-‐financial corporations would not create a threat to the whole world financial stability as bank failures would. It is now time to lobby against such a project, as presented by EU and the US Administration, as it would generate negative consequences on financial risks hedging and modify hedging strategies as a whole.

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5.4 Are we facing more expensive FX pricing in the coming years? “”Money often costs too much” (Ralph Waldo Emerson)

5.4.1

The Price Is Right

Banks are seriously contemplating credit-‐adjusting price when they quote on FX derivative transactions. The credit parameter to be included in quote would have a significant impact on cost of hedging unless corporates use collaterals. It could be one of the consequences of the current financial crisis. Treasurers will have in future to consider the potential extra margin to be included in forward FX transactions to reflect the credit risk faced by bank counterparties. Like in the famous game show created by Fremantle, is the price right? Is the FX pricing fair given current market situation? For more than 2 years, some precautious financial institutions have already started quoting higher longer maturity FX deals, to reflect a bigger risk taken. However, one of the unexpected or unsuspected consequences of the current financial crisis is or could be a significant increase of FX pricing on longer periods. Dealers are beginning to think more seriously about credit-‐adjusting for credit the prices quoted on FX derivatives in general (“derivatives” sensu lato, as defined in IAS 39). The pressure on banks may force them to adjust pricing up on longer period FX transactions to include this credit risk element. It means that leaving aside swap points and interest differentials, the longer a forward deal the more expensive it will be (higher margins). This evolution we have noticed the last years seems crystallizing now. This inflation is rather surprising for many corporations although it was inevitable, especially after such a deep credit and faith crisis we faced. The non-‐delivery risk is now a risk to consider carefully when dealing FX. We all know in Europe that a bank default is not a pure theory issue. Banks will now try to incorporate the credit risk element in quote or to find alternative protection against it.

5.4.2

Cash collateral solution

The solution to reduce the extra cost adjustment applied to FX transactions is to sign a cash settlement agreement to collateralize bilaterally amounts corresponding to changes in mark-‐to-‐market valuation of portfolio of FX transactions made with the bank. The idea, like for margin calls, is to secure the potential (unrealized) loss on portfolio of FX deals revaluation. If the portfolio has a negative change in fair value (lower value compared to inception value), the customer would have to secure this amount with a cash collateral deposit. In the case of a positive change in fair value, the deposit in cash

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would be made by the bank. Both deposits are or can be remunerated at EONIA rate, for example. It means that in case of default of the corporate counterparty, the bank would be compensated for the FX deal its customer will not deliver at maturity and would unwind the contract without any losses (given the cash collateralization agreed). Conversely, the corporate would be compensated in case of default from the financial institution. The documentation to be signed defines the terms under which collateral is posted or transferred between swap counterparties to mitigate the credit risk arising from in-‐the-‐ money derivative positions. The credit valuation adjustment translates the probability of default during each time period, using the famous CDS (“Credit Default Swaps”) spreads when available on the market. For the shortest dated transactions, the default probability tends to be low. However, sometimes this probability can be lower in two years because the market is taking the view that those having survived the current problems should be then around for a while. Of course, the larger and the more diversified the portfolio, the less collateral would be potentially required by the bank. It is obvious that in case of default (e.g. Lehman brothers or Kaupthing bank) the customer can recuperate and compensate, via the deposit, the loss incurred. Therefore, the treasurers have to analyse and to check whether it makes sense to reduce cost of hedging / dealing FX transactions by collateralization or not. The question is more complex than it appears: what is the corporation cash situation, short or long? What is the total volume of the portfolio and do some positions off-‐set others, reducing accordingly the collateral? How to manage these collaterals in case a company deals with several banks? Etc…

5.4.3

Technical and administration issues

The more FX transactions dealt, the more the banks used for dealing, the more collateral would have to be possibly immobilized and locked. It could not be considered as “cash and cash equivalent” according to IAS 7, as it is pledged to the bank. The return offered will not be as good as the one potentially achieved now with money market funds of prime quality. Collateral, for a borrowing company (being “short”) can be extremely expensive these days. For groups which are cash poor, it has an additional cost not to be neglected, especially when spreads are extremely high, as today. The contract signed with the bank will imply review by lawyers and extra legal costs, at least for first contracts to be signed (similar to ISDA schedules). Fortunately, limits and margin calls will be managed by the bank back-‐offices. Nevertheless, it will inevitably create extra administration for treasury teams.

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5.4.4

Corporate alternative solutions

The corporate treasurers could also decide to have recourse to shorter FX transactions rolled-‐over over time. Again, it will generate extra administration and interim volatility at roll-‐over dates. That is the price to pay for this type of solution. If not, the “deteriorated” FX rates could cost between 0,20% up to 1,20% (very rough estimate), depending on maturity. On a five-‐year ten million USD forward transaction, we can, for example, imagine costs increased be EUR 80 to 100k. This credit risk element has a related cost to be cautiously considered. The Cornelian dilemma is a huge premium to be paid on FX contracts or imperfect heavier hedging solutions based on several roll-‐ overs. It is, in any case, cumbersome solutions to be applied. With a cash settlement agreement a corporate is enabled to reduce the credit charges linked to FX dealing of derivatives, as well as to reduce significantly counterparty risk (what is not unusual these days). Of course, it means use of cash collateralized (but on symmetrically basis). The administration burden of such agreement can be reduced by increasing thresholds and frequency of matching and controls. The sophistication and calculation behind this risk assessment can and will vary from bank to bank. It therefore will impact cost of similar transactions requested to different banks. The good repartition and split between FX side-‐businesses will inevitably make it more complex for treasurers.

5.4.5

Brand new world for FX dealing

Before Lehman and Bear Stern (and all others having followed, in the USA and in Europe), treasurers were less credit risk sensitive. Now, dealing with a safer bank with absence of delivery risk can be essential for long transactions, especially in a hyper volatile FX context. We likely entered a brand new financial world and market practices will certainly keep evolving in the coming years. In general, the implied default probabilities increase as the tenor of the transaction increases. The longer a deal, the more expensive it will be. This important issue will probably have consequences on how corporate deal FX transactions. It can potentially affect their strategies and risk approaches. This consequence does not simplify the treasury management. It is rather interesting to notice that the more technology evolves, the more the framework and rules become. Unfortunately, some technologic progresses made are not always reflected in day-‐to-‐day treasurer’s life. Some customers can be less price-‐sensitive when they deal with safer banks. Others can be tempted to shift back to bankers offering best prices. Some banks could also be reluctant to move too fast in order to remain competitive. The reality is that we are in a new dimension. This will certainly become a market practice, no doubt about that. It is a simple question of time.

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5.5 A victory in a battle can obscure the problem also

In looking for exemption for collateral, we are forgetting the derivatives reporting requirement…

“Any word you have to hunt for in a thesaurus is the wrong word. There are no exceptions to this rule” (Stephen King)

5.5.1

Spotlight on the collateral requirement

Are we failing to see the wood of reporting requirements for the trees of the collateral requirement? Some treasurers, perhaps somewhat naïvely, think that they will neither be required to provide collateral nor to report on it. However, it looks as if they are refusing to face facts. Even if they are exempt, which is by no means certain, they still need to report all traded OTC derivatives to ESMA. Those treasurers who are best-‐informed about the future OTC (Over-‐The-‐Counter) derivatives regulations have focused so narrowly on exemption from the requirement to post collateral that they have almost overlooked the reporting requirements that come into effect on 1 January 2013. From the beginning of next year no less, all derivatives must be reported to ESMA through what are called "Trade Repositories" (TR), which are a sort of virtual repository/register of the deals done. We need to realize that treasurers will have twenty-‐four hours to report deals. As a result, without automation, we are looking at a lot of hard work for treasury staff. It would also seem that meeting the mandatory deadlines will require flawless organization. This will be no easy job. By becoming obsessed with the most important item in the proposed derivatives reform – the requirement to post collateral as security for the counterparty – we have lost sight of the reporting burdens for which there will be no exceptions or exemptions. It is therefore none too soon to start addressing the matter and to consider how to formulate and automate reporting on derivative products.

5.5.2

Treasurers: shipshape or “I see no ships”?

As so often happens, many treasurers who fail to make preparations now will find themselves caught out when the storm hits. It's better to be busy as a bee, preparing to report on the OTC derivative products that you process. To make your life easier, there would seem to be no alternative to automation. The volumes processed are often such that the question of automation or no automation does not even arise. It is hard to see multinationals entering up their transactions in duplicate by hand. The risk of mistakes would be far too high. Moreover, at this stage it is planned in the new regulations that

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the contracts being traded will have to be confirmed "electronically". So this in any case leaves no room for manual or semi-‐automated solutions. For reporting, there will be no minimum threshold, either in the USA with Dodd-‐Frank, or in Europe with EMIR. Some even have no idea that the EU is imposing requirements on us to report the contracts we deal in. However, there is something more that not all treasurers know… We also need to consider reporting all deals in existence and processed before 31 December 2012. Deal history must also be reported from the outset. It is not enough to report post-‐December 2012 deals.

5.5.3

Report format

The question of the format of the report to be submitted and the electronic data format (for example XML, MT300, etc.) is still open. The European authorities are still in discussions with the trade repositories to come up with the best way of working. This playing for time on technical matters may give us a little breathing space, but it will certainly not make this requirement go away. Therefore, ESMA is expected to define the format(s) to be adopted for reporting. Our bet is that this will not take all that long. Discussions are proceeding apace, and we may expect the various suppliers to react fast. That, however, brings us to the issue of the source of the data. Where are treasurers going to extract this information from? On the face of it, it would seem to make sense to extract it from the TMS (Treasury Management System), especially as this contains all the deals processed. Sometimes, some TMS systems do not allow you to input all transactions, especially if they are complex or structured. There may also be several sources. Furthermore, the same considerations may be applied for trading platforms which are often dedicated to one product class, or on which treasurers do not systematically do 100% of their deals. Comprehensiveness is therefore the key to this problem. It is a very strong bet that we will have to use several data sources. Another idea would be to use a trade confirmation matching system (for example Misys CMS or SWIFT MT300 controls in the Treasury Management System). We must expect that suppliers of ERP and TMS systems, financial product and trading platforms (for example EUREX, CALYPSO and others), confirmation control applications, central counterparty clearers (CCPs) and even SWIFT will speak to the future data repositories, such as CLEARSTREAM with its REGIS-‐TR solution developed in conjunction with IBERCLEAR. This important and complex technical aspect seems to have escaped most corporate treasurers who cannot see the reporting wood for the collateral trees. The multiplicity of possible sources and parties involved seriously complicates the question of what reports to provide. This aspect needs to be taken into account, and perhaps our strategies and partners should be adapted to fit the new obligations.

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5.5.4

Using an independent intermediary or a trade repository directly?

The best-‐informed treasurers think that they can rely on their foreign exchange platforms to report their deals. But what about deals done off platform? What about interest rate, equity, credit or commodities deals? Some treasurer’s naïvely think that their treasury management system suppliers will soon offer a solution. Have you heard anyone talking about this functionality? You certainly haven't, because no treasury management system supplier has yet addressed the reporting problem. The platform providers have not yet worked on reporting solutions to offer to their customers. The interaction of the trade repository with the CCPs and other parties involved will be crucial. The trade repositories will also offer other services, for example REGIS-‐TR in Europe, such as confirmation matching, data consolidation and reconciliation, communication with the appropriate authorities, and the formatting and authentication required by the EU. There are or will be various TR solutions or Swap Data Repositories, particularly including: DTCC and ICAP in the USA and TriOptima. However, at this stage it is not easy to predict which solution will be suitable or the best for a European company. However, at least REGIS-‐TR will be up and running, providing a European solution and offering interfaces with other systems. We may hope that other solutions will emerge soon.

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5.5.5

Reporting challenge

So it's not just simply one extra report to be submitted. We are faced with a real challenge, even though exemption is almost a certainty. In practice, of course, this exemption appears to be complex and ESMA’s suggestions are not very plausible at this stage of the debate. It is now possible that CRD IV will allow it to free bankers from giving a different weighting to OTC transactions that are with or without collateral, or that use or do not use clearing houses (CCPs). It seems to be the outcome of the Danish Presidency Compromise text published by EU. Let’s be optimistic… while remaining prudent. Being realistic and pragmatic, we must face facts: we shall have to post collateral to cut the cost of our OTC deals or review our hedging strategies, and we shall have to report all derivative product deals within twenty-‐four hours of the deal being done. The technology will be there to help us, but for those pioneers who are trying to make preparations, the task is not as easy as it seems – so many of the various parties involved do not seem to be much bothered by or interested in these problems, which are nevertheless inevitable. So don't put it off until tomorrow, and leave other people to decide for you how it should work. Start looking now for a means of being ready to issue the reports that ESMA requires. Happy hunting!

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5.6 OTC derivatives, a victory or a lost battle? “Finance is a gun. Politics knows when to pull the trigger” (Mario Puzzo)

5.6.1

Exemption of the OTC derivatives reform

Even if corporate treasurers obtain the exemption of OTC derivative reform that EMIR (European Market Infrastructure Regulation), what we all reasonably could expect, this temporary victory could hide the ineluctable future of derivative market. Being realistic, we can imagine the derivatives will become more and more expensive over time and that we will have more administration to deal with the types of financial instruments. The most prudent treasurers would be tempted to say that better to wait for the final outcome of this key reform before shouting “victory”. The European institutions and MEP’s have accepted the idea of an exemption (despite the fact that some populist tendencies would favor no exception at all). However, the form of the exemption is not yet defined. EACT has heavily lobbied in order to avoid any exemption based on certain types of products or (even worse) on qualification for hedge accounting. And even if they decide to adopt an exemption based on a defined threshold, there are open questions like: at which level should we fix this threshold and how should we apply it in practice? In case we are above the predetermined threshold (limit), would the whole portfolio be tainted and non-‐exempted? There are as we can see many open issues even if treasurers succeed in being exempted.

5.6.2

Non full exemption

Unfortunately, the exemption even if finally adopted, will be applied to clearing and to collateral; but it will not cover the reporting, which will remain compulsory for all market dealers. For non-‐standardized and non-‐clearable contracts, they should be electronically confirmed with auditable monitoring process for all participants and, in this case, no threshold will be applied. Therefore the exemption will remain a partial success for treasurers. No one could contest the aim of having a sort of full picture of each market participant full net portfolio situation. The idea is by passing via clearing houses to force market players to secure deals with collaterals and to force a defined reporting to collect all deals netted. For this reporting obligation, all treasurers will have to pass by trade repositories. How does it work? Who are the market players (only few of them e.g. DTTC, ICAP and Clearstream)? Who will pay for it? (A priori the corporates will pay for their deals and all banks for theirs). If the recourse to clearing houses is necessary, which one to use? Does it mean that depending on counterparties, we will have to pass via a CCP and via a trade repository? We can expect a connection between all of them in order to multiply intermediary partners.

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All these very practical questions stay unanswered. In practice, all this nice planned system will imply a lot of technical issues and will necessitate recourse to IT solutions for automating processes. The timing for the reporting being an issue (no later than trade day plus one) would imply an excellent system to produce reporting in due course on a standard that can be consolidated format. The CCP’s and the trade repositories will have to be interconnected and interfaced to exchange in real time the necessary information. Reporting without being able to give a full and comprehensive position won’t be useful for users. In case we are eventually exempted, then the question will turn around the issue of reporting obligations. We understand that exempted corporations will avoid passing through clearing houses (i.e. CCP’s). However, they will have to get deals OTC reported via a trade repository house. ESMA has defined a standard format for reporting (September 2012).

5.6.3

Collateralization shall eventually be imposed banks on bilateral basis

If the banks have not the possibility to get compulsory collateral with corporates, they will try to enter the back door by proposing bilateral CSA agreements. At the end of the day, the risk is to have to provide banks with collateral. Then, the CCP’s will be a better and more standardized solution. The market will be right and will impose its views and wishes. If corporates refuse to provide them with collaterals, they will have to accept a significant increase of hedging cost (the longer a forward period, the more expensive the derivative will be). If all banks respect Basel III new provisions, they will be negatively impacted when no collateral required for derivatives dealing. Basel III is clearly a much important issue and it will be a “killer” on this matter. If not legally enforced, collateralization will be required by market players themselves (i.e. banks). At the end of the day, treasurers will be caught by a bank regulation. We could end by celebrating a short term victory as we will all have to place collaterals for derivative dealing. A battle we won or a war we will lose? Optimistic could think that corporate treasurers have won an important battle. However, we could reasonably fear that the war is lost on medium run, because of administration and reporting obligations and cost of hedging which inexorably will increase over time. The risk is clearly to have banks trying to come back with CSA (bilateral) agreements to post collateral. Basel III will certainly affect more the OTC derivative market than the EMIR (European Market Infrastructure Regulation) will. The future of this market is to more adequately price derivatives (which are sort of commodities) including the implied credit risk (which increase over time and depending on derivative final settlement date). If you want to have whole market transparency and a full picture of the products dealt (including corporate’s despite their smaller weight

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into the total of derivatives), you need to have general rules applied to all or, if there are exceptions, these exceptions should not prevent exempted players to report their OTC derivatives via specific vehicles. There are still many open issues on how all will function in future (e.g. trade repository, clearing houses, collateralization management, etc…). The lobby action lead by EACT and made by corporate treasurers of couple of large MNC’ was necessary but, in my opinion, not sufficient for being fully satisfied on the long run. Treasurers will pay more for derivatives, reporting duties will increase administration burden for treasurers and at the end of the day, the bilateral agreements would be requested by all major banks and would be the only way to reduce cost of hedging. The dilemma would be hedging with higher cost or not hedging at all to reduce cost of collateralization. The corporate strategies on hedging will definitively change over years.

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5.7 To give it, steal it back… “Life spent making mistake is not only more honorable but more useful than a life spent doing nothing” (George Bernard Shaw) EU Commission has a plan for adopting stricter capital requirements and better corporate governance for banks and investment firms (the so-‐called “CDR IV” project). Despite the fact it only concerns financial institutions, this project of Directive could indirectly heavily impact non-‐financial corporations. The new rules will have to be translated into national law by end of 2012. In this new proposal (http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm), it appears that there will be no exemptions for exposures to corporates from Credit Valuation Adjustment (CVA) charges (regulation, part3, title VI, p.56). Should we as European corporate treasurers be worry by this part of the proposal? We certainly should. At Treasury Associations level, we are really concerned about potential impact on bilateral derivatives trades, which may become very expensive due to new capital requirements imposed on banks to hold the capital to cover the CVA risk. Banks will be forced to charge more to corporates and therefore hedging may become unaffordable. As for the EMIR discussions on OTC (“Over-‐The-‐Counter”) derivatives reform, we believe that there is a very strong case for exempting trades with corporates from the CVA charge in the CRD IV. In the draft of EMIR (European Market Infrastructure Regulation), it has been recognised that, in general, transactions with corporates should be exempted from central clearing counterparty (i.e. CCP’s) for hedging commercial risk and under certain threshold and should receive a proportionate capital treatment. In first drafts of CRD IV, it clearly appeared that transactions with a CCP and including collaterals will be excluded from the own funds requirements for CVA risk (cf. article 270 CVA2 scope p. 380). It is clearly stipulated that all financial institutions shall calculate the own funds requirements for CVA risk in accordance with all OTC derivative instruments. The idea was to reflect the counterparty risk run by the bank while dealing with third parties. When calculating the own funds requirements or CVA risk for a counterparty corporate risk, a bank shall base all inputs into its approved internal model for specific risk associated with traded debt position on specific complex formulae (depending on which model adopted by the financial institution calculation are based on). Therefore, we can clearly identify an interaction between EMIR and CRD IV on this particular issue. EU regulation on OTC derivatives contains exemptions (which we were claiming and lobbying for) from mandatory clearing for non-‐financial counterparties using OTC derivatives to cover pure commercial risks and where derivatives exposure does not exceed the clearing threshold (to be further determined in the

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regulation). However, if the capital that banks are now required to hold for non-‐cleared OTC derivatives transactions (i.e. without collateral) is too large due to the CVA capital charges that CRD IV Directive would impose, banks will be forced in future to charge more to corporate treasurers. Therefore, hedging transactional risks may become unaffordable for all of us. Such a regulation could effectively block access to risk management products for end-‐users and limit our ability to hedge the operating business risks we are facing. Even more, it would actually increase volatility and risks on the whole financial market. The obvious risk would be to stop hedging some exposures (especially on longer terms) to reduce financial costs. Eventually it would be exactly the opposite of what EU was looking for. Fortunately, it seems that the Danish Presidency Compromise text would include an exemption (similar to EMIR) for non-‐financial counterparties and pension funds. It has to be validated and confirmed. EACT and all treasury associations have lobbied EMIR on OTC derivatives for same reasons and for avoiding posting collateral which would have been extremely expensive for corporates, specifically when they are structurally “short” (i.e. net borrower). The EU Commission’s proposal for a regulation on OTC derivatives, central counterparties and trade repositories sets out a number of new rules for OTC derivatives clearing. Some OTC derivatives transactions will have to be cleared, while others will be exempted from mandatory clearing. We don’t think posting margin on cleared trades will reduce systemic risk. Furthermore, it would be difficult for some end-‐users to post margins, because of the indebtedness situation. No one could contest it would be both operationally complex and costly. If the corporations were required to give collateral, it would inevitably result in treasurers not hedging some exposures, which were previously passed on to bank dealing-‐rooms. In the USA, rules implementing Dodd-‐Frank should contain a similar exemption (even of its form could slightly vary from ours). Commissioner Barnier has to implement Basel 3 capital rules (under its project called “CRD IV”). Key principles of Basel regulation is that a financial institution must maintain at all times financial resources as a cushion against potential losses. These potential losses are of course including, for example, a non-‐financial institution counterparty which would not pay back its part of the FX or interest rate deal (e.g. the bank pays the USD bought but is not receiving the EUR sold by the corporate). It is what we commonly call the counterparty risk or delivery risk (i.e. risk of default of the corporate before maturity of the FX deal or risk of the creditworthiness of the corporation deteriorates significantly without necessary defaulting (the so-‐called CVA risk). Actually, the former Basel standard already requires banks to hold capital reserves to cover this counterparty default risk. The third revised version of Basel Accord will add new requirements to hold equity to cover CVA risks. It results in financial institutions being subject to capital charges for potential negative change in mark-‐to-‐market valuations and deterioration of

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counterparty credit worthiness. Banks will be requested to make provision for potential credit risk. In summary, we all understand that all efforts made for adapting EMIR regulation on OTC derivatives could be killed by the new CDR IV if it doesn’t include a similar exemption. Apparently, a compromise has been found to grant an exemption to the real economy. There are no needs for exemptions if at the end of the day; banks are highly motivated to impose clearing. If no clearing obtained, banks will hugely increase costs of hedging to compensate capital requirements. EU Commission is maybe undermining the effectiveness of this exemption we have obtained by “fighting” hard. If dealing hedging instruments become prohibitive, corporates will change their hedging approaches and strategies and even start hedging less while monitoring more “open” exposures. It could be a real revolution of risk management strategy. Again, the objective of EU has never been to increase volatility of corporations’ P&L. We believe it could have a negative impact on our activities as a whole. The risk is to be under or un-‐ hedged or to stop doing business in regions/ with products implying financial risks (too) expensive to be protected and to be mitigated. As always, who will be the most penalized? The SME’s which haven’t the capacity to manage this situation. SME’s have lower internal implied (bank) credit ratings that penalize them in terms of counterparty risk. Nonetheless, we understood that W. Langen report on derivatives markets has expressed the intention to provide exemptions and lower capital requirements for SMEs’ bilateral derivatives (see: www.eifr.eu/news0000261.htm). We had the impression that they gave with one hand back with the other. What good for an exemption if we resume? Treasurers hope that all these discussions were useful and that final version of this new Directive will not penalize them. We must remain confident and optimistic. The whole risk management approach would have to evolve in future to be adapted to this new reality if they do not apply exemptions consistently.

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5.8 A New Dimension to FX Dealing “If you don’t know where you are going, any road will get you there” (lewis Caroll)

5.8.1

Is the price right?

Banks are seriously contemplating credit-‐adjusting the prices they quote on FX derivative transactions. The credit parameter to be included in price quotes would have a significant impact on the cost of hedging, unless corporates use collaterals. It may turn out to be one of the consequences of the current financial crisis. In the future, treasurers will have to consider the potential extra margin to be included in forward FX transactions to reflect the credit risk faced by bank counterparties. As is the case in the famous game show created by Fremantle, the question to be asked is whether the price is right. Is the FX pricing fair, given the current market situation? For more than two years, some cautious financial institutions have already been quoting higher and longer maturity FX deals, to reflect the greater risk taken. However, one of the unexpected or unsuspected consequences of the current financial crisis is or could be a significant increase of FX pricing on longer periods. Dealers are beginning to think more seriously about credit-‐adjusting the prices quoted on FX derivatives in general (‘derivatives’ sensu lato, as defined in IAS 39). The pressure on banks may force them to adjust pricing up on longer period FX transactions to include this credit risk element. It means that, leaving aside swap points and interest differentials, the longer a forward deal, the more expensive it will be (higher margins). This evolution we have noticed over the last few years seems to be crystallizing now. The current inflation is rather surprising for many corporations although it was inevitable, especially after such a deep credit and faith crisis we are currently facing. The non-‐delivery risk is now a risk to consider carefully when dealing in FX. We all know in Europe that a bank default is no longer a merely theoretical issue. Banks will now try to incorporate the credit risk element in their quotes or look for alternative protection against it.

5.8.2

Cash collateral solution

The method of reducing the extra cost adjustment applied to FX transactions is to sign a cash settlement agreement to collateralize bilaterally amounts corresponding to changes in mark-‐to-‐market valuation of the portfolio of FX transactions made with the bank. The idea, as for margin calls, is to secure the potential (unrealized) loss on the revaluation of the portfolio of FX deals. If the portfolio has a negative change in fair value (lower value compared to the inception value), the customer would have to secure this amount with a cash collateral deposit. In the case of a positive change in fair value, the deposit in cash would be made by the bank. Both deposits are or can be

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remunerated at the EONIA rate, for example. It means that in case of default of the corporate counterparty, the bank would be compensated for the FX deal its customer will not deliver at maturity and it would be able to unwind the contract without any losses (given the cash collateralization agreed). Conversely, the corporate would be compensated in case of default of the financial institution. The documentation to be signed defines the terms under which collateral is posted or transferred between swap counterparties to mitigate the credit risk arising from in-‐the-‐money derivative positions. The credit valuation adjustment translates the probability of default during each time period, using the famous CDS (Credit Default Swaps) spreads when available on the market. For the shortest dated transactions, the default probability tends to be low. However, sometimes this probability can be lower in two years because the market is taking the view that those having survived the current problems should then be around for a while. Of course, the larger and the more diversified the portfolio is, the less collateral would potentially be required by the bank. It is obvious that in case of default (e.g. Lehman Brothers or Kaupthing Bank) the customer can recover and compensate, via the deposit, the loss incurred. Therefore, the treasurers have to analyze and to check whether it makes sense to reduce the cost of hedging / dealing in FX transactions by collateralization or not. The question is more complex than it appears: what is the corporation’s cash situation is it short or long? What is the total volume of the portfolio and do some positions off-‐set others, reducing the collateral accordingly? How to manage these collaterals in case a company deals with several banks? And so on…

5.8.3

Technical and administrative issues

The more FX transactions are dealt, the more the banks are used for dealing, the more collateral would have to be possibly immobilized and locked. It could not be considered as ‘cash and cash equivalent’ according to IAS 7, as it is pledged to the bank. The return offered will not be as good as the one potentially achieved now with money market funds of prime quality. Collateral, for a borrowing company (being ‘short’) can be extremely expensive these days. For groups which are cash poor, it has an additional cost not to be overlooked, especially when spreads are extremely high, as is the case today. The contract signed with the bank will imply review by lawyers and extra legal costs, at least for first contracts to be signed (similar to ISDA schedules). Fortunately, limits and margin calls will be managed by the bank back-‐offices. Nevertheless, it will inevitably create extra administration for treasury teams.

5.8.4

Corporate alternative solutions

Corporate treasurers could also decide to have recourse to shorter FX transactions rolled-‐over over time. Again, it will generate extra administration and interim volatility

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at roll-‐over dates. That is the price to be paid for this type of solution. If not, the ‘deteriorated’ FX rates could cost between 0.20% up to 1.20% (at a very rough estimate), depending on maturity. On a five-‐year ten million USD forward transaction, we can, for example, imagine costs increasing by/up to EUR 80 to 100k. This credit risk element has a related cost to be cautiously considered. The classic dilemma is a huge premium to be paid on FX contracts or imperfect onerous hedging solutions based on several roll-‐overs. In any case, the solutions to be applied are cumbersome. With a cash settlement agreement, a corporate will be enabled to reduce the credit charges linked to FX dealing of derivatives, as well as to reduce significantly counterparty risk (which is not unusual these days). Of course, it means use of cash collateral (but on a symmetrical basis). The administrative burden of such an agreement can be reduced by increasing thresholds and frequency of matching and of controls. The sophistication and calculation behind this risk assessment can and will vary from bank to bank. It will therefore impact cost of similar transactions requested with different banks. A good repartition and a split between FX side-‐businesses will inevitably make handling more complex for treasurers.

5.8.5

A brand new world for FX dealing

Before Lehman and Bear Stearns (and all others which followed, in the USA and in Europe), treasurers were less credit risk sensitive. Now, dealing with a safer bank in the absence of delivery risk can be essential for long transactions, especially in a hyper volatile FX context. We have very likely entered a brand new financial world and market practices will certainly continue to evolve in the coming years. In general, the implied default probabilities increase as the tenor of the transaction increases. The longer a deal, the more expensive it will be. This important issue will probably have consequences on how corporates are dealing with FX transactions. It can potentially affect their strategies and risk approaches. This consequence does not simplify treasury management. It is interesting to note that the more technology evolves, the more the framework and rules become intricate. Unfortunately, part of the technological progress which has been made fails to be reflected in the day-‐to-‐day lives of treasurers. Some customers may be less price-‐sensitive when they deal with safer banks. Others may be tempted to shift back to bankers offering best prices. Some banks may also be reluctant to move too fast in order to remain competitive. The reality is that we are in a new dimension. This will certainly become a market practice, no doubt about that. It is simply a question

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5.9 Reporting financial and non-‐financial performance in a single consolidated report “It’s not use saying “we are doing our best”. You have got to succeed in doing that is necessary” (Winston Churchill)

5.9.1

Avant-‐garde communication

A number of somewhat avant-‐garde multinationals have realised how far one single document, combining structured and comprehensive communication on financial and non-‐financial performance, can take them in projecting an image of innovation and in demonstrating real determination to be right up to date. This more coordinated and consolidated approach to communication also demonstrates that they want to create a company that is more sustainable in the long run. Doing it is great. Communicating it is even better. Publicising it in a more organised way is ideal. Sometimes it is more the form than the content that will give the impression of pioneering spirit. Some large international groups have understood this – for instance Philips and PepsiCo – and they try to show the readers of their annual reports that they are at the forefront of "social responsibility" and that sustainability goes hand-‐in-‐hand with finance. The concept of a single integrated report explaining financial and non-‐financial performance (ESG – Environmental, Social and Governance) is not just a passing fad. It would in fact be reasonable to expect that, in time, this type of report will be required by the various national and international regulators. In this respect, South Africa (RSA) has been right in the forefront since 1 March 2010, adopting the requirement to issue an integrated report. With "King III" ("King Report" or "Governance for South Africa 2009"), it is now a requirement to produce a report of this type. The aim of this legislation is to see that the Republic of South Africa continues to be a leader in corporate governance standards and practices. The aim is to spur companies on and to put the financial results into perspective, showing how they had a positive or negative effect on the economic life of the communities in which they operate. Alternatively, companies should show how they plan to eradicate the adverse effects in future, or at least minimise them. By this pioneering adoption, South Africa hopes to produce a domino effect. It is interesting to note that, as with E.R.M. (Enterprise Risk Management), it has been more exotic or far-‐flung countries, such as New Zealand and Australia, that have set the pace. We should also note that South African companies are excited by the idea of making a positive contribution to this sustainability drive.

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5.9.2

How things stand now

For a few years now, listed companies have had to report their financial results according to high-‐quality international standards – IFRS or US GAAP. We have sung the praises of the comparability that results from standardisation and financial transparency. This is one of the foundations needed for efficient capital markets. These financial reports naturally draw their institutional legitimacy from various factors such as the need for statutory audit, the effectiveness of mechanisms for preventing fraud, from internal controls, performance metrics, investor information, consolidated and condensed accounts. Unfortunately, accounting regulations often try to do too much, and users find ever greater difficulty in understanding and unravelling the mass of complex financial information. These standards are criticised because some people think they are not up to the job of capturing the company’s current and future real value, nor of bringing out true value creation. Detractors also see financial statements as being too retrospective, and not forward-‐looking enough. The idea of starting with voluntary good practice, and then eventually making it into best practice in terms of governance, is rather enticing. A company making disclosures in this way compels itself to be more virtuous by, for instance, giving details of its water or energy usage, its employee relations, its staff turnover, staff diversity, the independence of its Board, its risk approach, its charitable work, etc. Investors are now avid for such information, in addition to the financial results. For instance, since 2009, Bloomberg has added ESG information provided by companies, such as D.B. or GE. The European Union is also thinking of making ESG information compulsory (this is already done by a number of companies applying the G3 guidelines and, as of 2012, the G4 guidelines). These investors are, little by little, trying to require or encourage listed companies to publish appropriate information on the inclusion of sustainability in their long-‐term strategies. These same investors want to incorporate these non-‐financial details in their valuation models. They want to understand how the company will direct capital toward sustainable development.

5.9.3

Emergence of avant-‐garde companies

The adoption of a single integrated report demonstrates their determination to set themselves apart from other companies by highlighting their commitments to sustainable development. It is also about challenging themselves and striving to be ever more virtuous and to inculcate an in-‐house discipline. To achieve this, they have to commit to and set targets based on carefully considered KPIs.15 No measurement, no

Key Performance Indicators

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progress. In this specific case, it is practice that drives managerial theories, even though the concepts may have appeared for the first time in the 1990s, particularly with PwC's idea of value reporting. Since then, the Scandinavian countries, Brazil, South Africa and even France have published material on the subject. The IIRC (International Integrated Reporting Committee) has been in existence since July 2009 and intends eventually to publish guidance recommendations on the subject. Having a report that combines financial performance metrics with measurable non-‐ financial performance information, bringing out the relationship between the two, is unfortunately not yet common practice. It all starts to become really meaningful when, for instance, you can compare water consumed producing a cotton T-‐shirt for H&M or GAP against its competitors. It is worthwhile demonstrating the per capita investment in staff training to increase productivity compared to that of a competitor, thereby seeing whether customer satisfaction is greater or staff turnover less. Measuring well-‐being at work makes companies more competitive and attractive. Training is an investment and the return on it should be measured. It produces a number of benefits: 1. Internal benefits, for example better allocation of resources and better decision-‐ making, greater stakeholder engagement, lower reputational risk 2. External benefits, for example better information for investors wanting ESG data, appearing in the sustainability indices, and 3. Regulatory benefits, for example reducing the risk of non-‐compliance, being proactive and pioneering in adopting standards or specific requirements of the stock market on which you are listed Unfortunately, this is not a universal panacea, but at least it is a way of directing energies and of raising employee awareness. However, this non-‐financial part of the new approach to reporting has the failing of lack of standardisation. This discipline is still relatively young. Although guidelines such as G3 exist, it is hard to apply them as they stand to all companies. It is this lack of standardisation that makes it tricky to compare companies’ non-‐financial performance. Furthermore, since the "One Report" described by Professor R. Eccles of Harvard University is applied on a voluntary basis, it is adopted differently and to different degrees from company to company. Reporting rigour is therefore not the same for everyone. Government bodies could also have a major role to play in setting a good example of best practice. Philips considers this report (which forms part

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of its DNA), and sustainable development in general, as being a driver of growth. It has a threefold objective: keeping down costs, increasing efficiency and improving communication through a single channel. We should not underestimate the pride that employees feel in working for a sustainable and responsible company. Time passes inexorably, and it is time to create a more sustainable society. This is also achieved through the messages that we pass to the outside world.

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5.10 Rating agencies: In the spotlight once again! “Nothing travels faster than the speed of light with the possible exception of bad news, which obeys its own special laws” (Douglas Adams) The “big three” (although two of them carry more weight than the third) call all the shots in the small world of credit ratings. No rating means no passport to enter the capital market! But rating costs money for the issuer who requests it and it also has a cost in terms of the effort needed to defend that rating with body and soul, especially during these times of financial crises and huge sovereign debts. Even countries need this essential support to navigate the waters of financial markets and borrow money under the most favorable conditions. The rating agencies are useful, but sometimes their opinions are considered hard currency by investors, rather than a simple assessment they have issued. After all, they aren’t almighty, infallible Gods, far from it. Recent economic history has had some cruel reminders of this in the past few years (e.g. Enron, Lehman, Icelandic banks, AIG, PIGS, etc.). Their mission is to evaluate, as extensively as possible, the risk of default and bankruptcy by the issuer/borrower, whoever that might be. They inform the investor (this verb is very important and assumes its full meaning here) about the exposure to risk of non-‐recovery of the debt. However, this evaluation is nothing but a simple opinion, issued in good faith. Advice is cheap, as the old saying goes. So, from AAA to CCC… where exactly do you stand? Are you worthy of an investor’s confidence? That’s the essential question they are trying to answer. They suggest a possible answer but have never claimed to have the answer to the question of default risk. The European Union has complained about the lack of a European agency (although FITCH is the most European of the three). We can ask ourselves what the EU has done to promote competition and open up this oligopolistic market. Unfortunately, nothing! A credit rating is the result of an analysis performed by a small team of specialists and then validated by a larger group of seasoned professionals. Today, we are always looking to lay blame on someone, and the agencies are "easy targets”, since we have overestimated the value of their opinions, elevating them to the status of Holy Scripture. A credit rating is a reference that serves to define and balance portfolios of stocks, bonds and other investments as a function of the risks inherent in the underlying securities. This rating is also necessary in order to set internal policies for financial risk management. It is therefore a measurement, necessarily imperfect but useful. And like any unit of measurement, we best see its usefulness when we employ it consistently over time. These agencies have become very cautious and are now afraid of being seen as too indulgent. If the EU, as it stated during recent preparatory work, were to incorporate

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the concept of civil liability for the agencies, we would see an exponential increase in costs (owing to higher insurance premiums and risks), excessive caution in the rating process in general and increasingly conservative ratings, and a high probability that the riskiest issuers would be excluded from the rating process all together, making them untouchables. The European Central Bank and the EU are now contesting the ratings of sovereign states in order to preserve the equilibrium of the Euro zone. The rating agencies are also criticized for their non-‐independence and their ownership by private shareholders. For example, Warren Buffet owns 13% of Moody’s. Fitch belongs to FIMALAC in France, with the Hearst Group owning a 20% stake. In addition, S&P is owned by the McGraw–Hill companies. Is this a sufficient guarantee of independence? Some say no, but no one has arrived on the scene to replace them or compete with them. The three agencies do, it must be admitted, have the market locked down. There is also criticism of their business model, in which the issuer pays for the rating. Some critics ask whether it would be acceptable for a restaurant to pay the Michelin Guide for its stars in the precious red book. However, this is an extra fee that each issuer incorporates in its cost of financing. The minimum cost is around US$70,000 plus supplements, depending on individual bond issues and their specific characteristics. The agencies have all adopted codes of conduct, and IOSCO has also introduced a code of good practice for these agencies. Is this sufficient? Comments made during US Senate hearings after the sub-‐prime crisis revealed that their independence was quite relative and that they were above all for-‐profit companies. This implies a high risk of subjectivity. The agencies all have very enviable profit margins, which some people are criticizing today. But can we really do without them? No. Is there hope for a new competitor to arrive on the scene? Yes, but apart from COFACE (France), it’s difficult to see who that might be, and the possible creation of a European agency appears highly unlikely. For the time being at least, it looks like we’ll have to live with these ratings and try to get the best out of them, without giving them more credit than they actually deserve. Risk management is done with a number of different tools, including credit ratings. It's up to each of us to make our own assessments and not to rush too quickly to believe these highly relative economic prophecies. Blind faith in a rating and the search for profit at any cost has often led investors into major blunders. To be rated, or not to be rated, that is not the question. The important thing is to place a rating in its proper context and take it for what it is: an opinion.

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5.11 How to fairly measure the « raters »? “The only man who behaves sensibly is my tailor; he takes my measurements anew every time he sees me, while all the rest go on with their old measurements and expect me to fit them” (George Bernard Shaw)

5.11.1 Sub-‐prime summer

After the summer 2007 so-‐called “sub-‐prime” crisis, lots of people were convinced Credit Rating Agencies (CRA) could act with a bit more rigor and within a more competitive environment. The explosion of the issuance of structured finance products, like bonds backed by mortgages (sometimes highly risky and therefore qualified as “sub-‐ prime”), car loans and the like, as well as the derivative instruments linked or attached to them. It appears that rating such products now accounts for 40% and more of the CRAs results. Isn’t it too much compared to what should be their traditional business revenue?

5.11.2 Oligopoly situation

Moody’s and Standard & Poors (S&P) have a combined market share of 80% and if we add FITCH it accounts for 95%. This high concentration has raised obvious questions about competition. Regulators and governments, including European Union, have big concerns with rating agencies power. As Pierre Le Pensant de Bois Guilbert (French economist) suggested, in the 17th century, monopolies imply producers could be tempted to adopt excessive tariff. Conversely, too much competition drives price to zero. A fair competition should insure a right balance of interests. The US Congress and SEC have tried to develop alternative solutions to main rating players. But market is driving the car… Who would ask for being rated only by unknown agencies, not well-‐ established, not well-‐known and without sufficient track records? After the real first crisis (i.e. ENRON case), rating agencies pretended they were not responsible and objected their ratings were only “opinions” constitutionally protected as a free speech. This type of stance could be more and more difficult to defend. The issuers pay for a credit rating which would only be a “free speech”. Everybody acknowledges credit rating agencies statements are much more than simple opinion. And even if they are only free opinions they have enormous impacts on way investors act. Although politicians and regulators pretended having promoted for years greater competition, they haven’t really succeeded so far. The EU would have created years ago

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a “European (Central) Rating Agency” (ERA). Like in IT, everybody wants to contest Microsoft supremacy but everyone uses rather PCs. We certainly need more “LINUX”, “GOOGLE” or “APPLE” in this computer world to encourage higher degree of competition. Financial institutions are even ruled as recommending or imposing one of the two major CRAs. The market is always right, even in choosing right partners. Without changing its own guidelines, how could we expect these banks to encourage more competition? It is an oligopoly situation with side players nobody really wants although ever requested. To change things, the market should start changing attitude.

5.11.3 Conflict of interest

The conflict of interest lays in the ratings obtained which are paid by the issuer himself. Could you imagine a hype restaurant requesting from “GUIDE MICHELIN” one or more “stars” and paying for that service? Nobody would trust the famous French guide anymore? For CRAs it functions in a wrong way. Why not having rating fees paid by a government independent body to agencies upon a random selection process? The rating charges could be in fine charged by banks to issuers as arrangement fees. The idea is to avoid temptation to give wished rating to the issuer in order to insure future business for the agency.

5.11.4 Rating the rating agencies

What could guarantee rating agency independency and professionalism? Who will rate rating agencies? They are private companies or affiliates of publicly listed ones. The main question for lots of investors and issuers is how to better measure these “measurers”. Why not rating CRAs to insure their independency and reliability? In the USA it seems that an investigation has been launched to check whether rating downgrading of some American utilities companies has been requested by them in order to justify higher energy pricing. If it is true, we can imagine the consequences. As usual, after a scandal, American regulators and US Senate could decide to vote a law to rule rating processes. IOSCO has issued a code of conduct, incorporating numerous principles raised by Corporate Treasurers (IGTA credit rating agency code of conduct).

5.11.5 Structured finance

With structured finance, the concern is even bigger. CRAs depend on few large investment banks for big portion of their revenue. There are critics on the too close “cooperation” between CRAs and these investment banks on complex products such as Collateralized Debt Obligations (CDOs) and tranches of pools of debt from different sources. They could have to face lawsuits from disgruntled investors or investigations initiated by IOSCO or related market control authorities.

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Operations are becoming more and more complex to analyze. Therefore, CRAs need high level analyst staff. But everybody knows they struggle to keep up mainly because they are loosing some of their best people to best investment banks which pay much higher salaries. Observers pretend that by highly paying these resources, banks try to get revealed the ways to penetrate the computer model armor created by CRAs.

5.11.6 Absence of signals or wrong understanding of reports issued?

They also think models were not really sized for such complexities and asset correlation levels with sub-‐prime lending. We could easily imagine that CRAs certainly have misread models and lacked from sufficient historical data. Others pretend that, since February 2007, they ignored market signs that risks were great (or greater than expected). The CRAs summer shift drove to downgrading of mortgage-‐backed bonds. They started have a closer look at CDOs. The rating agencies answered that they look only at credit default probability. But investors have also their own responsibility in this bad story. Do they have read carefully reports issued by CRAs? It is certainly too easy to transfer full responsibility to agencies and to qualified them a “black sheep”.

5.11.7 Consequences

In any case, all these bad stories and huge loses will inevitably limit fervor for such structured products. It could command higher rating fees for corporate and sovereign issuers, to compensate revenue reduction from structured finance. Based on possible lawsuits, we could expect new rules from regulators to better define the framework and principles applied to CRAs. The absence of real competition among rating agencies, the agency business model itself, the investors and hedge funds money appetite but also the market general emulation contributed all to such a terrible crisis which contaminated all financial products in the world. Something must happen soon. It is difficult to predict whether and when things will change in terms of rating rules. But one thing is certain; sooner or later it should change to reestablish market faith.

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5.12 Corporate Connectivity to SWIFT Our technological powers increase, but the side effects and potential hazards also escalate”. (Alvin Toffler)

5.12.1 SWIFTNet from a bank model to a corporate standard

SWIFTNet has become the bank communication mean of multinational companies, with large network of affiliates and multibank relationships. Nevertheless, SWIFT, whatever the form, can be used by smaller entities, especially with newly created ALLIANCE Light, adapted to SME’s. With 1000 companies connected, SWIFT is now a real corporate treasury tool. With a target of 5000 corporation (non-‐financial companies) connections by 2015, we have to admit that SWIFT is rather ambitious, even if the success keeps following. With good quality implementation, companies can get all benefits of such banking connectivity. Some large banks have acquired over years a strong experience.

5.12.2 Types of connectivity models

There three main models for a SWIFT connection: A. Direct connectivity B. Service bureau C. Alliance Lite The corporations can directly manage the SWIFT gateway and the associated infrastructure. Early adopters have often opted for such a direct connection. At beginnings, the service bureaus were not yet set up. Once implemented, service bureaus became a great solution to reduce costs, complexity while offering stability and expertise. Nowadays, even large multinational companies prefer to opt for service bureaus. Outsourcing to a specialist service bureau or to a member concentrator is now one of the best solutions to optimize your bank connectivity. It is a cost-‐effective solution to leverage expertise and quality infrastructure service bureaus can offer. The most recent model, created in 2009, is a web-‐based solution for lower transaction volumes. The even more recent Alliance Lite2 will go a step further via a “cloud-‐based” connectivity to SWIFT, with enhanced integration capabilities and cheaper pricing model. It is ideal for those who are uncomfortable with outsourcing. Finding the right and most appropriate model is a challenge for every corporate. Some banks can even offer a sort of in-‐house service bureau, white-‐labeled service provided by a third party company. However, it means absence of bank-‐neutrality, which was one of the main

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objectives targeted. Nevertheless whatever the solution chosen and even if you adopt a single channel to communicate with banks, the efficiency will or can continue to be hindered if corporates need to exchange information in different formats with each one. Ideally, by adopting a common format like standard ISO 20022 for financial messages, a corporate can empower its bank connectivity. Even SWIFT has launched initiatives to enable and endorse messaging standards. Such projects can deliver full benefits when the company tries to extract additional value by rationalizing bank relationships, by centralizing (further) payments and by implementing new ERP/ TMS, or simply by upgrading IT tool(s). One of the objectives of the ROI (Return On Investment) will be to demonstrate the potential gains beyond the bank connectivity. Such projects are maximized when objectives are combined to go beyond simple connectivity models and when they offer opportunities to revisit internal processes and the whole organization.

5.12.3 3SKey or Personal Digital Signature Now SWIFT had a possibility to add a personal digital signature to transactions with all their banks, leveraging SWIFT as a single communication channel. 3SKey is a multi-‐bank personal digital identity solution developed by SWIFT in partnership with its customers and banks. A corporate can therefore with such a key sign financial messages and files sent to different banks with a single device. It enables them to use one device instead of several security tokens. Ideally, the bank should support SWIFT, XML and 3SKey. Unfortunately only few banks would be ready to comply with all three. Beside the current benefits 3SKey can bring now, there are many others that should come in future with eBAM (electronic Bank Account Management). 3SKey can typically be deployed for the following: Bank security channels for the replacement of proprietary authentication / signing devices Multi-‐banked corporates who want to streamline signing process across applications and banks Banking communities eBAM – new solution for electronic Bank Account management It will generate benefits for the corp’s (e.g. security based on latest cryptographic technology, reduced complexity, reduced costs,…) and the banks (e.g. interoperability without reliance on other banks, enhanced customer service, opportunity to reduce investment in proprietary solutions). One of the main issues is the fact that number of banks does not support this kind of product and solution with operating personal signatory capabilities. Often, corporates

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are forced to pass via other IT tools to allow transactions to be duly approved and signed before reaching SWIFTNet.

5.12.4 Virtuous circle

The adoption of SWIFTNet has brought many cost reductions over years. The idea is to exit the classic approach of using in the best case the proprietary electronic banking system of each bank. The aim of such a project is to rationalize number of bank accounts and bank relationships. The ultimate goal would be to have a single format for messages, bank accounts reduced and eventually costs minimized. The objectives and also the challenges are to move from multiple proprietary systems, with different security and integration requirements, and diverse formats to a single bank connection system standardized and interfaced with all other IT tools and ERP’s. Today, corporates have an unprecedented opportunity to rationalize their bank communications through a single channel and to standardize formats using XML-‐based standards. Some banks remain pioneers in connectivity and format standardization. It is crucial to choose the right ones. It is one of the keys to success. Corporate access to SWIFTNet has evolved from being the domain of the world’s largest, most sophisticated corporations to a realistic connectivity choice for a wide spectrum of companies, particularly multinational corporations with more than one bank. Among major factors which contributed to this impressive expansion, we can list the following ones: 1. Complete, timely and consistent visibility over cash is “key”. It is more difficult with multiple bank approach 2. Cost of maintaining and integrating separate banking systems can be high. Rationalization gives obvious benefits 3. In some countries more IT advanced, it gives an opportunity to change and to comply. Changes are somewhere imposed by infrastructure changes 4. SEPA migration is also a catalyst for launching such projects while being compliant 5. Corporates always prefer to seek for bank-‐agnostic connectivity solutions as part of their risk management strategy. Economic uncertainties push treasurers to be and to remain extremely cautious Costs have fallen considerably. Connections via service bureaus are now easy and simplified. The existing corporate customers have helped improving and simplifying processes and implementation issues. We should also note that SWIFT messaging can be used for matching financial instruments dealing confirmations and to initiate reporting to ESMA under the new EMIR – OTC (“Over-‐the-‐Counter”) derivatives reform implemented in 2013. The MT 300 can be the basis for matching confirmations as well as being the main source of

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information for reporting to the trade repositories (see EMIR / ESMA reporting requirements). These are two other examples of benefits a corporate can get from being SWIFT customer and user.

5.12.5 Next milestones

As SWIFT is rather ambitious and more and more used, we can all expect fees will come even further down (as their business model is based on volumes and rebates to shareholders of their corporation – “cooperative” status in Belgium – benefits are redistributed under the form of rebates and discounts to participants). On the list of potential area of developments, SWIFT has 3SKey, Alliance Lite2 and eBAM messages. These three areas should be expanded in next years and become standards of the market. The aim of SWIFT is to offer more products for SME’s and give easier access to their network for customers with lower turnover, less activities, less IT resources and internal expertise or skills. Many corporates are looking at ways to improve their treasury and finance function through accounts and treasury centralization, internal process and controls enhancements, bank rationalization, technology replacement or upgrade. Reviewing bank connectivity should be an integral part of these projects. Whatever the size, a large multinational with a presence across the globe or a mid-‐cap corporation operating in several markets, there are many opportunities for (enhanced) efficiency, security and bank-‐neutral connectivity through SWIFT. These opportunities have never been so high. We could expect lots of IT developments in future and serious improvements of corporate internal controls around treasury activities and operations.

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5.13 SCORE Standardised CORporate Environment “Every reform movement has a lunatic fringe” (Theodore Roosevelt)

5.13.1 SWIFT, a well-‐known name for a financial communication giant SWIFT is the abbreviation of “Society for Worldwide Interbank Financial elecommunication”. The name is familiar, but some people do not know what this company does. To sketch out a few details and give an idea of what it does, it is a cooperative company based in Belgium, in La Hulpe. We should remember that it connects 8,000 organisations together, processes over $5 trillion daily with an average of 7 million messages and 1.5 billion transactions per year (*). SWIFT is a European Economic and Interest Grouping (EEIG) that provides its members with a financial transactions system. It was founded in 1973. The system went live in 1977. At that time it replaced the famous telex which was then used for international trade. Its members included banks and financial institutions, stock brokers such as EURONEXT and clearing houses. But a few years ago Swift decided to broaden its user base to non-‐financial corporations, which also generated a large number of international and domestic payments.

5.13.2 From SwiftNet to SCORE

Since 2002, SWIFT, by means of its "SwiftNet" solution, has enabled international companies to operate in its specific universe, just like banks, all of which are SWIFT members and use the system. The idea was to consider making the "corporate" treasury function more professional by providing it with access to a universe hitherto restricted to financial institutions. At the outset, however, they were not falling over themselves to grasp this new technical opportunity. In Europe, we can safely say that the French were amongst the first to take the plunge. They used the famous "MA-‐CUGs" (Member Administered Closed User Groups) to arrange the exchange of messages and communications between banks and corporations. SWIFT announced it had achieved a figure of over 1000 "corporate" businesses using its network, almost 60% of them European. SWIFT published many case studies of prestigious groups such as GE, Arcelor Mittal and Microsoft. These documents describe the financial savings made by these firms, as well as efficiency gains, and the particular advantages for internal controls under SARBOX. They are instructive and a good illustration of the potential for major companies that wish to participate in it.

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Businesses can use FileAct type messages (aimed mainly at trade transactions – several messages and large files) and FIN (mainly for treasury transactions – one financial message at a time e.g. MT 101 for a payment and MT 940 for a report)

5.13.3 SCORE is available to listed companies

Only listed companies can have access to SCORE. This is a market estimated at 22,000 companies, in 31 countries, on the world's main stock markets. If they do not qualify, they must turn to the other solution above. So the end has not come for MA-‐CUGs, as people might have expected. The idea is to further simplify access to the network without increasing the number of MA-‐CUGs being set up. A company may have set up as many as about fifteen MA-‐CUGs. SCORE improves access to SwiftNet and greatly simplifies the administrative process. Bank messages are then standardised and formatted to a recognised international standard. Messages are then more standardised and the format more regulated. At the beginning of 2007, the French company ALSTOM became the first SCORE user. In addition to SCORE, users often use a "service bureau", a sort of intermediary with technical and IT skills in SWIFT universe software. This also

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avoids the need for in-‐house development of the cumbersome IT architecture that is needed to make SWIFT work.

5.13.4 Benefits of using SWIFT

Users don't hesitate to declare that SWIFTNET enabled them to make productivity gains, improve the quality of processes and make their finance departments more efficient (e.g. EADS, Swiss RE, T-‐Mobile, Yves Rocher, Arcelor-‐Mittal, in particular). The German telecoms company estimated an ROI of 258%, a net saving of EUR 4.2 million and a payback period of only 25 months. GE mentioned a figure of 406% for ROI with a net saving of USD 10.5 million. Arcelor-‐Mittal announced an even shorter payback period of only 18 months. What more needs to be said to convince treasurers? As a general rule, though they may vary from one company to the next, the goals sought are: Improving and strengthening risk management Standardising processes to absorb a growing number of transactions without increasing headcount Achieving the greatest efficiency gains in treasury transactions Establishing a solid and robust base for setting up a payment factory and/or a SSC (Shared Service Centre) Decreasing in the number of proprietary connections and systems (often dozens of them per group) and therefore IT maintenance costs Improving the visibility of cash positions throughout the world, on one single central platform One single set of group financial messages with one single portal to communicate with 100% of banks Reducing the number of order or financial information transmission failures Ability to share information within the group One single central “source of truth” Facilitating and improving internal controls, while cutting administrative costs Improving automation and moving towards Straight Through Processing (STP)

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5.13.5 SCORE's future We may suppose that SWIFT will seek to expand its SCORE service to other products or message types. By way of example, we might think of "Asset Management", which treasurers use a lot. The money market products being dealt in involve transactions which are still all too often, surprisingly though this is in the 21st-‐century, manual, with the requests and confirmations being sent by fax. Similarly, the XML format (ISO20022) which makes it possible to use SEPA applications will no doubt become the market standard. But we don't think that SWIFT will stop at that. It will keep on developing its solutions and try to provide corporates with the same functionalities that financial institutions have. With no pleonasm intended, "SCORE's score" is more than encouraging. SWIFT contributes very effectively in its own way to improving the financial supply chain and to making it more secure. Europe, a region used to dealing with multiple banks, more so than the USA, is excellent and fertile ground for developing SWIFT solutions.

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5.14 BAM or eBAM ? (Electronic Bank Account Management) “Technology has to be invented or adopted” (Jared Diamond)

5.14.1 Bank data issue

Treasurers want to manage bank date (all), corporate signatories and exposures, rapidly and securely. Large corporations work with sometimes more than 20 banks, with paper stashed across the company. How can anymore know which accounts are open or closed? Your business has its accounts and who has access to those accounts, is often stocked in filing cabinets and storage boxes. When an audit is due, do you know where your signatories are? Does it take time to communicate changes to the necessary channels when an account signatory leaves the company or changes department?

5.14.2 Solution treasurers look for

Ideally, treasurers would like to automate workflows, streamline authorization and reduce audit time. They dream of a centralized account management center, single centralized an secured repository for all information concerning corporate bank accounts, that would enable treasury manager to see, edit and report properly on account access and provides instant document generation. They also dream of a bank management center providing real-‐time score cards, including 360 degree view of all banks he works with. It should include information on fees, services, ratings, credit profiles an even more... in the night dream, treasurers also would like to have an authority management center, single central auditable record of who is authorized to initiate, approve and sign any type of financial transaction. What a nice wish list? Is it wish full thinking or near future technology he can foresee and start considering? There are solutions on the market (a few) which enable treasurer to administer their global banking accounts, internal signatories, authorization thresholds and account support documentation.

5.14.3 Regulators want financial transparency

Managers are coming under increasing pressure to streamline processes, consolidate cash and provide accurate information, fast. Fortunately, the technology provides more and chose for idle cash, treasurers want now to have a comprehensive view on their bank accounts. Without access to the information, it is impossible to maximize cash

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centralization, isn't it? Therefore more and more corporates have invested in technologies to general real-‐time payment data, reduce administrative and banking costs and also to improve quality of their management information. Now, they want to go a step further after having implemented a stat to the xxx TMS and rolled out their payment factory across the world. They also want for internal control reasons reduce enterprises' operational risks. With the never-‐ending financial crisis corporates need to improve their quality of counterparty exposure information. For all those objectives, treasurers need a Bank Administration Solution (BAS) covering maintenance of a central registry for accounts information a controlled workflow for opening, maintaining and closing bank accounts and achievements of a streamlined and secure eBAM. But how could pretend to be on track on the above targets? GE, Microsoft, Shell of HP probably. The others are far behind thinking about what will be their next steps and targets. The idea is also to move away from (remaining) paper process and to tend to full electronic messaging. Today, more than « eBAM », we should say « BAM » (messaging). But even if technology is ready and even if some vendors quasi ready, the banks have other financial issues and priorities. EBAM could therefore be considered as a system to further improve cash management. We are at early stages and investing in IT solutions not really tested and proved, with banks not ready and in a shaky economic environment is not a priority (solutions e.g. Avantgard Integrity Treasury Solution ; Speranza with WSS or Equity). The problem with e-‐solutions, sometimes they go too fast and certainly faster than legal provisions. It may happen that WP must rely on paper legal binding documents and that we are not yet allowed to base some of the official documents and evidences on soft copies or on electronic messaging. The “electronification” should not play the partition faster than the music. We should and could not cut corners on breach rules. It will be a full change of brank management approach, even a revolution. Some treasures still struggle to justify on business case that flies to convince management to move to digital documenting and messaging with banks (eBAM). Pioneers treasurers are sort of prophets who try to deliver messages to a world not yet prepared and ready to move.

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5.15 Did you say “eBAM” or “BAM”? “The great growling engine of change – technology” (Alvin Toffler)

5.15.1 Bank data issue

What are the issues of corporate treasurers with regards to bank account management and try to determine the wish list of processes to enhance in future? The new “eBAM” messaging can be one of the solutions, coupled with ad hoc IT tools to store information and initiate messages to banks. It is also a way to improve even further treasury internal controls. Eventually, a better view on your accounts enables treasurers to better manage bank relationships. Treasurers want to better manage and securely store all bank data and official documents (e.g. corporate signatories, proxies and mandates, account opening forms, ISDA schedules, KYC questionnaires, etc…). When treasurers need to show proof or evidence of agreements with original documents, for (internal/external) audit reasons for example, it can be difficult to find them. They have often been signed and exchanged years ago and nobody can find trace of them. Large corporations work with sometimes more than 20 banks, with paper stashed across the company. They have activities across the world. Who can pretend he is able at any moment in time to identify the comprehensive list of all his group bank accounts? How can we know which bank accounts are open or closed? The information related to these accounts is spread across the group affiliates, rarely centrally stored and sometimes no one knows precisely who has access to some accounts. The information can be stocked somewhere in a filing cabinet or a storage box. When an audit is due, can you immediately and easily identify what your signatories are? Does it take time to communicate changes through the necessary channels when an account signatory leaves the company or changes department? The communication with your banks in terms of power of signatures is generally done on paper and by post. Therefore it takes times to get originals ready and you never know if they will be well received by addressees at the bank. Annual (external) audit confirmations are for all treasurers a classical January nightmare.

5.15.2 Solution treasurers look for

Ideally, treasurers would like to automate workflows, streamline authorization processes and reduce audit time. They dream of (1) a centralized account management center, single centralized and secured repository for all information concerning

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corporate bank accounts, that would enable treasury manager to see, edit and report properly on account access and provides instant document generation. They also dream of (2) a bank management center providing real-‐time score cards, including 360 degree view of all banks they work with. It should include information on fees, services, ratings, credit profiles an even more... in the night dream, treasurers also would like to have an authority management center, single central auditable record of who is authorized to initiate, approve and sign any type of financial transaction. What a nice wish list? Is it wish full thinking or near future technology he can foresee and start considering? There are solutions on the market (a few) which enable treasurer to administer their global banking accounts and maintenance of them, including: internal signatories, authorization thresholds and account support documentation.

Examples of needs A. Instantly see what accounts are open, closed, active or inactive/proxies and powers of signatures B. Controls on entire bank relationships C. Account information in real-‐time D. Appropriate documentation generated for account openings, closings, changes, audits, mandates, etc… E. Audit confirmation initiation F. Comprehensive audit trails to track changes G. Automated processes to reduce risks of human errors H. Compliance with IC and governance through internal automated processes (including compliance to SOX or equivalent under 8th Directive) I. Paperless processes J. Mitigation of risks associated with unauthorized access K. Accelerate times to manage accounts (e.g. openings) L. Facilitate audit-‐support information (chart source: Wall Street System -‐ WSS)

5.15.3 Regulators want financial transparency Managers are coming under increasing pressure to streamline processes, consolidate cash and provide faster accurate information. Fortunately, the technology provides more solutions to chase and track down idle cash. Now treasurers want to have a comprehensive view on all their bank accounts. Without access to this information, it is impossible to maximize cash centralization, isn't it and to have a good bank relationship

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1management? Therefore more and more corporates have invested in technologies to generate real-‐time payment data, reduce administrative and banking costs and also to improve quality of management information.

5.15.4 After a payment factory, what are the next steps?

Now, they want to move a step further after having implemented a “state-‐to-‐the art” Treasury Management System (TMS) and rolled out their payment factory across the world. For internal control reasons, treasurers also want to reduce enterprises' operational risks. With the never-‐ending financial crisis corporates need to improve the quality of counterparty exposure information. For all those objectives, treasurers need a Bank Administration Solution (BAS) covering: 1) Maintenance of a central registry for bank accounts information; 2) A controlled workflow for opening, maintaining and closing bank accounts and 3) Eventually the implementation of streamlined and secured (e)BAM processes for exchanging messages with bank counterparties How could we pretend to be on track on the above targets? Some very large corporations can probably pretend to be there (e.g. GE, Microsoft, Shell or HP). The others are far behind thinking about what will be their next steps and targets. The idea is also to move away from (remaining) paper process and to tend to full electronic messaging. Today, more than « eBAM », we should say « BAM » (messaging). The electronic part of this type of message format remains conceptual in reality. SWIFT has developed this new eBAM format (ISO 20022 XML messages transported via FileAct) in order to dematerialize, automate (via STP processing) and standardize the processes around bank account management. They have now created roughly 15 different types of eBAM messages. In future, SWIFT expects that banks and corporations could get rid of fax machines and paper transmission via post. The idea is also to use electronic digital signatures instead of current (paper) signature cards. Main objectives of SWIFT with eBAM are: Reduced total elapse time; Increased corporate customer satisfaction; Reduced cost; Improved STP and traceability

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5.15.5 Technology is there, but banks are not ready yet Even if technology is ready (or quasi ready) banks are usually not ready at all. They are glued into other financial issues and have completely different priorities. EBAM could therefore be considered as a system to further improve cash management. We are at early stages of eBAM. Investing in IT solutions not really tested and proved, with banks not ready to generate or to treat messages and in a shaky economic environment is not a priority (solutions exist: e.g. Avantgard Integrity Treasury Solution ; Speranza with WSS or Equity). The problem with e-‐solutions, sometimes they go too fast and certainly faster than legal provisions. It may happen that a treasurer must rely on paper legal binding documents and that he is not yet allowed to base some of the official documents and evidences on soft copies or on electronic messaging. The “electronification” should not play the partition faster than the music. We should and could not cut corners on breach rules. It will be a full change of bank management approach, or even a revolution. Some treasures still struggle to justify a business case that flies to convince management to move to digital documenting and messaging with banks (eBAM). Nevertheless, we believe it is time after having implemented a payment factory to define the road map for the coming years. This new “eBAM” format can give you a fantastic opportunity to enhance your internal controls in treasury and to revisit or revamp your internal processes, procedures and bank relationship strategy. Pioneer treasurers are sort of prophets who try to deliver messages to a world not yet prepared and ready to move. However, if we do not start with IT solutions (like for example VISUALSIGN from Equity or others), even if current messaging remain physical, we will have no chance to shape the eBAM to our needs.

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5.16 E-‐BAM: a banking connectivity fantasy or a mirage in the middle of the financial desert? “Any sufficient advanced technology is indistinguishable from magic” (Arthur C. Clarke)

5.16.1 e-‐BAM, bang!

“e-‐BAM": what lurks behind this onomatopoeic acronym? A term that is fashionable in treasury management? A buzzword doing the rounds? A word redolent of promise but that does not convince us that there is any substance behind it, at least not now. Finally, surely e-‐BAM is a very virtual concept, not really tangible? A treasurer's fantasy, a mirage in the middle of the financial desert? Perhaps just wishful thinking? We should not be so negative. Nevertheless, we have not got very far with it. For once, some treasurers seem quick(er) off the mark and especially more ready than their banks to take advantage of a new type of SWIFT message to manage the banking relationship (i.e. "electronic Bank Account Management"). Perhaps treasurers are getting too far ahead of the game? Surely supply falls far short of demand? A number of treasurers have raised a whole series of core, legitimate, questions. Could the reactiveness of corporate treasurers move things forward and push the banks into offering more? By pushing the banks to offer more, they might make things happen faster. Some eBAM pioneers have anyway already gone down that road, and plan to spur the banks into action.

5.16.2 More than just a fashion item

Aside from being a fashion item or a somewhat innovative concept, eBAM would not seem to be the most exciting and sexiest subject that treasurers could come across. Who, however, would dare say that managing the banking relationship is not worthwhile, or that it is simple, easy, carefree and most of all free of risk. No one, obviously! It is one of the areas of improvement identified by many treasurers anxious about their procedures and internal controls. Buzzword or fuzz? That is indeed the question that you expect us to answer, to convince you that sometimes you have to act to move things on, without waiting for the banks to serve them up to you on a platter. Treasurers need to contribute to shaping the future of eBAM, rather than submitting to it passively sooner or later when the banks are ready. Many of us have so many other things on our plates that e-‐BAM has been relegated to the back burner. Worthwhile, helpful, but

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unfortunately often not considered a priority for the treasurer's job, eBAM has not kept treasurers awake at night (and with a few exceptions they don't sleep that well).

5.16.3 The complexity of managing bank accounts

However, managing bank accounts is no easy job. What is more, no TMS is really suited to managing banks accounts. You need proper specialist software in parallel to manage you bank accounts satisfactorily and comprehensively worldwide and amongst group subsidiaries. No treasury manager that I know would dare to suggest that with a single click he could instantly get a report giving a complete and comprehensive overview of all his bank accounts, however sophisticated his IT tools may be. Surprised? This would certainly seem incredible, but even the biggest groups are usually unable to produce reports of this type. And when the information is available, it is most often obsolete because it dates back to the last annual audit and the confirmations needed for that purpose. Often bank information repositories are in paper format and archived here and there. At best they are scanned and held in a repository in OFFICE or equivalent software. We often lack a comprehensive overview of data on bank accounts opened and active throughout the world, and of updates in signing powers on these accounts and official signed documents and contracts. We are working with counterparties, accounts or under the terms of contracts and conditions which we cannot check or refer to. Unbelievable, isn't it? Unreal? Impossible? Not at all! Unfortunately, this is the sad reality that an honest treasurer cannot deny.

5.16.4 Mismatch in supply and demand

Since there is a mismatch between supply and demand, many companies feel frustration. The most visionary treasurers or thought leaders see eBAM or more accurately BAM at this stage as a final and necessary step in improving and managing internal control procedures. E-‐BAM is the cherry on the cake of banking connectivity. This is the ultimate step in managing the relationship with banks and keeping your bank account under control. This is a missing piece in the treasurer's control panel. The most realistic and forward-‐thinking people see BAM as an intermediate step in preparing for and implementing eBAM. EBAM is certainly progressing, but not at the speed that corporate treasurers would like or would hope for. Since we now have an ISO 20022 XML type standard and since SWIFT has developed some fifteen types of message, we may expect to see eBAM projects emerge. Unfortunately in terms of fields to be filled in, information to be provided, appendices or documents to be attached, we are far from being on the same wavelength within the world of banking. At this stage, some IT sellers do not hesitate to tell you about or even promote standardization in banking before thinking about including their corporate

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clients in such projects. So presumably we are in too much of a hurry in the view of our suppliers.

5.16.5 4 years on

It is already four years since the eBAM machinery was launched. However, its huge inertia and its diesel engine make it hard for it to reach cruising speed. Some companies have volunteered themselves as guinea pigs to develop the concept and implement it in practice. We should be grateful to them because they will make it possible to shape the system and let eBAM attain its maximum speed sooner or later. At this stage, eBAM is still a project and a worthy concept, of great interest and full of promise. Perhaps some of these things could be realised in the next few months. At the same time, SWIFT products such as the "3SKey" are being developed, as are IDENTRUST type solutions for identifying who is involved in a deal and providing assurance on the quality of the counterparties with which we are dealing or with which we are exchanging documents or protocols. EBAM will only be worthwhile if it covers all banks with which we work, with no exceptions. Nobody wants mono-‐bank or proprietary solutions. All of us are seeking single, overall and multi-‐bank solutions. SWIFT is not being slow about "selling" its solution and its messages. The eBAM Central Utility (E-‐CU), a SWIFT portal, can also be used to promote and build or establish relationships between banks and corporates. For example, having a portal that tells you exactly what you need to open a bank account in Greece or India, and the standard documentation to attach, is an excellent idea for promoting this information and details requirement (failing true standardization). So initiatives can come from all sides. The E-‐CU should become operational in mid-‐2013. Banks such as CITI, JPM or Bank Mellon and corporates such as INTEL, BT, GE have agreed to be guinea pigs. SWIFT's "E-‐CU" database should act as a catalyst for speeding up implementation of e-‐BAM.

5.16.6 Who wants to go first, any volunteers?

Often there remains the question of knowing whether you want to be proactive and play a pioneering role or cautiously and patiently wait for others to do it for you and experiment in your place. It is up to everyone to choose their own option and decide where and when to adopt e-‐BAM because at the end of the day it is only a question of time. We think that reducing such a project to opening and closing bank accounts electronically (in time, in the e-‐BAM version) would be of only limited interest. By contrast, a project involving setting up a repository (electronic/virtual) for information and documents relating to bank accounts, which would need to be comprehensive and systematic, in addition to access to these types of secure, formatted and standardized messages (existing or to be created) would streamline and automate internal procedures. Such a project would then be of extreme interest. Strengthening internal controls is and always will be a fundamental priority for all treasurers. For some companies, accessibility and compatibility with SWIFT e-‐BAM will also be the means of

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selecting and "picking" its bank partners. In short, this will be discrimination through technology. Technology will provide the required speed, security and standardization.

5.16.7 The merits of e-‐BAM

With e-‐BAM we will not have to worry about finding out what we do, or do not, need to provide. These changes in local legislation and regulations "pollute" bank account management and make it more complicated. Combating money laundering and tax evasion make these account opening procedures trickier as time goes by. In principle a bank, just like a mobile phone operator, hates losing customers and closing accounts, and fights as hard as it can to prevent closure. With e-‐BAM, closing an account will be easier and more routine. Some treasurer associations have worked on standardizing contracts and documentation. But the fragmentation and the local legal aspect complicate the task. The environmental aspect and the cost would appear to be minor in choosing to move to e-‐BAM type messages. However, we should not lose sight of them. In the future e-‐ BAM will also make it possible to send year-‐end audit circularization requests and receive confirmations quickly and securely rather than by mail, fax or e-‐mail. If e-‐BAM makes only that possible, it would still be a solution to a problem shared by all treasurers generally. e B A M P R O J E C T A D V A N T A G E S +

Central repository / register for all bank account documentations and contracts (requires anadapted IT tool), sort of global bank database for the group

Controlled work flows and defined automated processes for bank account maintenance (in general) and related operations

Electronic (formatted) exchange of information between banks and customers

Insurance of proposed transmission of information required by banks on correct / appropriate format

Full paperless process decreasing significantly costs and operational risks

Automated upgrade of documentation process when and where necessary

Final stage of in-‐house banking and single bank gateway project

Uniformed and comprehensive reporting system on bank relationships to gain better control over company accounts an to actively manage bank relationships

Improvements / enhancements of external audit review (including confirmations from banks) and audit trails

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E-‐BAM is also "paperless" with no physical object being sent. It is thus clearly more eco-‐ friendly and less expensive than sending things by mail. SWIFT messaging is better than an acknowledgement of receipt at the end of the day. The role of proactive treasurers in e-‐BAM is and will be helping banks to evolve and adapt. They too will be winners (surely more so than non-‐financial companies) when they adopt e-‐BAM. Managing bank documentation is extremely demanding and expensive. The pioneers will shape the process to their needs. This is a considerable advantage when you are involved in such innovative projects and in unknown territory. Some of those who are hanging back suggest that so long as we are in BAM mode they will not change and prefer to wait for the e-‐BAM version. These are the possible approaches, but not a very courageous or creative one.

5.16.8 Fashion or a worthwhile project?

Aside from the "fashion" or "trendy" aspect, e-‐BAM promises many advances and true "plus points" in managing the banking relationship. It will give a complete and unobstructed view from the treasurer's control tower, a view that today is often lacking on bank accounts. Replacing ink by a digital signature and being sure that the counterparty has indeed received what it needed is a key objective. So far we are only seeing the first signs of e-‐BAM but the show is on the road and even though it may be going slowly, is on the way to better management of the banking relationship, there is no doubt about that.

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5.17 eBAM, the next step in paperless account management “The march of science and technology does not imply growing intellectual complexity in the lives of most people. It often means the opposite” (Thomas Sowell)

5.17.1 Did you say "eBAM"?

What is lurking behind this "eBAM" acronym (not to be confused with IBAN)? What should corporate treasurers expect from this new form of SWIFT messaging? This article attempts to describe what will certainly be a major project for corporate treasurers over the next few years. It is one of the final steps in dematerialisation and achieving paperless processes integrated from one end of the financial chain to the other. The eBAM format will perhaps make it easier to issue year-‐end audit confirmations, which are always a problem. Behind this bizarre abbreviation, the idea is to define the terms for "electronic Bank Account Management". eBAM could well be the next step that corporate treasurers hope to achieve as part of their "payment factory" plans. To provide the structure for another swathe of bank/corporation interactions, seamless integration between banks’ back-‐offices of and corporations’ in-‐house systems is needed. The idea is and will be, by secure electronic means, via SWIFT (see www.swift.com/corporates), using a specific protocol, to exchange e-‐documents relating to "end-‐to-‐end" bank account management. The ultimate goal is to provide a solution for managing, maintaining and updating accounts and the documentation relating to them. Maintaining all the various databases, in diverse forms and different formats, is and always has been a challenge – a complicated and completely manual task. Treasurers would like to improve and standardise audit reports (from independent external auditors) on their bank accounts. They want better control over their accounts and they want to simplify bank workflows. Sadly, we are only at the very start of developing the eBAM concept itself. Not all banks are yet ready to process these messages, nor to issue eBAM-‐type SWIFT message formats. However, we might expect that in the medium term all of them will be able to process messages of this type, in this specific format. Dematerialisations of original documents as well as the adoption of digital signatures and electronic copies in support of this documentation are technically possible. However, certain countries still require physical copies in paper form. Digital identities will have to be accepted by all banks in the medium term. At a time of hyper-‐standardisation, wouldn't it be a good idea to lay down a standard for exchanging information about the accounts themselves?

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5.17.2 From concept to reality… But when? Nobody would dare dispute the benefits to everyone, including bankers, of fully automating electronic bank account management. Today, we know that SWIFT has signed up a few pilot companies. Others are watching closely, and are ready to become part of this project. However, as always, there is a chicken and egg problem. Some people are waiting for the banks to be ready, and others are waiting for businesses to adopt SWIFT and particularly eBAM before investing in it further. As we have often seen in such cases in recent years, a few businesses will have to show determination and pioneering spirit to drive the concept forward. After that, it will only be a matter of time. The biggest banks that deal with cash management are at least open to this, if not ready. Some IT vendors have also developed eBAM solutions, such as Alsyon or Datalog. When will all of us be using eBAM? Nobody can say, but we can still hope that it won't take another decade.

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5.17.3 The pigeon, the postman, the fax… and eBAM For a number of years account information has been sent by traditional means such as fax or post. When you send documents, for example signatory documents, you use photocopies that you have to certify and sign as being true copies. You transmit copies of identity cards and passports. These exchanges have remained virtually the same for decades and work in a completely "physical" way at a time when secure technology is available. For companies that deal with multiple banks and many countries, no two documents are identical, and all are sent physically by mail (and sometimes by fax). Surely there is a problem of inconsistency, security, ineffectiveness and inefficiency? In terms of internal control, companies are seeking to strengthen their processes and to make them as secure as possible. In an age when everything is supposed to be automatic and paperless, why do some actions still need to be manual? Why do both businesses and banks spend so much on managing and maintaining bank accounts? Nobody knows.

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5.17.4 Internal controls and the need for automation We have a clear need for automation in an activity that is crucial to both parties (customer and supplier). Solutions exist, so why not adopt them? These days, time is a crucial factor. Yet we seem to put up with it taking so long to open or close accounts, or to change signatories, even though nobody can explain why. We should be working to reduce manual operations for internal control purposes (see SARBOX or the provisions of the Eighth Directive on internal controls). Just think of the lengthy administrative formalities needed simply to add or delete a name from the list of bank signatories. If you are in no hurry to add a new signatory and if you're not worried about risks attaching to signatories you want to cancel, you will not be interested in eBAM. On the other hand, if this does worry you, eBAM is for you and you will be very interested. The aim is, in a few hours or even less, to make the required changes to bank accounts to ensure continuous and secure bank account management. The traditional method of sending a letter to the bank seems somewhat out of date. It leaves the door wide open to fraud or misappropriation by somebody whose signing powers or other authorisations are being withdrawn – perhaps for dismissal for serious misconduct or

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because they are leaving the company. Even if companies have made an effort to keep down the number of bank accounts and use standardised instructions16 to prevent opening accounts unduly, that still leaves a large number of accounts to be managed in many different countries, currencies and jurisdictions. The selection of a global banking group is often of little help because local specifics have to be adhered to. As of today, eBAM offers a structured and standardised message format for transmitting electronic documents and perhaps other information, together with digital signatures and identities that cannot be repudiated. A certain amount of time will clearly be needed to define a standard way of using eBAM to best effect, and a transition period will be necessary before it comes up to speed. The pioneers of eBAM know this and are ready to adopt it, realising that it is going to grow and expand. Nevertheless, the pioneers will have the advantage of tailoring it to their needs and making their banks do the same.

5.17.5 Digital signature and identity management

Obviously, the identification and signature management aspect is both tricky and crucial. Replacing traditional signatures in special boxes with digital signatures will amount to a radical and revolutionary change. But why should we be able to transfer funds using digital signatures but not be able to change signing powers themselves in the same way, or by using SWIFT messages? Personal Digital Identity management seems inevitable in time. SWIFT has recently unveiled its "3sKey" solution in the form of a memory stick or USB key for producing an electronic signature. This key will replace the manager's pen. The adoption of eBAM and the harmonisation of signature management will automatically result in standardising forms and procedures for opening bank accounts, indirectly making the treasurer's job easier. Currently, there are as many types of accounts and account opening documents as there are banks and even countries. You have to wend your way through a real labyrinth to open a bank account in some countries. Money laundering legislation does not help with the procedures that have to be followed. This ideal world of market standardisation still looks like a utopia, and there will have to be changes in mind set and culture first. If you're a banker, you don't abandon good old paper without a fight.

5.17.6 Audit confirmations

One of the things that often cause problems to companies is getting the external auditor confirmations that treasurers have to ask their banks for at year’s end or at the end of accounting periods. This is an on-‐going nightmare, since banks take ages to send out their confirmations in disparate and varied formats (for example fax, mail, email or not at all). eBAM used to full effect in combination with a powerful TMS and a payment factory application would make it easier to initiate these messages. Alternatively the 16 Transfer to the account of a correspondent without a bank account

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company could initiate them itself to "force" its bank counterparty to react within a reasonable time, placing the onus on the banker to prove otherwise. Good treasury software can initiate financial product portfolio positions instantly. Payment management software applications, at least some of them, already enable you to manage open accounts with their closing balances and also other information such as account opening, signing powers or even documents such as signed ISDAs, general terms and conditions and other MiFID documents. Again, this is certainly a development which we would hope to see gaining ground in the coming months and years in order to resolve the symptomatic problem of interrelated documentation. The banks, too, want to become more efficient and improve their own internal controls and processes, so they will aim to make it easier to issue documents in this way. Sending them out electronically as secure and unalterable messages will safeguard content more effectively, in the interests of both parties. It will be a long road, beset with pitfalls and cultural and technical obstacles rose by the banking industry. You have to preach like a prophet if you want to be heard. Perhaps the banks could even take advantage of this technical development to provide their customers with new services. This is a service with which "eBAM-‐enabled" banks could attract major corporate customers. To some extent it is the culmination of the full STP (Straight Through Process) treasury strategy. The banking industry will need time to answer the outstanding questions on how to implement eBAM. The implementation cost will not be neutral for financial institutions, once again. But do they have any option other than to move to this technological development in the medium term? Obviously, we think not. The most optimistic hope is to have an eBAM offer worthy of the name before the end of 2012.

5.17.7 Running a greener treasury department

The idea of using the ISO 20022 message format to process enquiries and requests on transactions is new and advantageous. We could receive extracts and other documents connected with an accounting period close (circularisation) for external auditors, particularly by eBAM. We could go further to save time (getting confirmations quicker), to save cost (no more correspondence by letter, so "greener" and more environmentally friendly) and also to be more secure (fraud would no longer be possible). This all amounts indirectly to being more environmentally aware and responsible "green" citizens. As always, this is only a small action but, when added to others, it will help our planet. The ultimate goal is to conduct all our transactions with banks paperless. The paper bank statements, when extracted by the payment factory application, are no longer kept, nor even scanned. This is a significant saving. The idea is even to keep all official bank documents (MiFID, ISDA, account opening documentation, general terms and conditions, etc) in pdf format in the software application's single database, which is itself (as in Datalog for example) centralised and secure.

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All e-‐Documentation initiatives are welcome in contributing, at the department level, to cutting the company’s carbon footprint. Dematerialisation should also become the norm for all documentation between the bank and the client. The initiatives for cutting cost, dematerialisation, automation, strengthening internal controls and cutting the carbon footprint are not incompatible. On the contrary, they are additional arguments for selling your payment factory plans in-‐house. Certainly few companies have yet taken the plunge. However, they will all come round to it, as will the banks; it's just a matter of time.

5.17.8 For eBAM it's already tomorrow

To conclude, we may hope that the banks will get to work quickly – the most proactive among them, at least – to provide their clients with satisfactory eBAM solutions. They have a wonderful opportunity to differentiate themselves from their competitors. They must try to simplify administrative procedures by standardising the procedures for opening and closing bank accounts, and for managing signatories and other official documents connected with the accounts. This technological change will have indirect beneficial effects on the year-‐end close, with financial institutions sending out simplified year-‐end confirmations quicker. eBAM is the icing on the cake of automation, it is back-‐ office nirvana, or even the treasurer's holy grail, and the hope for simpler administration in future. Let us all rally round behind it and force the banks to "convert" to this new standard, as if it were a religion with "full STP" for its creed.

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5.18 Does SEPA really matter to corporates? “It’s easier to dismantle an atom than a prejudice” (Albert Einstein)

5.18.1 What is SEPA?

SEPA (Single European Payment Area): behind this acronym lies one of the most ambitious financial projects ever launched by the European Union (EU). In the face of geographical, legal, monetary and cultural fragmentation, we European treasurers have been having such difficulty managing our positions, that we have seen in the EURO, and then in the SEPA, real opportunities for optimising our day-‐to-‐day situation. It is perhaps this diversity and the complexity of our situation which have spurred us to become world champions at automation and electronic fiduciary management. Eventually, we will all be able to take pride in the progress made, as Europe will have achieved a degree of technical complexity and electronic solutions that will be the envy of the entire world. But there is still a long way to go. For a good number of us, the SEPA represents a real opportunity, as it should create a “single market” for the euro and, in the process, is sure to improve competition as demanded by ECOFIN, the Governing Council of the ECB, as well as by the European Parliament. The SEPA payment services and the added value provided will generate profits for all treasurers if they are prepared for a migration of the national euro instruments to the SEPA instruments. The European banks have made significant progress although, for many, there remains much work to be done. As any treasurer will readily tell you, the PSD (Payment Services Directive) constitutes a major challenge for European banks. The challenge for the bankers will centre on being innovative and proactive in order to prevent others coming in and taking over their turf. When it comes to payments, international governance will undoubtedly be required in order to regulate the market’s players, as well as to protect us users. According to the conclusions of the Council of the European Union, while real progress has been made, there remains a great deal to be done. The 2008-‐2009 financial crisis and the more recent crisis of the PIGS states (Portugal, Ireland, Greece and Spain) have demonstrated the importance of a single European payment area (SEPA) for creating an integrated and competitive internal euro payment market, in the interests of citizens and, above all, businesses. Let’s cut to the chase: progress has been made in terms of SEPA bank transfers, but now it’s necessary to actively develop and complete the work on the technical standards still required on the credit card market. It is vital to ensure transparency and to offer guarantees of total interoperability, security and open access in order to facilitate the deployment of one or more pan-‐European payment card systems.

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Eventually, it will be necessary to ensure the equal processing of electronic invoices and paper invoices for VAT and to develop innovative payment solutions that will serve as a basis for a more efficient and more competitive European economy, for the good of all citizens. It is hoped that the banks will embrace the role of payment service providers and develop solutions for electronic and mobile phone payments. The SEPA may be able to make a significant contribution to the modernisation of the public sector and to European economic growth in the wider sense, most notably by developing services with added value (e.g. electronic invoicing in an interoperable framework). Nevertheless, isn’t it regrettable that almost two years after the success of the technical launch of the SEPA bank transfer, the percentage of transfers processed in the euro zone remains very low and in the main limited to cross-‐border payments?

5.18.2 Expectations of treasurers What the treasurers want is a sort of acceleration in the adoption of SEPA transfers, particularly for national payments in euros. After all, they are setting the example as high-‐volume users by themselves migrating to the SEPA. The public authorities also need to show the way and energise the migration process by means of integrated and synchronised migration plans aimed at all government services. The setting of definitive deadline dates for the migration to SEPA debits and transfers would provide the clarity and incentives that the market requires. It would help make the considerable benefits of the SEPA tangible and eliminate the high costs incurred by the coexistence of the old systems and the SEPA products. One of the keys will reside in the capacity of the parties concerned, namely (high-‐volume) corporate users, government services and other entities, to swiftly establish an ad-‐hoc governance and monitoring structure for the SEPA.

5.18.3 “Can the PSD provide what treasurers want?” All corporates would like payments to be made within a clearly defined period and to be assured of the certainty of funds as, more than ever, they are essential for treasury management. The PSD (Europe’s Payment Services Directive) would appear to be the answer to the treasurers’ wishes, as it aims to establish clarity and uniformity of payments throughout the European Economic Area (EEA) by standardising and regulating the rights and responsibilities of all payment service providers and of the users of these services. Since the key to treasury management is cash flow management, the PSD is essential, as it will require the majority of payments issued and made within the EEA to be

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completed within a maximum period of three days (often less than one day for payments of under €50k) according to the instruction given and based on the full amount principle. The certainty of the timing but also of the value of the funds received or to be received will thus be guaranteed. However, treasurers are concerned about the capacity of second-‐zone banks to provide compliant payment services of this type. The financial crisis has hit some hard and they simply won’t be ready on time. The Hobson’s Choice facing the banks is a source of concern to treasurers, as the latter need to update their technological platforms in order to be able to guarantee the degree of granularity and information required by the PSD and to review their SLAs (Service Level Agreements) with all foreign partners. Moreover, they will need to find new revenue and resources to replace that which they will inevitably lose by dint of this directive (e.g. clearance and value dates). Nothing tends to be simple with the EU and, true to form; the regulation includes around twenty local exemptions allowing EEA states to modify the rules at their discretion. This can only make compliance more complex for the most pan-‐European banks, as these opt-‐outs will undoubtedly lead to divergence, thereby increasing the complexity of the processes. While it’s hard to feel too sorry for the banks, which have profited from this over the years, one cannot help noting that, for them, it amounts to a change that is compulsory but once again negative in terms of costs and revenue, as was the case with the adoption of the euro.

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SEPA – The 12 main opportunities offered to Corporates (Non-exhaustive list – potential advantages offered)

o o o o o o o o o o o o

Less bank relationships (review of core banks) and system interfacing Maximization of automation capabilities (end-to-end) – More STP Improvement of payment efficiency Less manual entries and therefore less errors and delays Better formats of payment data / more to XML as single format More transparency, necessary these days Potentially shorter execution times / extended cut-off time Certainty of timing for funds reception, giving more comfort to debtors Better cash-flow and therefore easier liquidity management Streamlining of bank accounts structure, reducing number of accounts Higher protection of funds transferred or collected Lower costs – potentially added value product

The choice of banking partners will increasingly be based on the technical and technological side. We’re heading into a new dimension in terms of the banking relationship and these days, nobody in the banking world would be so bold as to claim to have a solution to all problems connected with ensuring compliance. For this reason, the salvation of certain bankers will surely come from outsourcing or subcontracting to technical specialists who are already fully compatible and compliant. In other words, the payment function could move away from certain banks. For those which can master it, multimarket compliance will be a major advantage, but they will need to find partners who don’t swallow them up. The directive will be the template for the banks to branch out without actually increasing their physical presence abroad. This type of partnership undoubtedly represents the shape of things to come and is not necessarily a bad thing for treasurers.

5.18.4 Progress of the SEPA, satisfactory or not?

The SEPA has been up and running for quite a few years now, but can we really say it’s close to being fully deployed? Numerous parties, not just the treasurers and their associations, are keen to encourage the European Union to finally decide to announce

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an end date for the legacy clearing systems. There are many who feel that the complexity and challenges arising from the PSD, combined with the EU’s lack of clarity, are causing it to sometimes contradict itself. A number of treasurers take the view that, at this stage, there is no real motive or incentive for the majority of them to change. The way they make payments and their current systems are working fine for the moment. “If it ain’t broke, don’t fix it”, is their refrain. In any case, isn’t it up to the banks to take the lead role in the adoption of the SEPA? By waiting for the public authorities to act, aren’t they being reactive rather than proactive? It’s a case of who’s going to show themselves first. Many treasurers have not yet invested in their IT systems to allow them to support the XML format that is the standard for SEPA messages. Despite the SEPA being, on paper and in terms of its aims, it is a project that no one can afford to ignore. In practice, admittedly, it’s more complicated than that, especially when it comes to its implementation. To truly optimise the switch to the SEPA, corporate needs to seize the opportunity offered to standardise and further consolidate its processes, while at the same time centralising its operations. Indirectly, it will offer greater security and less paper, as well as the swifter verification of electronic signatures. It will also enable internal controls to be improved. But the SEPA is only another stage on route to an integrated Europe, at a time when the problems facing Greece are weighing on the euro and, according to certain pessimists, threatening to cause its implosion.

5.18.5 SEPA, hopes or over expectations?

Is the SEPA potentially the resource to raise the hopes, prayers and expectations of treasurers? Potentially, yes, as in principle, treasurers will benefit from panoply of resources and tools for maximising the efficiency of the receipt of funds, transfers and general cash management. In a still tense and challenging economic climate, cash management is going to be the prime focus for treasurers. In addition, cost reductions and automation (with the aim of improving internal controls) are also the chief aims in 2010, in order to construct an optimised treasury model throughout a Europe of still fragmented payment systems. Many treasurers are constructing “payment factories” with the idea of reducing costs by taking advantage of standardisation. These proactive treasurers are seeking to set up a single transfer submission channel with multi-‐country coverage. The SEPA therefore offers undeniable opportunities to those able to seize and harness them, while for others involved in B-‐to-‐B collection activities, the SEPA Direct Debit might also prove useful. But in many cases, these deployments need to be carried out in conjunction with active and innovative banking partners in the most proactive and dynamic countries. The ultimate objective may involve SWIFT Score, for example, centring on the standardisation of banking information in one coherent and unique format. So bon courage, as there’s still a long way to go along the road to payment Eldorado!

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5.19 What a wonderful regulation world! “I see skies of blue .... Clouds of white Bright blessed days.... dark sacred nights and I think to myself ...what a wonderful world” (Louis Armstrong) The pessimistic ones would say that the cup is half empty while the more optimistic one would pretend it is half full. Corporate Treasury associations prefer to be on the optimistic side and see positive aspects of current financial crisis, as well as opportunities offered to corporate treasurers and risk officers. Of course, we can be tempted by only focusing on liquidity issue (which went down rapidly and sharply), on volatility issue (which went up for lots of commodities, currency pairs, indices etc…) or on credit beside all these bad news, the market situation will offer us multiple opportunities to come (back) into the lights. Now, all Board Members and CFOs know what liquidity risk means in reality. Now these senior managers know what systemic risk is about in practice. Now, they also understand what sensitivity and stress (I would prefer “stretched”) testing means, applied to their businesses. The rules of the games have changed. Fully liberalized markets have demonstrated they don’t work for the good of majority but only for wealth of a minority. Some people will forget how to spell the word “bonus”. Banking regulation framework has failed too. Even the famous “Sox” and the tough S.E.C, in the USA, have not prevented frauds (Madoff, Standford, Sattyam among others). Even the IFRS (International Accounting Standards) have been criticized as the root cause for the crisis. Guess who dared blaming IFRS (IAS 39) and Fair Value? The bankers of course. We also noticed that corporate governance rules and codes were unable to prevent some major failures. We all should be grateful towards states, governments and tax payers who, somehow, saved our modern capitalistic model. We all have to clean this situation and to revisit in depth all regulatory rules to better prevent such failures in future. It will be our government financial key challenge. For corporate treasurers, it is now time to re-‐focus on basics of risk management. After having concentrated our minds on systems, technicalities, automation of processes, IFRS and cost efficiency, it is time to focus on how to better control and monitor financial risks. Some theoretical risks like liquidity and bank counterparty risk, for example, have become real. We unfortunately understand that financial markets are not perfectly efficient. After such financial tsunami, it is necessary to contemplate new ways of apprehending risks. We should re-‐consider the company risk profile and risk appetite.

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The mission of treasurers has to be sometimes re-‐defined. Policies should concentrate first on risk mitigation and company assets protection, rather than on returns and performances. We need more K.R.I’s than K.P.I’s (Key Risk Indicator) The nice thing with current crisis, this downturn offers us great opportunities to demonstrate added-‐value brought to the organization. Treasurers must work at influencing business performance. We should be prepared to re-‐shape the treasury strategy, to focus on cast, to remain extremely reactive and flexible to have a more responsive approach and to develop treasury team’s skills and expertise. Treasury department must anticipate and exploit opportunities of the market. Old certainties have gone. Therefore why not completely revamp the treasury group to better demonstrate our effective value?

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6 Part VI ERM and internal controls in finance

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6.1 Enterprise Risk Management (ERM) next steps to consider “It’s fun to do the impossible” (Walt Disney) Benefits of implementing an ERM process are vast. In a broad sense, they include organizational sustainability and, possibly, a strategic advantage. It also includes more granularity in understanding corporate goals and objectives in terms of risks taking, enhanced talent management, mitigation of expenses and losses, and overall, an improved corporate stewardship and stakeholder value. Unfortunately, ERM may still be seen as the route to helping corporates demonstrate compliance with governance and reporting requirements. Benefits of a good ERM program accrue as it matures and as it is embedded in key strategic business division process. There is no single standard approach to designing an effective ERM process. Each ERM program must be aligned to group strategy and organization’s culture. When the risk culture is there, it can help shaping the business in positive ways and it has greater chance of success. The communication and active engagement of internal and external stakeholders is vital to facilitate changes and to embed ERM in key business processes throughout the company. Usually when implementing ERM, risk managers focus on top executives and directors and forget to reach out to employees, who are owners of many risks within the group. ERM should also be shaped to support business changes and to deliver managerial sustainability.

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Benefits Benefits from from ERM ERM Ì Ì Demonstrates Demonstrates compliance compliance Ì Ì Enhances Enhances behaviours behaviours and and commitments commitments Ì Ì Reduces Reduces costs costs at at risk risk Ì Ì Improves Improves organisational organisational performance performance Ì Ì Improves Improves company company efficiency efficiency Ì Ì Secures Secures growth growth opportunities opportunities Ì Ì Is Is not not stated stated // is is applicable applicable Ì Ì Consolidates Consolidates risk risk picture picture across across the the group group Ì Ì Creates Creates added added value value Ì Ì Prevents Prevents risks risks and and consequently consequently losses losses Ì Ì Better Better defines defines objectives objectives and and risk risk appetite appetite limits limits Ì Ì Improves Improves risk risk correlation correlation perception/ perception/ understanding understanding

Rarely a company having ERM implemented could pretend using it to full capacity. There are three key elements in a successful ERM lifespan which are: Strategy Resources Culture A successful ERM should be fully integrated and embedded in the business processes can even help improving internal relationship among managers. With a well-‐defined performance measurements (KRI : Key Risk Indicators) to monitor progress and with an effective, as well as consistent, communication strategy, Chief Risk Officers (CRO) can engender collaboration across Business Units (BUs). ERM is a permanent and on-‐going process a group must keep improving with good and clear support from CEOs and CFOs. It remains one of the key challenges of the coming years for CROs and also for Group Treasurers.

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6.2 Treasury Risk Management: A Model for ERM? “If history repeats itself, and the unexpected always happen, how incapable must man be of learning from experience” (George Bernard Shaw)

6.2.1

Treasury, Example of Good Practices for Risk Management

What if the treasury risk management model was applied to enterprise-‐wide risk management (ERM)? It seems clear that the approach and techniques used for treasury could have applications for total risk management, not just financial risk. The treasury department, with its organization, procedures, technical analyses, key performance indicators (KPI), and its many reports and internal controls, remains a model par excellence of risk management. The general organization of a modern, up-‐to-‐date treasury department is a perfect example of what enterprise-‐wide risk management (ERM) should be. A treasurer uses many techniques and reports that could be applied directly by the CRO (Chief Risk Officer) of a multinational group.

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Treasury Treasury organisation organisation on on Financial Financial Risk Risk Management Management

IT SYSTEM REPORTING

General mission Main Treasury Policy Several Specific Policies (e.g. FX, IR, Bank policy…) Manual of Procedures

Systems around TMS (Interfaced – STP – Automation) Front-Office

Back-Office

Reporting – Sensitivity Analysis - KPIs

INTERNAL & EXTERNAL AUDITS

FORMALIZED RULES

Treasury & Corporate Finance

Risk Managed : FX, IR, liquidity, credit, commodity, equity

Segregation of Duties – Internal Controls

A treasury department is organized to manage a particular category of risks: financial risk. It manages foreign exchange risk (FX), interest rate risk (IR), liquidity, credit, commodities, and stocks, or any other listed financial security. The technical nature and complexity of this particular kind of management requires a highly organized, disciplined, scientific, controlled approach. A company’s treasury department could be considered a laboratory, or a model of the “best practices” to be applied to ERM. In the aftermath of the handful of sensational scandals that occurred in this decade, treasury departments have been under tremendous pressure to revise their methods of functioning from top to bottom. They have become more meticulous, and an excellent example of how to manage risk. C.F.O – Treasury Committee

6.2.2

Treasury Management Model

Treasury management departments are also a model par excellence in terms of policies and other procedures. They are highly formalized. All of their activities have been defined, described and standardized, and contingencies have been established. For example, in addition to the General Treasury Policy, considered to be a kind of “constitution” for the department, there are regulations for foreign exchange, bank relations, hedging compatibility, financial risk strategies, intra-‐group financing and asset

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management. Everything has been decreed. Back-‐office and front-‐office functions are clearly separated. Internal audit procedures, which are so important under Sarbanes & Oxley, are numerous (e.g. the “four eyes” principle, double signatures, audit reports, an audit trail, electronic access, etc.). The treasury is also supervised by a Treasury Board, a kind of supervisory body, in addition to being under review by auditors, both internal and external. The treasury department produces many status and management reports. Its activities are completely transparent. The monthly treasury report, on the KPIs or KAIs (Key Performance/Activity Indicators), on banking activity and transaction distribution statistics, on sensitivity analyses (IFRS 7) and other Values at Risk (V@R) are a testament to this extreme effort to keep activities transparent. Treasury departments are also highly computerized, using many IT solutions (for software purchasing or ASP). For example, the TMS (Treasury Management System), has a tool for market data and for on-‐line verification of transaction confirmations (e.g. CMS), Cash Flow Forecasting, a tool for on-‐line financial product management (360T, FXAll), for accounting and for group reporting, as well as one or more payment systems.

6.2.3

How Treasurers Deal with Risk?

The way in which a treasurer approaches risk depends on the group’s strategy and its risk profile. Are they “risk averse” or not? Are they a profit center or simply a service center? What is their appetite with respect to financial risk? Based on this profile, a treasurer can determine a series of financial strategies to pursue. He will then make sure that they are followed, and establish effective auditing tools. The strategy and principles are defined by internal rules of procedure that establish the scope of the treasurer’s work. He can now navigate using a map and radar, no longer simply by sight. To accomplish his various tasks and missions, he relies on computer-‐ assisted tools for decision-‐making, auditing, reevaluation and volatility analysis. His decisions, which become actions and operations, will be recorded, qualified, audited and reported. Performance will be measured through a series of KPIs. In case there is an incident or a fire, a diligent treasurer has established a BCP (Business Continuity Plan) or a DRP (Disaster Recovery Plan) to determine what procedures to follow to ensure continuity, company permanence and business security, which are by definition important and high-‐risk. Think of the millions of euros or dollars that a treasurer handles and transfers each day. Treasurers are therefore perfectly equipped to manage risks of all types. They put them in the context of a consolidated risk matrix, a sort of snapshot of the group’s net exposures. As a result, a treasurer is one of the first people to consolidate his risks and

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to identify their correlations. A treasurer maintains a management chart summarizing, identifying and evaluating risks. He identifies, quantifies, eliminates, monitors, selects and transfers risks, just like a CRO.

6.2.4

Mitigating Risk

Treasurers are experts in the art of reducing or eliminating financial risk, for example, when hedging foreign exchange positions to reduce volatility in the income statement. They will also apply IAS 39 hedge accounting to avoid additional intermediate volatility. They may even reduce translational risk by hedging line items on the balance sheet, which is unfortunately often imperfect due to accounting techniques. Hedging can be total or partial, perfect or imperfect, internal or external, gross or net. Risks may be preserved, reduced or transferred. Some groups resort to outsourcing, or even purchase insurance to cover exchange risk (e.g. COFACE in France). Treasurers therefore use the full range of risk management tools, including tools to manage exposure and open positions. They have even become experts in reevaluating risks at their market value (IAS 39) and in sensitivity analyses (IFRS 7). When managing credit or counterparty risk (especially non-‐financial), they perform operational management as the “risk owner.” Moreover, treasurers are the first to use high-‐ performance, integrated, interfaced, analytical computer tools (including an STP [Straight Through Processing] approach). They provide effective, precise, quantified, proactive risk management like no one else in their companies. Treasurers have a veritable risk culture, which they manage comprehensively, in a consolidated, aggregated manner.

6.2.5

Internal Controls and Various Regulations

Very early on, and even before the future “E-‐Sox” (8th guideline), treasurers’ work has been governed by various standards, regulations and other laws, such as IAS 39, IFRS 7, (“Tabaklsblat” corporate governance, “Lippens code,” LSF, and others), Sarbox (section 404), as well as a tendency to control a department that is, by definition, potentially high-‐risk. They have been the victims of a sort of witch hunt. The treasury department has had to “come cleaner than clean.” In addition, the treasury department applies the ISDA agreements that govern all financial transactions. They negotiate piles of documentation, generally according to English law. They are very fond of e-‐technology, capable of meeting efficacy and security requirements and reducing risk related to manual transactions, to free their precious time and dedicate themselves to high value added tasks. Treasurers are at the heart of all areas of finance. Their preferred position gives them an unusually clear overview of the company’s risks.

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Treasury Risks       

Treasury Risks IR Commodity Credit Counterparty Equity Liquidity

Management

Management Dealing/Netting Actions

    

Synthesis of Risks

Treasury Risk Matrix

TMS

Treasury Dash Board

Treasury Reporting

(consolidated & aggregated)

Hedging Cash pooling Netting Transfer Etc… Top Management + CFO

6.2.6

Next Step in the Development of the Treasurer’s Job

The treasurer, whose job has changed significantly over the past five years, may have a chance, as a result of his experience, to assume yet another role. In medium-‐sized companies and groups, where there is not necessarily room for a CRO, the treasurer could do this job. His intrinsic qualities, his specific expertise, his approach and operating methods are a perfect match for the role of CRO. Some companies have already entrusted this duty to their treasurers. We believe this is a wise decision. Yet, whatever happens, an international group cannot exclude their treasurer from risk management, even if it means simply including him in the Risk Committee. Treasurers may soon be adding another string to their bows.

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6.3 Results and conclusions of a European survey about corporate treasury possible role within the ERM process “Problems cannot be solved at the same level of awareness that created them. We must learn to look at the world in a new way” (Albert Einstein)

6.3.1

Objectives of the survey

The main objective of this European survey on Enterprise (wide) Risk Management (ERM) was to identify whether or not there is a potential role for corporate treasurers into the process. In case of positive answer, what type of role could treasurers play? The survey attracted 33 answers from corporate treasurers across Europe. Despite a limited number of respondents, we drew interesting conclusions. In former articles (TMI n° 159), we identified reasons to include treasurers into the ERM processes or to give them the key driving role in structures where there is no room to justify a full time Chief Risk Officer (CRO). We also addressed some of the reasons identified to explain why some treasurers are sometime reluctant or not motivated to embark into ERM. Beyond these reasons, it was interesting to identify what treasurers need to acquire, to develop or to learn in terms of techniques (incl. soft skills) to possibly fulfill this ERM function (full results of the survey could be consulted on www.atel.lu).

6.3.2

ERM, necessity rather than nicety

Corporations, in general, suffer from lack of information on best practices and benchmark in ERM. Every single effort to promote and reinforce the risk culture is welcome. The ERM is still at its early stages of development. The request for comments from Standard & Poor’s initiated in November 2007, for example, proves that things are changing. There are catalysts for developing a true risk culture in Europe. Although existing rules remain local, we could suspect to soon have a European Directive harmonizing the risk reporting approach. Economic down turn, stock exchange turmoil, currency volatility, liquidity crisis, environmental concerns, reputation issues, explosion of commodity prices are some of the reasons to remain prudent and to prevent (financial) impacts of risk occurrence. Unfortunately, ERM is not a science; it is more a sort of art. “Our task is not to foresee the future but rather to enable it” said Antoine de Saint-‐Exupéry. As business volatility has increased, risk management has become an important topic for corporations worldwide. The recent wave of governance scandals has prompted regulators and

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shareholders to scrutinize risks and control frameworks more closely. ERM is no longer a theoretical nicety; it is now a practical necessity.

6.3.3

Potential role of treasurers

There is no doubt that the treasurer’s role has developed over the past years as risk management skills are used in broader business context. In some organizations, this has developed in a formal manner with establishment of ERM Committees and specific new roles for the treasurers. By benchmarking large multinational companies, our goal was to determine roles treasurers could play in ERM (i.e. part-‐time role; full responsible role; or no specific role apart from reporting to CRO). We wanted to validate these different options and to measure treasurers’ willingness and motivation for such a career development. It appears that treasurers are well fit for this function. They have an obvious opportunity to better position themselves within the group. We hope that the most motivated ones would be able to succeed in this quest. It clearly appears that ERM is not as institutionalized at corporate level as in the banking sector. Top managers still need to instill a better risk culture. The treasurers are not often directly involved in risk management. However, all companies questioned manage directly and specifically financial risks. 63% of respondents acknowledged that they personally only focus on financial risks. It does not mean that nothing is done in the non-‐financial risks area. It also appears that if and when something is done it is not always coordinated, widely organized and sometimes (even worse) not well communicated to treasury departments. It also shows the silo approach of risks. Risk notion remains assimilated by professionals as purely “financial” (as if no operating risks could be envisaged and risk management was compartmented). Fortunately, 50% of companies which do not have yet ERM process in place plan to implement one in the coming 24 months.

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6.3.4

Motivating factors

The main reasons for implementing ERM are: the corporate governance pressures (incl. national regulation as KontrAG, LSF or Tabaksblat,…), good business practices and in third position the competitive advantage it could give. 6.3.4.1 Factors motivating ERM: Risks treasurers are well placed to monitor and report The main financial risks a treasurer is well placed to properly manage, monitor and report are: FOREX, liquidity risk, credit risk, commodities, insurance (which is a mean to reduce/mitigate risks rather than a risk in itself), market value of investments and eventually the political risks (which can affect trade receivables, foreign assets and dividend repatriation). Treasurers acknowledge managing risks, before reporting identified risks. This “managing” role is extremely important. They role partly consists of managing financial risks identified, to monitor them, to mitigate or hedge them and to eventually report them to the CFO. This risk management is professional, organized, computerized and must be efficient to avoid accounting (major) impacts. Every single employee, at his own level, has to manage risks. What make treasurer’s risk management different are its more specific technical skills which enable him to take on this huge portion of the whole company risks. He needs to manage where others simply try to reduce or avoid risks as far as possible. Furthermore, he measures risks and quantify them, as well as potential impacts they could have in several scenarios. Risk management is a key task for them. For other executives, risk management is subsidiary to their main (operating) tasks. Treasurers fully cover risks management with a well-‐organized methodology. It certainly differentiates him from others in risk management. 6.3.4.2 Types of risks treasurers have expertise to properly manage: Potential benefits of ERM ERM can potentially generate benefits for corporations and increase risk awareness within the group. It also enhances (internal) controls quality as well as control on uncertainties. It improves financial losses avoidance and lowers earnings volatility. Eventually, it contributes to shareholder value.

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6.3.4.3 Benefits of ERM: Potential roles for corporate treasurers It clearly appears that more than half of respondents believe they are well positioned to take over this function within their own organization, if requested or suggested to them. However, the main other functions which could be well positioned too, according to respondents, are, of course, a dedicated CRO, Controllers, Internal Auditors or even CFO. We think that this function (full time or part time) must be assigned to a direct report of the CFO rather than to the CFO himself. In case ERM is already in place, we noticed that approximately 21% of respondents are not involved into the process. Conversely, 16% roughly are in charge of ERM. The others are partly or indirectly involved into the process. They contribute by delivering information, by reporting risks measurement or by participating to a Risk (Management) Committee. In biggest corporations where they have sufficient tasks and work around risk management to fully dedicate one person, as CRO or even a (small) team. There are around a quarter of companies having a full CRO function (24%). It also appears that some mid-‐size companies have preferred to dedicate this function to a member of the financial team, on top of his own major function. Eventually, when there is no specific CRO appointed, 76% of respondents do not plan to hire one. 79% of treasurers estimated being involved directly or indirectly into ERM, although sometimes, there is no specific process in place yet. It demonstrates that, at least for major financial risks, all organizations admit to incorporate them into ERM processes. Some participate to Risk Committees, some report (on specific formats) to CRO and sometime to Internal Audit and the remaining portion directly manage the process. Despite different roles (depending on the company size/activity), nobody could contest their involvement. It proves Treasurers must be included into ERM processes for their obvious highly specialized expertise in finance risk management. Interestingly, if the CFO decided to propose this function of CRO to the treasurer, roughly 83% of respondents would be ready to accept this additional role. It shows that Treasurers are open to keep expending their role and tasks, although it has already considerably evolved in the last years. Eventually, ERM is viewed as a springboard for Treasurers to be promoted and to increase their role, within the finance department. Around 90% are convinced of this professional opportunity.

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6.3.5

Role of Treasury Associations

The European Corporate Treasury Associations (CTA) could certainly play an interesting role. Roles of Corporate Treasury Associations: CTAs (and all members of EACT) could help in promoting risk culture, in instilling good and best ERM practices, in offering skills and means for treasurers to cope with ERM and potentially to take over leading role in the process or in simply giving benchmarking and information useful for international groups for better managing their own (financial) risks. It certainly offers a fantastic opportunity for associations and their members to extend the scope of activity of treasurers and, indirectly, to extend services and training proposed to members. It corroborates to the expending service offering approach developed by the major treasury associations, these last years. They also could help inoculating a better risk culture within Europe.

6.3.6

Conclusions

Whereas a few years ago Treasurers would only have had to concern themselves with financial risk mitigation, today they may need to be aware of risk throughout the company. This is a result of regulations such as Sarbanes & Oxley and IFRS, and their demand for more stringent controls throughout the organization. Treasurers may now have to look outside the financial world at indirect risks, such as damage to the company’s image, environmental risk and operational risk. Treasurers often have a thorough understanding of the language of risk management, due to their experience in the financial sphere. This means that if they become involved with ERM they can communicate effectively with other departments and use their knowledge to facilitate understanding across the group. The role of the treasurer in dealing with risk management throughout the business as a whole should not be underestimated. There is a danger that ERM can turn into an exercise in internal auditing and compliance. With the involvement of the treasurer, however, organizations could be able to transform this exercise into a process that adds shareholder value and contributes to the smooth running of the company as a whole: treasurers are usually experienced risk managers and their involvement can enhance ERM, improving decision-‐making and adding value to the organization. As ERM becomes more widespread, treasurers can be particularly suited to an active role in implementing such a risk management procedures, since they often have the benefit of relevant experience.

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This survey underlined and undoubtedly demonstrated the real opportunities offered to Treasurers to increase their roles and higher profile their “classical” function within the financial department. For that, they need to demonstrate a true will to enhance their standard profile towards ERM and to exit pure financial risks management. It can mean training, courses and external support (consulting firms, treasurers’ associations) to be fulfilled. Consequently, it is an open opportunity for those who are volunteers to embrace a new role, additionally to their main function. The highly specialized profile of treasurer (although to be further enhanced) is a wonderful asset and advantage treasurers could lean on to potentially become the Head of Treasury and ERM.

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6.4 Contingency Plan for the Treasury Function “Action will remove the doubt that theory cannot solve” (Tehyl Hsich)

6.4.1

It might be worse

We would like to describe the process and the organisation required to prevent any forced interruption of the treasury function for any reason. Having a "BCP" (Business Continuity Plan) is no longer just a luxury, but a real necessity for any multinational business. It is vital to assure the CFO that at any time the treasury function will continue to operate, even under the worst scenarios, especially in the current unstable environment. The terrible moments, often verging on financial chaos, that we lived through in 2008, sadly remind us that things might be worse. Who would have imagined an earth-‐ shattering event of such proportions? And nevertheless, we could have seen the storm clouds gathering. These events prove to us, should that be necessary, that we should not shelter behind the illusion that such things happen only to others, that they are impossible or we have never seen such things happen before. We may draw a parallel with outside events that might slow down, stop or temporarily prevent the treasury function being carried out. The worst, as we now know, often happens when it shouldn't, following Murphy's Law. That is why we have to prepare meticulously. A "Business Continuity Plan" (BCP) and a Disaster Recovery Plan (DRP) are necessary for all treasury departments. Preparing a BCP can even turn out to be helpful in detecting sources of problems and structural inefficiencies. The work of treasury is by definition a day to day activity which cannot be interrupted without the risk of loss, lost earnings or inefficiency. Treasurers are duty-‐bound to put in place a tested and effective contingency plan which will give Management the reassurance that even total destruction of the building in which the treasury function is located will not put a stop to the department's activity or to good cash management.

6.4.2

Treasury structure flowchart

The starting point is fully to flowchart the operations and activities carried out by treasury department. When a complete list has been worked out, a criticality factor has to be applied. Can activity X or Y be closed down for 4 hours, for 1 day, for 3 days or only for 1 hour? Where a greater or lesser criticality level has been decided for each operation, we can try to find a "workaround" that might, at least temporarily, make it possible to continue activity X or Y. Paradoxically, the more the department has been computerised and built up, the greater the technical difficulties that will arise from any stoppage, and the harder it will be to find any workaround. Technology improves efficiency and productivity, but also creates (over)dependency by treasurers. Machines

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improve work efficiency, but keeping staff numbers to the minimum makes the department more vulnerable, however. We have to distinguish between tasks that cannot suffer any delay, those that can suffer some delay, and those for which there is a workaround solution, at least for a short time and finally those for which a reasonable delay would not give rise to much in the way of consequences in the short term. Is there a failsafe mode or some temporary workaround? Would the halted or delayed activity impact downstream on any other vital financial activities or accounting reports? Would complete shutdown threaten the company within a very short time? These are the sorts of questions to ask at the flowcharting stage. Tasks also need to be sorted by order of priority and importance into the (most) critical, to identify the priorities in the event of an incident. Secondly, operations for which a delay could be critical need to be identified (for example telephone or electricity being cut off, IT network failure, lack of staff due to food poisoning in the canteen, or server downtime). This appraisal will enable you to set out backup procedures for personnel, jobs, tasks and systems. It is also an opportunity to draft out any procedures that may not yet have been documented. It is an exercise in self-‐evaluation, and one that is very healthy for improving your internal structure. Sadly, as is too often the case, the most difficult thing is finding the time to initiate the BCP process, unless this is included in a wider BCP/DRP exercise at group level.

6.4.3

Setting up a BCP

Setting up such a BCP may form part of an overall plan deployed throughout the company. It is then quite common to use external consultants. They can coordinate and organise the implementation of an overall plan by entity and for group headquarters. Failing an overall BCP, it is the duty of everyone, and of the treasurer in particular, to foresee a potential shutdown of activities, and to take steps to mitigate it. Sometimes, the measures to be taken are straightforward and not burdensome. Common sense can often prevent incidents or mitigate their impact. Simple security measures sometimes need no great amount of work. Others, by contrast, require additional investment (for example a backup server or remote backup hardware). For example, should the treasurer not have the list of addresses and telephone numbers of his main contacts, particularly banks, what would he do in the morning when he arrives in the office? How much time will be wasted in recreating the contacts and telephone numbers? A (paper) copy kept at home could be a simple prevention measure. Because in the event of fire, there is a high risk that even a BlackBerry, an I-‐ phone or any Smart phone will no longer work.

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In addition to the operation's contingency plan as described in this article, treasurers keen on taking precautions could also think of other scenarios involving the occurrence of external events, such as a bank failure, the merger of two banks resulting in a line of credit being reduced, a “credit crunch” affecting the company's liquidity or even the collapse of an IT systems supplier resulting in maintenance ceasing.

6.4.4

1. 2. 3. 4. 5. 6.

6.4.5

BCP objectives: Identify critical headquarters functions and recovery time objectives Define recovery priorities Identify the BCP processes to be maintained Establish a migration plan in case of disaster Prepare a communication plan Evaluate the potential solution of an external disaster recovery site

Test the BCP regularly

A contingency plan that is not tested regularly is just about useless. You have to put yourself into the conditions of a major incident at least once yearly to really test the plan's effectiveness. It needs to be detailed and documented if it is to be able to be applied at any time, irrespective of the circumstances and people at work on the day of the incident. This general document must also give exact details of the measures to be taken and the migration process in the event of a disaster. A good internal and external communication plan must be drafted out. Banks, suppliers and subsidiaries must be notified of the incident and of the contingency plan, so that the new temporary arrangements do not alarm them. The aim is to ensure activities are not impacted, or are impacted as little as possible, so as not to lose even a single Euro unnecessarily through negligence. There is a high risk, if preparations are not taken, of losing money or losing earnings because funds stay "dormant" for a period of time (not renewing a deposit and non-‐interest bearing funds or non-‐delivery of purchased currency or debit balances not being cleared). A BCP must be updated regularly on the appearance of any new IT solution, for example a new process or procedure. Any new tool may potentially require changes to the BCP. It is helpful to sketch out an impact matrix, on two axes (probability on the horizontal axis and impact as a percentage of interruption on the vertical axis). The treasurer can position the main risks on this matrix depending on their probability (low – medium – high) and their criticality. This chart gives a fuller overview of the risks and the criticality level in relation to day-‐to-‐day activity.

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6.4.6

Be prepared!

Preparing for a major event firstly gives you the chance to conduct a thorough review of your structure. Secondly, it enables you to exorcise the risk of an incident. The best way of fending off or exorcising risk according to some ancient folk beliefs is to address it and prepare for it. The British Army's 5 Ps applies here: "Proper Preparation Prevents Poor Performance”. A BCP is a preventative measure, but could also prove to be curative. The risk is one of not thinking up simple preventative measures that may involve no cost, no particular work and no effort to implement.

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6.5 Enterprise Risk Management Analysis Applied to Corporate Ratings “Economy advance is not the same thing as human progress” (John Clapham)

6.5.1

Rating agencies looking for ERM processes review

Standard & Poor’s (S&P) published in early May 2008 a new document on its approach for inclusion of Enterprise Risk Management (ERM) analysis in corporate ratings, having first sought feedback from users and rated enterprises since last November. An ERM review will now form part of credit rating analysis and every company must be prepared to demonstrate they have sound and effective risk measurement and management practices in place. Since November 2007 and the request for comments issued by S&P, we all knew that credit rating agencies were contemplating how to best address ERM processes for non-‐ financial companies. At that time it was apparent S&P was not yet certain of the best way to approach such a review and how to integrate it into its rating review process. As from the third quarter 2008, they will start including ERM in their discussions with customers, with the inclusion of commentary related thereto in their reports from the fourth quarter 2008. It means, ERM by another external party are a reality. Therefore, it is better to be ready as soon as possible and to be prepared to answer S&P, and possibly Moody’s and Fitch in the coming months. Rating agencies want at least to increase transparency by providing the market with views on the ability of management of an enterprise to organize and to make effective ERM processes. With such analysis, providing it is serious and in-‐depth, S&P expects to assist elaboration of what if and sensitivity scenario forecasts. It also expects to form a more forward-‐looking rating opinion. Taking into account the feedback they received S&P has decided, for the moment, to focus on strategic risks, and on assessing the prevailing risk culture and governance. It also admitted that it needs a minimum number of reviews to enable an effective formal scoring approach to be formed (i.e. “weak”; “adequate”; “strong”; “excellent”). After having conducted enough reviews (likely in early 2009), they hope to be in a position to establish a credible benchmark as well as evaluation criteria. Although, they do not expect changes of existing credit ratings in the initial reviews, they don’t exclude the possibility to penalize customers at a later point in time if and when necessary. (For new up-‐grades from S&P, please see: www.spnewactions.com)

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6.5.2

Creation of more systematic framework for an inherently subjective topic

Everybody can reasonably accept that whatever the review process articulated by S&P, it will remain highly subjective and judgmental. But the same persons also admit that this is not a reason for not addressing the ERM issue. S&P have indicated it will take a scorecard approach based on a view drawn from using a structured questionnaire and interviews conducted with select personnel from an enterprise. The difficulty resides in their finding the right balance between straight forward closed questions and more open ones to rightly capture and assess the risk culture and appetite of the company. The recourse to a generally accepted risk-‐management standard like COSO (promulgated by The Committee of Sponsoring Organisations of the Treadway Commision) or AS/NZS 4360 (promulgated by Australia & New-‐Zealand Joint Committee OB/7) would be considered but is neither a prerequisite nor is having adopted such a framework of itself sufficient evidence of a sound fit-‐for-‐purpose ERM process. They have indicated they will compare practices among peers and will be open-‐minded in their analysis. Who could contest ERM is more than an approach to assure the management is attending all risks, more than a method to fulfill board responsibility or even more than a nice toolkit? Clearly, all non-‐financial companies should shift focus from a singular focus of “cost/benefit” to “risk/reward”. All companies must communicate with stakeholders on risk management, despite a common and natural reluctance to disclose sensitive information, including risks and how they monitor and mitigate them. However, ERM is neither a recipe for eliminating all risks, nor a simple risk mapping. ERM is not a replacement for internal controls of malfeasance and it is not a simple compliance necessity. As explained above, S&P has decided, as an initial measure, to concentrate on assessing the risk culture & governance as well as strategic risks. They have chosen to delay the assessment of other elements of an ERM, specifically the two others topics listed in their November document, being: control-‐risk management and emerging risks. These last two major issues will be addressed and reviewed later. We can expect S&P to start analyzing these two topics in last quarters of 2009 or the latest early 2010.

6.5.3

Sector diversity issue

Arguably non-‐financial institutions more greatly differ according to their sector of activity, geographical location and size than do financial institutions. The major issue for credit rating agencies will be to develop sound benchmarking per sector taking into consideration all industry specificities and practices, and to realize even then, that it may be appropriate that peer organizations within these same dimensions could reasonably adopt different strategies, adopt a different risk appetite, and utilize a

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differing governance structure that none-‐the less is fit-‐for-‐purpose to measure and manage risks. It explains why it could take roughly a year from now for S&P to build an effective database with clearly defined criteria. The sectors analysts should be a guarantee for taking these own specificities into account while reviewing ratings.

6.5.4

Recommendation: be prepared!

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The objective is to deliver an enhanced understanding of the enterprise reviewed, including the entity level objectives (the diagnostic can be performed at an entity level); risk appetite; and, identification of “priority risks”, which together help Avantage to form a view of the Board’s desired (target) risk management capability. The diagnostic tool, whatever the consultant used, should enable you to identify potential gaps and areas for improvement, as well as playing a role of rehearsal for agencies interviews and questionnaires. To having such a snapshot diagnostic of your ERM process provides a perspective from which you can build a consensus of priority risks, of current gaps with respect to risk measurement and management for these same risks, and as importantly, develop a plan of action for closing the gaps. ERM remains a relatively new concept and as such corporates have some difficulties in setting up and in measuring, with any degree of sophistication , the risks, and comparing existing practice against good practice (notably vis-‐à-‐vis their peers or also in terms of market “best practices”). Absence of track records, of clearly identified leading edge ERM practices and diversity of industries make the task highly complex for non-‐financial institutions. Recourse to specialists in ERM assessment and evaluation can be a solution to transform a new threat into an opportunity to better manage risks.

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We only can recommend you start thinking on how to best present the ERM processes in place, and of how to potentially improve it and to rehearse to be ready for interviews with the respective rating agency. The better a company will be prepared, the higher its ERM process will be ranked, and (supposedly) the truer the credit rating.

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6.6 The Risk Matrix – Tool for the Management of Risk “We are drivers looking through the rear view mirror while convinced we are looking ahead” (Nassim Nicholas Taleb)

6.6.1

Mapping treasury risk

The treasurer usually manages the risks associated with his activities in segments, without always having a global view of them as a whole. A matrix of treasury risks begins with the idea of mapping the whole range of such risks, their importance in terms of impact and the factors which allow the minimization of the final risk and the rating or weighting of each risk on a defining grid. Clearly, a treasurer is not required to avoid every financial risk completely. On the other hand, it is essential that each existing risk should be addressed, measured and controlled. The concept of this matrix showing the whole range of risks pertaining to treasury and corporate finance, by category, gives a treasurer or a chief financial officer a tool with which to gauge risks and assess their management. It ultimately provides an overall picture of the management of financial risk.

6.6.2

Relativity of measurement

Measurement will certainly be relative because it is necessary to begin with assumptions about the probability of occurrence, of the impacts on results, of constraints and percentages. It is not an exact or ‘rocket science’. It is a question of quantifying, coherently and above all consistently, the identified risks. This identification must be exhaustive and precise. It must begin with pragmatic definitions; for example, the likely occurrence of a rise in the value of the dollar (for a company which buys in dollars): is it 10, 20 or 50 per cent? One must accept as a hypothesis a 33 per cent chance of seeing it rise against the same percentage of seeing it remain stable or falling. At the same time, what percentage of rise must be taken as a realistic maximum risk? We might think that a 20 per cent rise or fall is not unrealistic in view of what happened in 2003, for example (a fall of 23 per cent). Therefore one can hypothesise a 33 per cent risk that the dollar will rise 20 per cent in the coming twelve months (say 6.6 per cent). Then it is easy to measure the net impact before hedging and hedge accounting in order to mitigate the exchange risks.

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6.6.3

The risk scale

It is necessary to start with the conventional evaluation of risks and their financial impact because, in the end, it is this cost which is important. The final result will produce a notation or rating of risk. The scale or grid of risks must be defined on the basis of the size of the company or its financial results. What is important for some is perhaps not so important for others. This is the threshold of the materiality of an impact of millions of euros. The result before and after management will define the mapping of risks. A representation of this on a graph is the clearest method of showing the Directors how treasury is managed. Risk management can use either particular measurements or KPI (Key Performance Indicators). For example, the cost of a rise of one basis point in the interest rate for a borrowing company clearly indicates the potential risk that might be incurred.

6.6.4

A global revue

It is by such measurement, even if it is imprecise and relative, that the treasurer can improve the management of his department. The treasurer must think deeply and carry out a global revue of his working methods. This effort is useful, in a preventive sense, in the framework of treasury audit, of due diligence (for a merger or acquisition) and above all from the perspective of regulations such as Sarbanes-‐Oxley and its European equivalents, including the German Kontrag, the French Loi de Securité Financière (LSF) or the UK’s Cadbury report. The idea of the measurement of control of a company’s activities is now more important than ever before. The business must be able to demonstrate the existence of a system for identifying and managing risks, especially financial ones. If a situation is not measured or evaluated, it is very difficult to be able to show that its management has improved. The result can otherwise be integrated in the report of the management of global risk of the business, operational as well as financial. It will form a major part of it.

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Treasury Matrix Risk Categories

Types of Risks

Foreign Exchange Risks (FX)

FX Transactional risk FX Translation risk FX M&A risk FX Accounting risk FX Underlying/Contract Embedded derivatives risk

Interest Rate Risks (IR)

IR Risk

IR Accounting risks

Liquidity Risk

Short term (temporary) liquidity risk Long-term liquidity risk

Counterparty Risk

Counterparty risk (external – banks) Counterparty risk (internal – affiliates)

Off balance sheet commitments/ Guarantee Risks

Transactional Risks

Treasury payment risk Subsidiary payment risk Transferability risk

Financial instruments Dealing

IT Risk

Personal related Risk

Compliance Risk

Marketable Securities / Other financial Assets Reval Risk

Other Risks

6.6.5

Major treasury risks

The chart can usefully be accompanied by a graph showing the position of each risk before and after mitigation measures and …fitting onto a curve. The axes of the graph are the probability of occurrence against the financial impact in millions of euros. The matrix should ideally include the figures, actual or estimated, beginning with realistic or effective suppositions, detail the measurements taken and outstanding, the tools or ad-‐hoc management reports dedicated to one particular risk, the ‘small print’ of the rules and procedures under which each risk is managed, whether or not it is reflected in the budget and finally who is responsible (centrally or in an affiliate company). The perfect matrix will also incorporate the correlation of risks among themselves. In effect, a USD/EUR risk can impact, in a similar or opposite manner, the purchase of goods, borrowings in USD and the consolidated accounts in USD of affiliated companies. Moreover, a change in interest rates can impact not only the cost of finance but also the calculation of the swap points. The perfect matrix shows and consolidates this correlation between external factors, which have a potential impact on the group results. As some factors could influence different risks, the consolidation of the matrix is essential. Clearly, some impacts would be cumulated while some others would offset.

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It is quite clear that the total of all the risks, however quantified, does not correspond to the total maximum risk, and statistically they cannot all occur at the same time. But Murphy’s Law has alas demonstrated all too frequently that unlucky events can take place simultaneously. The approach to risks must be global – but the total risk is not just a simple sum. Good or bad – it is just because things are not so simple that it is so necessary to model them.

6.6.6

Matrix of risks

The establishment of a matrix of risks pertaining to treasury is essential for professional financial management. The relativity of this exercise and of its result is not important. Like all measurement tools it is only a standard which will serve as a benchmark for quantifying and estimating the good management of risks and, the ultimate aim, their reduction. Also it can help to define the objectives to be reached within the management framework. The exercise will aggregate the general management of risks, the compliance with legal constraints and regulations concerning matters of control and the application of procedures or policies of the treasury in particular. The matrix is a summary of all the management functions particularly dedicated to risks, or photosynthesis of the work of the treasurer.

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6.7 Risk Appetite: Are you Hungry for Risk? “If pages come from work, rent from real estate and interest from savings, where do profits come from? The answer is the profits come from risks (Anonymous)

6.7.1

“Risk Appetite” or “Risk Profile”?

Risk appetite… this notion is something of a paradox in times of crisis. Generally speaking, no one likes risk; we all strive to limit it as much as possible. However, behind this notion is hidden the idea of determining a company’s profile. Without a precise definition of its profile, how can one adopt the appropriate strategy that would be approved by the company’s shareholders? Defining this profile is a prerequisite for ERM (Enterprise Risk Management). This concept somewhat confusing concept should be demystified. The touchy subject of “risk appetite” always sparks heated debates. The term itself originated in the English-‐speaking world, and the approach is not universally embraced. Many CFOs prefer the idea of a “risk profile,” which is less harsh and more “sellable” internally. Having an appetite for risk is a strange concept, isn’t it? Generally speaking, no one is hungry for risk. Yet this notion, which everyone agrees is complex and even a bit mysterious, is nevertheless the cornerstone of an actual ERM (Enterprise-‐wide Risk Management) process17. The ERM policy must or should contain the foundations of “risk appetite” in its set of defined rules. Within this concept, there is the idea of measuring the types of risk that the company is willing to keep and those that it is prepared to sell, to eliminate or to mitigate by various means, and to incorporate this into the group’s risk management strategy (see British Standard Institute’s Code of Practice on Risk Management BS 31100 published in October 2008 – www.bsigroup.com).

6.7.2

As Many “Risk Appetite” Concepts as there are Companies

This concept varies from company to company, depending on their own risk culture and depending on the industry, the degree of centralisation and the maturity of the ERM process. Just as there is no single ERM solution applicable to every company, neither is there a miracle “risk appetite” solution that applies to every organisation. Although the 17 See www.avantage.eu.com

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criteria are often quantifiable (e.g. credit rating minimum, leverage maximum, cash flow at risk with set limits, maximum risk concentration level per client, and others), the same is not always true of risk appetite. As a result, it is not based solely on numbers, but is also influenced by principles and measurements related to social or environmental considerations and reputation. This notion will therefore also be defined by more qualitative criteria, such as maximum tolerance to operational risk, minimum compliance with current regulations, and others. This risk appetite charter must specify what is acceptable and what is not. The degree of risk “acceptability” must be determined based on the strategy adopted by the senior management and must meet the expectations of the company’s stakeholders. The next step is to determine what has to be covered and what does not, what can remain exposed and what cannot. A sort of golden rule would be to always ask whether a shareholder or employee would be surprised by the announcement of a loss due to the particular risk in question. Unacceptable risk is a risk that would not contribute to attaining the company’s strategic vision or would not provide a strategic or competitive advantage for the company. In order to establish precisely what the appropriate level of risk appetite is, it is first necessary to test the likelihood of a worst-‐case event and its consequences in financial terms. From there, one could say that all ERM measures should then fall into place. We might compare this concept to a car, when we say that the better the brakes, the faster it can go. Simply put, in order to learn how to drive faster, one must be aware of the car’s potential, its technical limitations and its breaking ability. This is the approach that will generate added value for a commercial company. The British BS 31100 document may become a benchmark for defining risk profile. When reviewing the ERM process of a company to determine its rating, a rating agency hopes to find a chapter on risk appetite, since this is essential for ascertaining the company’s complete operational approach (see www.standardandpoors.com). The agency’s objective is to identify the risk profile and how it relates to the operational limitation structures established to cover these risks and limit them. S&P, for example, tries to determine whether the strategy pursued and the methods used are consistent with this predefined profile.

6.7.3

Keys to Success

To successfully establish a risk profile, it is crucial for the executive management to guide the process directly, with support from the CFO. It is important to keep in mind the company’s own risk culture and to use its past risk-‐related decision-‐making as a basis. Non-‐financial parameters must also be included. By testing the company’s capacity to absorb and tolerate risk, these limits can be calculated precisely. Reports to the management and board of directors should reflect the risk appetite and risk tolerance. The company’s risk appetite cannot go against its fundamental, founding values. It all must be consistent. Finally, the basic advice is to start out simply and then

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increase the complexity gradually. The risk profile will then take the form of limitations, percentages, ratios to be maintained, key indicators and other quantifiable, identifiable measurements. In this respect, EVA (Economic Added Value, a point of reference for many companies) is an important starting point and reference measurement.

6.7.4

Strategic Objectives: The Basis of the Risk Profile

In order to establish this set of limits and criteria, the management will have to answer a few essential questions surrounding the notions of cash flow volatility, EBIT(DA), return on investment objectives and others. What rating level do we want to maintain? What is the maximum loss over one year, three years, or ten years that we are willing to accept? What is the confidence level on the payment of dividends? How much volatility are we willing to accept in terms of results? In terms of return on capital? Based on its consensus regarding strategic objectives, the company will be able to define its risk profile. The company must be able to manage its business activities without exceeding its maximum risk absorption capacity. In theory, a formally established risk appetite should be comprehensive enough to take into account the specific concerns of the stakeholders and to give the company a basis for keeping its risk within the tolerance limits. Many people talk about it, but few do this effectively. What should such a risk profile document contain?

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Risk Profiling for Corporates - Illustratives

Risk Profile Perpective

Quantitative examples of risk profile undertaking

Metric or Element (*)

Type

Stakeholders

Qual(itative) + Quant(itative)

C/E/S

Qual

PA / E

Quant

S / FC / E

Qual + Quant

C/S

Qual + Quant

FC / S / E

(non exhaustive list of risks)

Reputation

zero-tolerance for permanent altered reputation

Legal

zero-tolerance for legal events and litigation

Earnings Shareholder value

EBIT(DA)@risk ; EVA; debt capacity; probability of dividend dispersion ; risk concentration, etc.

Products

Innovation and quality

Solvency

credit rating > BBB+; max. credit spread of XX bps; liquidity > EUR 750m facilities or cash, etc.

max. variation of EBITA at risk variation of -25% on previous year; ROIC > 5%; <10% probability cf. dividend < X€/share, etc.

maximum spread of 250 bps over EURIBOR; min. unused committed facilities of €500m; debt capacity at k. rating of € Xbln; etc.

*indicative metrics – level to be defined by corporation

6.7.5

Stakeholders types C : Customers E : Employees S.: Stakeholders PA : Public Authorities FC : Financial Community

What is Typically Included in a Risk Profile

The document defining the company’s “risk appetite” is often simple. It is necessary to start out with a basis that will be enhanced along the way and become gradually more complex. It will also evolve with the life of the company, as the organisation develops. At first it will be incomplete, non-‐exhaustive, and will address only a few key points for the stakeholders. It generally covers the financial aspects of liquidity, solvency, creditworthiness, revenue and financial ratios (like in the example in the table). Traditional points of reference are found, such as ratings, financial agreements (occasionally modelled after those required by the credit facilities), VaR and sensitivity analyses or other stress scenarios. This serves as a basis for setting operational limits and boundaries. Oftentimes, it is aligned with the annual budgeting process and capital allocations. The long-‐term view (3 to 5 years) is usually missing from this document. Just as often, we notice a lack of consistency in the overall definition of this risk appetite.

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The qualitative and operational aspects should not be concealed either. The document must mature and improve with time, and history will help to refine the levels set and to specify them in greater detail. Generally what is lacking is the communication aspect. The company does not communicate its levels with all of its stakeholders, even when they are commendable and advantageous for them. The concept of risk profile is not addressed enough by companies in their annual reports or websites. This is regrettable.

Stakeholders interested at different levels in Risk Appetite of a company  Employees

 E.U  Governments  Regulators

 Shareholders

Corporation Risk Profile

 Stock Exchanges  Bond Holders / Other Creditors  Rating agencies

6.7.6

Risk appetite paradox

The difficulty lies in talking about risk appetite. It is a sort of paradox, as who can claim to be hungry for risk? Generally speaking, no one can. Setting a framework and limits is often perceived as a constraint that will oblige the CFO or the CEO to set his own limits and force him to follow them. On the contrary, as the treasurer likes to have a clear policy of what he can and cannot do, the CFO must establish a framework for himself, if it is not established for him, within which he must work, without diverging from it. Although this framework might seem limiting, it actually frees the CFO and gives him tools he can use to reason with employees in order to contain and prevent excesses and sources of unacceptable or

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intolerable risk. A manager needs limits within which he must work. Without these limits, we run the risk of going astray or getting off track entirely. The greatest challenge is being able to align this risk profile with the company’s strategy. Then it is necessary to communicate it to the world outside, and particularly ratings agencies and the financial community. Like an athlete, the CFO must know the limits of his body, his abilities and his extreme tolerance threshold in order to determine how to train and how far to take it, and whether he can survive if he exceeds the limits. This profile is never set in stone. It will evolve with the company.

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6.8 Adding value for stakeholders through better ERM processes “The best way to protect the future is to predict it” (Winston Churchill)

6.8.1

ERM, an evolving concept to be developed

Rating agencies with a new focus on Enterprise Risk Management (ERM) give corporations an opportunity to revise their ERM processes. European companies have been using an ERM initiative as part of an on-‐going effort to develop appropriate internal control processes and procedures and to pursue strategic objectives which add value for stakeholders. Certain European companies have decided to take advantage of Standard & Poor’s (S&P) recent initiative to focus more on the ERM processes of non-‐financial companies in order to revise and improve their own system. They have used the ERM initiative as part of a wider effort to revise internal control processes in order to make them more efficient and more appropriate. They also intend to pursue the strategic objective of creating more value for stakeholders when seeking to revise their ERM processes and are looking at how to tackle this project in the most efficient and practical way without having to resort to using a myriad of consultants. It decided to call upon Avantage Capita18, whose methodology and approach based on comparison (benchmarking) is fairly unique and meets the expectations and the desire to develop risk measurement and management in order to reflect internal and external strengths. The objectives were to improve the processes where possible and necessary by identifying any weaknesses or gaps and to define a roadmap with priorities for the next two years. This plan then needed to be validated by the RMC (Risk Management Committee).

6.8.2

S&P has issued a document presenting the ERM approach adopted for non-‐financial companies

In November 2007, S&P consulted users of its analyses in order to validate its approach to ERM processes within non-‐banking businesses. Nobody disputes the fact that ERM is an important and significant factor in optimizing the predictability of future cash-‐flows and increasing the value of companies. ERM is increasingly becoming an important part 18 www.avantagecapita.com

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of companies’ strategies the recent setbacks with the banks, the liquidity crisis, and the extreme volatility and depression of the financial markets only make an ad hoc risk management infrastructure all the more necessary. Shareholders can only benefit from ERM processes that aim to describe the risk environment and mitigate as best as possible the financial costs of a possible disruption to the business and its operations. Not having the necessary internal resources, S&P decided to adopt a gradual method for rolling out their project. The analysis will be not only quantitative but also qualitative and consequently judgmental. S&P has been slightly delayed on the project, for which they hope to compile a comparative database (benchmarking). It is clear that the diversity of activities of the rated companies increases the complexity of this comparison, which will be made on a sectoral basis (media, public services, telecom, airlines, etc…). S&P will develop a methodology and assessment criteria in order to establish a score card that leads to a “weak”, “adequate”, "strong”, or “excellent” grade. The rating agency will concentrate on the culture of risk management and governance, as well as on the strategic approach (e.g. potential impact on access to credit, sensitivity analysis, and role of Risk Management in day-‐to-‐day management). The adoption of a recognized COSO or AS/NZS 4360 framework is helpful but is not a pre-‐requisite or sufficient proof of having adopted good practices19. Since this revision process will be based on the S&P analyst’s judgment, it is preferable to be prepared and have a solid, persuasive case. You will have to show that you have implemented an appropriate ERM structure built more on the risk/reward concept than the cost/benefit concept.

6.8.3

Analysis of the ERM process

Some corporates have adopted AVANTAGE IRPM (Integrated Risk & Performance Management) methodology.

19 www.standardandpoors.com.

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This tool developed by Avantage Capita enables the weaknesses in the current process to be identified and compared to the best practices in this field. This inventory is aimed at defining the future improvement that the company intends to gain from its ERM processes. Courtesy of this in-‐depth analysis, the company can pinpoint which aspects need to be improved and establish a development plan to be put into practice. The diagnosis will also provide an external, independent view and analysis that can be useful to S&P's ERM review. After the IRPM analysis, the objective for Senior Management is to make a clear decision on how to develop the ERM. The group's management must formalize a risk and capital management strategy based on their operations strategy. For those who have not already adopted one, this involves implementing a recognised COSO or AS/NZS 4360 framework. Risk measurement should be an integral part of the establishment of the group’s strategy, planning, and allocation of resources. Ideally, the ERM initiatives should be integrated into and aligned with the group’s operational activities and overall strategy. The ERM thus enables them to enhance the degree of sophistication of operational procedures and information to be produced as part of the decision-‐making process.

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6.8.4

Basis for analyzing and setting future objectives

Using the heat map and the conclusions from the score card, the company studied can determine the possible areas of action in order to improve their ERM processes. When the desire is to remain practical and realistic, it is then necessary to specify some of the primary objectives and to allocate the associated resources in order to establish the road map for the next two or three years.

In general, the same type of problems can be observed from one group to another. For example, defining and clarifying the appetite for risk is often a weak point, and yet it's one of the first things the rating agency seeks to understand. The KRI (Key Risk Indicators) are often incomplete, non-‐existent, or scattered. It is important to centrally define and control them. When the risk is measured, the company can then set objectives and targets. Similarly, even though IFRS 7 imposes stress testing exercises, sensitivity analyses are often insufficient. It is equally essential to make the V@R-‐type approaches (e.g. market share at risk, EBIT(A) at risk, free cash flow at risk, etc…) or Monte-‐Carlo-‐type simulations systematic. But whatever efforts are made to improve ERM processes, it is an ongoing exercise that should consist of comparing oneself to one’s peers and to the best practices in the field. With the information often lacking, calling upon a specialist frequently proves inevitable. Just as in financial matters, good practices need to become compulsory and widespread. It's simply a matter of time.

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6.8.5

Creating value through ERM

This is where the greatest challenge lies for the CRO (Chief Risk Officer): convincing management of the opportunities to create value using better ERM. The group should have the ability to take more risks, while relying on solid management and visionary leadership. “The better the brakes are, the faster the car will be.” The group should establish its risk management strategy on the basis of its core values. When a group’s value is “entrepreneurship”, the principle of risk taking seems inherent and essential. ERM frequently falls down due to a lack of alignment with the company's core values and strategy. The CRO’s numerous skills and required knowledge need to include good communication skills in order to internally convince top management concerning the value created or to be created. ERM is more related to art than science and the same goes for its internal/external communication. The CRO needs to show conviction in order to gain the support and essential resources for developing ERM. Gradually and with patience, he or she must help generate a greater culture and awareness regarding risks and the importance of managing them. It is a long-‐term job that requires patience and perseverance.

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6.9 Are your internal controls effective and efficient? “If everything seems under control, you’re not going fast enough” (Mario Andretti)

6.9.1

The 8th European Directive (2006/43/EC-‐ 17 May 2006)

It is useful to describe the new reporting requirements for Internal Controls following the transcription of the 8th Directive into the legislation of some European countries. Compliance with the Directive may offer companies unaffected by the Sarbanes-‐Oxley Act the chance to get something out of this cumbersome exercise. How should we carry out a review of internal controls? How can this undertaking be linked to ERM reports? These questions must be addressed by treasurers and finance directors too. The 8th European Directive supplements its two sister directives (the 4th and 7th Directives – 2006/46/EC) which dealt with corporate governance and reports on internal controls and risk management systems from a specifically accounting viewpoint. This Directive is of major importance for business finance professionals. In particular, it describes aspects of the independence of financial experts sitting on Supervisory Boards and other Audit Committees; the broader obligations of Auditors in terms of financial reporting; Auditors’ recommendations to Audit Committees; the requirement to set up Audit Committees, and it addresses the requirements for more specific monitoring of Supervisory Audit Bodies (i.e. Supervisory Boards and Audit Committees). These new measures, which are or should be internally adopted by EU State Members, require, inter alia, the Supervisory Board to monitor the effectiveness of the risk management and internal control systems currently in place. Companies therefore have to comply with these new requirements which have been laid down at European level20.

20 Report on Internal Controls and Risk Management System with regard to the accounting process in the management report – Description of key attributes of Internal Controls ( ICS) and Risk Management Systems (RMS) with regard to the accounting process. They also require the publication of a Statement of Compliance.

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6.9.2

Recommended approach

It is desirable, at the very least as a first step, for a pragmatic approach to be adopted, its starting point being those main generic processes which are well known and understood within the company. The starting point is very often the adoption of guidelines or policies relating to risk management. This is a bottom-‐up process, like Enterprise Risk Management (ERM) reporting processes. Internal controls and other existing procedures, together with any necessary improvements which may be made (parallels can be drawn with Sarbox) need to be formalised and documented. Materiality thresholds (often comparable with ERM reporting) must be defined, as well as the format and frequency of reports. The perimeter must also be predefined broadly but not necessarily exhaustively. It must be possible to define a materiality limit which will enable coverage of the principal and significant part of the activity (e.g. 80% of the main subsidiaries, which would cover more than 95% of turnover). The prerequisite in terms of format is to establish a complete framework, most often in the form of an Excel spread sheet-‐type table. This matrix will enable all processes, sub-‐ processes and their attributes to be consolidated in a systematic, coordinated and aligned way. The success and the quality of the outcome depend on the limit which has been set and the time spent achieving it. What is recommended is the adoption of a gradual, progressive approach which can be improved over time (e.g. greater exhaustiveness, more completeness, wider scope, better quality of information reported and described).

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6.9.3

Matrix structure – an example

Risk management textbooks recommend that the starting point should be classic generic processes (see table below).

10 Main Generic Internal Control Processes* 1.

Accounting

Purchasing / Procurement

Debt & Cash Management / Hedging Activities

Asset Impairment

Production, Warehousing & Logistics

Taxes

Financial Statement Closing

Consolidation Closing

HR – Payroll

10.

I.T.G.C

* This list is not exhaustive NB : Beside generic processes, there is a need to address specific processes to each type of business within group scope

Organisational charts, descriptions of functions and tasks and even flowcharts are excellent reference points for those attempting to scale the internal controls mountain. A mountain offers a good comparison given that the task seems so enormous to those setting out. It is true that internal controls can be found everywhere to some extent, but they are often neither written down (because they originate in a sort of oral tradition) nor formalised and even more rarely monitored, with the result that they ultimately lack effectiveness and efficiency. The knack is to be comprehensive without getting swamped by too much detail. This is a risk experienced by many groups which have over-‐used their consultants. They have built up huge reporting structures consisting of hundreds of reports only to fail, over time, to achieve their aims. Excess is always harmful, not least when it comes to internal controls.

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6.9.4

Evaluation objectives

The design of control matrices should be such that it enables visualisation of the main processes, with the implied killer question: What can go wrong? Next, once it is known what may not function properly, what are the checks and controls guarding against these eventualities? Are they effective and sufficient? If there are deficiencies, what plans exist to remedy them? How can the residual material risk be quantified? Once this initial exercise is complete, it must be updated and upgraded annually. The Chief Risk Officer (CRO) of the Corporate Centre will each year administer a Self-‐Assessment Questionnaire to take a snapshot and measurements of the state of play regarding internal controls. If responses are rated (assessed and quantified), this exercise can even be used as a Key Performance Indicator for management and to set the objectives set for managers (e.g. is the control environment “not reliable”, “informal”, “standardized”, “monitored” or “optimized” in terms of its level of maturity?, can the rating be improved in Y+1?, etc.). In the initial stages, it is highly desirable to start with a few pilot schemes within the group in order to test the procedures and matrices which have been drawn up. This will enable tables to be readjusted and populated with generic or specific processes or sub-‐processes.

6.9.5

Matrix structure – an example

The objective is to list, process by process, each risk that the internal control is supposed to limit or to prevent, to compare it in relation to recommended good practice and to describe it in a complete manner, indicating the management actions designed to remedy it over time. Structure of the Internal Control Matrix 

Process

Sub-process

Control objective

What Can Go Wrong?



Risk

What is the risk impact in relation to the What Can Go Wrong?

Control responsible

Describe the control in place at your organization in relation to the What Could Go Wrong

Control frequency

Describe the control frequency

Identify the control owner

mpl e

Example of control description Guideline

Example of leading practice control guidelines to address the What Can Go Wrong

2. Self-Assessment Control description

Exa

1. Guidance

Control type

Control documentation - formalization

How you formalized the control execution and its review?

Is the control detective or preventive?

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Description Control of control assessment deficiency

Action plan

Assess whether the control is: effective, partially effective, ineffective, not applicable

Describe the control design and/or operating deficiency

Deadline

What is the deadline for remediation ?

How do you plan to remediate the control deficiency, if any?

Controls may be: 1. Effective (“properly carried out”) 2. Partially effective (“missing control step”, “missing action plan”, “not formalised”) 3. or Ineffective(“missing controls”) Whatever the effectiveness of the control, a residual or even significant risk may remain to be reported, with a probability of occurrence and a (net) total amount to be estimated. This consolidated report should enable detection and prevention of any significant deficiency (that is, a deficiency less severe than a material weakness but which either individually or when aggregated is more severe than a simple deficiency). These shortcomings may lead to important omissions or inaccuracies in the financial reporting. Because of this, one needs to ask the “5W” questions: Who? When? Where? Why? What? By incorporating other checks and controls considered relevant by the external Auditors, it is possible to reduce auditing costs by reducing the number of tasks which need to be carried out.

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Use of check-list for process identification Question

Examples of detailed question

What?

• • • • • • • • • • •

Why? Who?

How?

• • • •

When? Where?

How often/many/much?

• • • •

What is the aim of the work? Is this the “main process”? Which relationships exist? Why is this work done? Does the work support the company’s targets? Who performs the work (person/department)? Who initiates the process? Who is the customer for this process? Who checks the results? Who is the external contact? How is this work done? How is this process supported using information systems? When is this process performed? When does the work start/finish? Where is this work done? Are there individual sub-processes that take place at other locations? How much time does the process take? How many checking stages are there? How many employees are involved in this process? What is the transaction value of the process

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Benefits of carrying out a review of internal controls

Benefits From Internal Control Review Ë

Reduction of Audit fees

Ë

Rebalancing of the audit from being substantive to higher level analytical review with reliance placed on key controls to prevent errors in core repetitive processes  added value to the business

Ë

Streamlining of the audit process during critical periods, thus less pressure on the business

Ë

General improvement in internal audit ratings

Ë

Monitoring and following up of efficiency/effectiveness of key processes areas which leads to process improvement and better policy deployment

In most European countries, the control environment has changed markedly in recent years. In this context of constant change, it is necessary to concentrate and focus even more on the compliance function to ensure an appropriate control framework covering reports on key risks for the company. Fortunately, these new legal constraints can have positive effects by improving organisation and reducing the occurrence of risks (e.g. increased segregation of tasks, policies and procedures, automated systems and interfaces, master databases which are protected and not accessible to users, effective regular reviews of analyses, reconciliation of accounts, application of the “four eyes” principle)21. 21 Examples of changes affecting the control environment:

ISA 265: new International Audit Standard. New definition of Significant Deficiencies, their reporting to the Board, including potential affect -‐ Senior Accounting Officer disclosure: new tax legislation requires the SAO to report on the systems environment and whether it appropriately captures the tax effect of financial transactions -‐ Going Concern: greater focus on impairment testing, loans scrutiny, cash positions, forecast projections th -‐ Transcription of 8 EU Directive: for UK entities reporting to an EU-‐based entity, requirement to report key characteristics of accounting-‐related internal control and risk management system and Declaration on corporate governance practices.

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This is an opportunity to review the overall design of existing controls and to set up those which are missing. Since the exercise is gradual, over time one can adjust the focus to cover more and more entities and controls. Examples of Compliance Learnings Category

Learning

Generic & Specific

Get the balance right. Should be weighted more to Generic than Specific to avoid significant volume of controls

Compliance function

Need to ensure responsibility/accountability for controls and monitor changes both at compliance and business level

Three Tier controls

Need to have compensating controls when key falls over Need to have management controls to measure E & E

Lite documentation

Careful consideration as to level of documentation given it will need maintaining

Risk approach

Focus on significant deficiencies in financial reporting

Clear controls design

Clearer controls design (5 W’s)

Integrate audit controls

If external audit controls integrated then prevention of audit issues up front and less substantive work required

Self Assessment

Enforcing ownership at the right level, continual visibility

Control Balance

Greater preventative controls and system controls are better than detective controls, however balance of preventative and detective needs to be right to avoid controls everywhere

Carrying out a complete review of controls (both detection and prevention) has the effect of increasing revenue generation potential and implementing more effective back-‐up procedures that include Business Continuity Planning and Disaster Recovery Procedures.

6.9.6

Yet another regulation offering opportunities

Optimists will see in this umpteenth new regulation an opportunity to improve the company’s health as regards preventing and detecting risks. Pessimists will see a new constraint which is either completely useless or disproportionate to possible returns. We prefer to come down on the side of the optimists, since there are so many advantages for those with the skills to “sell” their project. A company and its Chief Risk Officer can make use of existing procedures such as flowcharts and walkthroughs to identify risks and measure controls. As with the ERM process, the CRO must be able to deploy communication, coordination and persuasion skills. Not a straightforward role, you might say. This overview of the state of controls will enable internal audit to

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standardise and systematise monitoring of the group’s various subsidiaries, while improving the process by reference to a benchmark for the group as a whole.

6.9.7

Quantification of residual risks caused by internal control failures

When internal controls are effective but leave a residual risk or when they are partially ineffective with an ultimate potential risk, the CRO should ideally report this. The objective of any control, whether automated or manual, is to detect a risk prior to its occurrence or following an incident and to prevent or repair it, depending on whether or not it has come about. One of the benefits of this exercise (whether Sarbox or similar) is to seize the opportunity to automate manual processes, which by definition are never completely infallible. Even if this quantification continues to represent the main difficulty, when it is applied in a consistent and coherent manner, it enables developments to be monitored via internal controls, just as controls themselves can be rated. Have we made progress compared to last year’s results? Are processes well documented and formalised? Measuring the net impact of a deficiency in dollars or euros (after applying a probability percentage) gives the CFO a more precise idea of the measures which need to be taken and their priority. What is the risk of a double payment or fraud when purchasing plant or materials? Do we comply with current legislation? Do we take account of a client’s credit rating when we offer terms? Starting with the rather long lists of questions such as these, we can draw up the matrix according to type of activity and process, together with its financial impact (if significant or appropriate). This in fact provides a very useful management tool, although one which remains cumbersome to set up in the first place and restricting thereafter. Should controls be deficient, making a reasonable estimate of a net impact by multiplying it by a probability (itself needing to be estimated) is a tricky exercise which is often based on a personal judgement and on good sense. Precision is less important than adopting a consistent measurement which allows for comparisons to be made over time. Past history, together with historical data can sometimes be useful for quantification. The impact to be evaluated is on EBIT(D)A and Free Cash Flow22 (to capture the impact of cash or non-‐cash items).

22 Free Cash Flow (FCF): operating EBIT + depreciation +/-‐ charge in provisions/working capital investments + proceeds from disposal – acquisition price payments + acquired cash + proceeds from disposal (= pre-‐tax cash flow with exception of tax-‐related risks)

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6.9.8

Constraints can become opportunities

A regulatory constraint can sometimes turn into an opportunity to review and formalise internal processes. Examining these often proves that there are numerous gaps to fill. This process is never superfluous or useless. Its regulatory and compulsory aspects may help to sell a project which otherwise would have been rejected or referred back. Every cloud does indeed have a silver lining.

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6.10 How to be ready with good internal controls in treasury departments? “Risk: when written in Chinese the word crisis is composed of two characters; one represents danger and the other represents opportunity” (John F. Kennedy)

6.10.1 Internal control for treasury departments

If you ask people, even financiers, how to define internal control, you get a big surprise and a huge disappointment. So what is an "internal control"? According to the ICI (Internal Control Institute – www.internalcontrolinstitute.org) an internal control is "a process, effected by an entity’s Board of Directors, management or other personnel (including treasury team), designed to provide reasonable assurance regarding the achievement of (treasury and corporate finance) objectives in the following categories: effectiveness and efficiency of (treasury) operations; reliability of financial (and treasury) reporting; compliance with applicable laws and regulation". Treasury managers, like any other employees, are required (for companies governed by national laws transcribing the Eighth Directive) or will be required (for unlisted companies) to map out the internal controls applicable/applied to their businesses. Besides, IT technology and the resources at the disposal of treasury managers now enable them to fine tune their internal controls or to strengthen them. The sums at stake are sizeable, the transactions can be complex, there is a high risk of fraud (due to the amounts being processed) and the timing is by definition extremely tight in order to ensure that the same day's value date is applied. The treasury manager can start by simply listing his internal controls on a spreadsheet.

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An example of an internal control framework for treasury departments: In terms of policies and procedures, treasury managers have one of the most regulated jobs, with the most checks and restrictions. They are prearranged and must be organized to ensure their departments run efficiently. They measure their effectiveness by using KPIs. They automate all systems and procedures as much as possible. Furthermore, they fulfill all the functions of effective internal control: they adhere to the code of conduct but are themselves subject to their own rules of conduct through "general treasury policy"; they adhere to the firm's core values and to the general principles of their own policies; they set the example ("walk the talk"; they have a quite structured group; staff that have to be competent and highly qualified (ever more so); they delegate and are themselves delegated to by management; they hold general authorizations, mandates and proxies; they are frequently subject to internal audits (very much so given the specific features of their work and amounts involved); they are responsible for safeguarding the group's financial assets and finally, as a tenth feature, they monitor their performance using Key Performance Indicators.

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6.10.2 The treasury manager, a sort of mini CRO The Group Treasury Manager is often a sort of mini Chief Risk Officer (CRO), something that is sometimes overlooked. In a structured and ordered manner, they use specialist IT applications to manage the risks inherent in their work, usually with better effect than anyone else in the business. This is why they are increasingly involved in the process of mapping out risks and in ERM ("Enterprise Risk Management"). Treasury managers are like a little Circe, explaining the risks of the voyage to Ulysses to prepare for the dangers of the Odyssey and, for example, for the dangerous songs of the sirens or the dreaded Scylla and Charybdis. Treasury managers know what risk taxonomy means and prepare a long series of reports on managing it and on the underlying (financial) risks. It is because they manage

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risk day to day that they are prepared and have developed a battery of internal checks to keep it fully under control. They know about the difficulties of the segregation of tasks. They have their own "Business Contingency Plans" (BCPs) to cater for scenarios of non-‐access to buildings or systems. They are ordered around a series of policies and procedures, themselves the implementation of general group policies and drawn from the company's founding principles or fundamental charter. They are used to measuring the stage of completion of the duties that fall upon them through the use of KPIs; Key Risk Indicators (KRIs) and other Key Activity Indicators; because if it is not being measured, it is not being managed. Like everyone else, they are subject to specific regulations and laws (e.g. IFRS for accounting principles and disclosures, with all the increased responsibility for the CFO who will ultimately have to sign the accounts; ever more restrictive European Directives, particularly on OTC derivative products, SEPA and MiFID; etc). More so than for any other employee, it is essential that the treasury department’s code of ethics (often more restrictive than the company's own code of ethics) is adhered to so as to ensure the department runs properly. But this specific code of ethics must be monitored and supported by software and ad hoc checks that are preventive, but also detective, or even corrective. Treasury technology (e.g. ERP and TMS for instance) now makes treasury management more effective and efficient (especially when the whole IT architecture and solutions are fully interfaced for real STP), reducing not only costs but more importantly the operational risks of handling and processing financial data. It must assure the completeness and integrity of the data in the IT systems, the basis and container of its work, and provide a transactions audit trail. At a time when the CFO has to personally commit to the reliability of the accounts being presented, it is important to have prior assurance that the mechanisms limit inherent risk and provide assurance of the quality of the outgoing content to be certified.

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6.10.3 Don’t wait until you are forced to make preparations It cannot be stressed enough that treasury managers should be scrupulous in preparing (sometimes even anticipating the requirement) a comprehensive list of the internal controls that they intend to follow up and carry out. Furthermore, this exercise often involves increased use of computerized management techniques to automate and secure procedures and databases. This is a good pretext for the in-‐house sale of a number of projects related to IT development. These days, the words "tighter security" ring bells in the minds of CFOs and result in larger budgets being allocated for mechanizing the department. In some ways, the treasury is an excellent testing ground for anyone wishing to tackle their list of internal controls, often for reasons of compliance with the European Eighth Directive, as it contains everything required for putting effective controls (it is often here that the problem arises, through a lack of effective controls) and effective monitoring in place. Treasury managers can be very virtuous and make their departments centers of excellence for the internal controls that are so vital for their organizations.

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6.11 Internal Controls for the Treasury: The Missing Piece... “My major hobby is teasing people who take themselves and the quality of their knowledge too seriously and these who don’t have the guts to sometimes say: I don’t know” (Nassim Nicolas Taleb)

6.11.1 Internal Controls

Many companies, because they are listed on the American stock exchange, have had to comply with Sarbanes-‐Oxley for five or more years. They produce a detailed report of their internal controls, and the treasury is no exception. In Europe, the gradual transcription into domestic law of the EU’s Eighth Directive (e.g. the German BilMoG) makes it mandatory to document the existence of internal controls, thus supplementing risk management system measures. Unfortunately, oftentimes although rules and policies exist, the controls have not been made official and are not effective, particularly with respect to the treasury. People often speak of internal controls, but few can define what an “internal control” really is. It is the process by which an organisation structures its activities to accomplish its mission effectively and efficiently. It is an integrated process used by the managers and staff of a company or a department to handle risk. It also serves to provide reasonable assurance that, within the context of the organisation’s mission, the following general objectives will be met: 1. Completion of well-‐ordered, ethical, economical, efficient, effective operations; 2. Fulfilment of accountability obligations; 3. Compliance with current laws and regulations; 4. Protection of resources against loss, improper use and damage. This applies on three levels: (1) performance, (2) information, and (3) compliance (with current standards). The treasury department must respond appropriately to the operational, financial, legal and market risks with which it is confronted. Yet it must also improve the quality of the financial information provided, both internally and externally. In addition, it must encourage compliance with the internal and external rules applicable to the company. In fact, it is a set of good governance rules focused on

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Monitoring

Control Activities

Risk Assessment

Inf

or m

ati

Co mm un ic

a ti

quality assurance and identifying and analysing risk. These are rules and procedures, combined with various controls that are intended to mitigate or eliminate a risk. Consequently, this is a fairly vast concept, as these controls are supposed to cover delegation of authority, chains of command, management of sensitive information, access to systems, procedures, infrastructures, risks of fraud, internal charters, definition of roles, identification of risks and more (see COSO Framework: Guidance on Monitoring Internal Control Systems, 2007)

Control Environment

6.11.2 Integrated Framework for Internal Controls The famous “COSO framework” mentioned above (“Committee of Sponsoring Organisations of the Treadway Commission” -‐ www.coso.org) is a private initiative intended to improve the quality of financial reporting, corporate governance and internal controls. According to COSO, an internal control is a process carried out by an entity or one of its members at various levels designated as responsible for providing “reasonable” assurance that its objectives in terms of operational effectiveness and efficiency, the reliability of financial reports and compliance with applicable laws and regulations, will be met. These control activities cover tasks such as approval procedures, authorisations, segregation of duties and even reconciliations, for example.

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Although the controls sometimes have their limitations, which are occasionally felt by the company (decisions by the management to get around or to overstep a rule, collusion, cost/benefit analysis or the judgment/subjectivity aspect, among others), it is nevertheless essential and now even mandatory for some to prove the existence of these internal controls. The complexity of organisations and their treasury departments has become such that, in recent years, the risk of losses related to this activity is too high not to address it directly. In addition to fraud, the simple risk of human error is simply not acceptable. There must be an attempt to minimise it. To this end, it is not sufficient to establish onerous procedures or restrictive policies. It is necessary to establish a method of control and organise the oversight of it. Let us compare this concept to a traffic law that establishes a speed limit, but is not accompanied by radar to measure it or police to monitor it, or even penalties to ensure better compliance with set limits. It would not make any sense. Often the company contents itself with establishing the traffic law and sometimes uses (automatic) radars, but then forgets to monitor it or to impose sanctions to make the measures more effective and better respected, with the ultimate goal of reducing traffic accidents.

6.11.3 Internal Control Checklist

It is often helpful to provide a few, more practical examples of internal controls that should be implemented, in order to make our discussion more explicit and more concrete. The tables below follow a well-‐established methodology. Large firms have their own methodologies, but we can easily find example checklists that pertain to treasury or accounting matters.

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Few examples of checklist of internal controls with comments Controls Typical controls

√

√ √

√

Etc..

Controls for treasury system / excel / manual environment

e.g. Policies: They should outline the organisational structure for the management of financial risks, incl. the authority and role of each body or individual e.g. Organisational structure: There should be sufficient resources for the treasury to operate effectively

Specify role of individuals, committes and board / state role of individuals, committe and board

The level of staffing and type of staff (interms of qualifications and experience) should be commensurate with workload and compelxity undertaken by the treasury staff

e.g. Limits: To be stated in treasury policies: counterparty, credit, settlement, investment, trading limits

Limits should be reviewed annually and approved by the board. To the extend possible, limits are loaded in the treasury systems. Credit limits based on external info suppliers (e.g. rating agencies)

e.g. Personnel: training, compliance and performance: Employees sign ethics code when joining cy. Appropriate level of education required e.g. Operational reports: Exception reports are provided to senior mgt. and board, especially relating to policy breach Stress testing, Board reports, Mgt reporting,… e.g. Risk Management activities: The audit trail of new deals as well as deal amendments and cancellations, must be reviewed daily by a party independent of the dealing function (segregation of duties) e.g. Post-deal controls: Internal counterparties receive a listing of open deals once a month and are requested to acknowledge the correctness of the listing Static data cannot be changed within treasury systems in an uncontrolled manner Etc…

Controls on who has access to TMS change static data, e.g. counterparty details incl. bank account details of counterparty + swift address. Etc…

non-exhaustive list - simple examples

source: CPA Australia checklist - www.cpaaustralia.com

Self-explanatory e.g. CFA, ACT or AFP levels, local University degrees, etc.. Monthly board report on treasury activities on key financial risks of the organisation which should be tie in with KRIs , data and graphics

Amended and cancelled deals are reported on an end of day report. It is reviewed by treasurer. Cancelled deals are cofnirmed as cancelled by counterparty. Necessity of management sign-off if non automatic environment. Sent automatically from TMS Copy for treasury records

6.11.4 Automation: A Solution to Boost Internal Controls Automation allows treasury departments to establish a more reliable, more secure environment of internal controls. Well beyond the potential operational efficiency gains, the key driver of any compliance exercise is the need to lubricate the internal control processes. By eliminating the inherent manual reconciliations, double entries and other non-‐virtual validations, the treasurer meets a dual objective: to cut costs (today’s buzzword) and improve or facilitate internal controls. Any CFO tries to ensure better

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real-‐time visibility of reports, various risk and performance indicators (KRIs/KPIs) and other operating reports. Based on the experience acquired by companies listed on the stock exchange in the USA, which are subject to the Sarbanes-‐Oxley (SOX) Act of 2002, treasurers try to incorporate and inculcate more controls and inviolable protections into their interconnected systems, not only to eliminate any inefficiencies, but also to simplify reporting on internal controls. The leitmotiv, aside from simply “compliance,” is to reduce risk. Information technology is a catalyst and a means of standardising operational processes and thus strengthening controls and better segregating duties. The The16 16key keyareas areasfor for Internal Controls Internal Controlsfor forTreasury Treasury 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.

Risk Management framework and governance Policy and procedures Organisational structure Limits Personnel : training, compliance and performance Treasury and financial reporting Operational reports Risk Management activities Post-deal control Operations / settlements Controls over settlements Reconciliation of bank accounts and treasury records to the general ledger Cash management Physical security (records/key systems) Monitoring of Risk Management activities Treasury infrastructures

6.11.5 Establish, Document and Monitor Effectively Many treasurers establish procedures and policies, and then document them. Unfortunately, just when they are on the right track they stop short, because they forget to ensure effective, efficient monitoring of the internal controls they have established. And that’s where the shoe pinches. If there are controls that are found almost everywhere, they are (1) traditional IT controls, such as access control (e.g. rules on passwords, their rotation and renewal, or limits on access to certain functionalities; (2) database controls (e.g. data backup, storage of electronic or physical data off site); (3) security controls against pirating or data locking (e.g. anti-‐virus protection, firewalls, intrusion detection, file encryption and physical server protection); (4) loading controls when conducting IT updates (e.g. approval, patching, test base, replacements). This IT structure leads to an increased segregation of duties and the establishment of remote support.

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Designing and Executing Monitoring Procedures

4. Develop and implement cost-effective procedures to evaluate that persuasive Implement information Monitoring

1. Understand and prioritize risks to organisational objectives

4 Prioritize Risks

3 Identify 3. Identify information Information that will persuasively Indicate whether the internal control system is operating effectively

1 2

Identify Controls

2. Identify key controls across the internal control system that address those prioritized risks (Source COSO)

6.11.6 Cost of Establishing Compliance Of course, you may have read comments, here and there, about the exorbitant, prohibitive cost paid by some companies in order to comply with the famous “SOX.” Were they exaggerated? It is beyond us to make that judgment. However, it is not unreasonable to think that it might be too easy to point fingers at SOX for what, in a normal world of good practices, is necessary for most companies anyway. If SOX (Sarbanes-‐Oxley Act, Section 404) or the equivalents transcribed from the EU’s Eighth Directive are catalysts for a switch to more automation and STP, we should be thrilled! At the very least, the new regulations on internal controls are a wonderful argument for convincing the CFO to invest (which is sometimes a touchy subject these days) in technology. ROIs must also take into account a qualitative aspect, as internal controls and risk management are both operational and financial. Technology provides leverage that should be used to establish controls and deploy them (e.g. interfacing, data encryption, protection of work flows, audit trails, security logs, and others). It is important to switch from unprotected tools to completely secure, locked tools.

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6.11.7 Visibility and transparency are key Today, the objective is to increase the visibility and transparency of the processes that are in place within the treasury department, while ensuring that they are effective. Straight Through Processing – automation pushed to the extreme – can have a leveraging effect on internal controls and can help adopt the best practices. It can also be used to improve the design of the controls and their monitoring. Automation is consequently doubly advantageous (reduced costs and improved security). The less his controls are manual and physical (and therefore consume time and energy), the more free time the treasurer will have to dedicate to tasks with a high(er) added value. Establishing a framework for managing the treasury with policies and procedures, addressing risk through an exhaustive, consolidated, correlated matrix, and operating according to standards recognised by the market, will no longer suffice for the proper management of the department. Regulations are now requiring us, sadly in a very restrictive manner, to verify the existence, pertinence and most of all the effectiveness of existing internal controls. The treasury department handles major operational and financial risks; this is exactly why it can be a veritable laboratory for internal controls within the company. Of course, it will come at a price… the price of security. The qualitative aspect and the risk aspect must be included in any analysis or any treasury project (e.g. change of TMS, Payment Factory, integration of online trading platforms or cross-‐border cash polling). Transforming a legal constraint into a technical opportunity to improve productivity, which is synonymous with cost reduction and increased efficiency, is an art form, and the Holy Grail of the treasurer. In order to achieve this level of internal controls, it is necessary to follow tested, recognised methodology and fill out ICQs (Internal Control Questionnaires) in order to map the organisation and identify weaknesses that need improvement. Self-‐evaluation will also be necessary (unless it is done by a third party or an experienced consultant). It is an on-‐going, unrelenting process that must be constantly updated to ensure the integrity and quality of the controls established.

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6.12 Enterprise Risk Management Analysis Applied to Corporate Ratings “Economy advance is not the same thing as human progress” (John Clapham)

6.12.1 Rating agencies looking for ERM processes review Standard & Poor’s (S&P) published in early May 2008 a new document on its approach for inclusion of Enterprise Risk Management (ERM) analysis in corporate ratings, having first sought feedback from users and rated enterprises since last November. An ERM review will now form part of credit rating analysis and every company must be prepared to demonstrate they have sound and effective risk measurement and management practices in place. Since November 2007 and the request for comments issued by S&P, we all knew that credit rating agencies were contemplating how to best address ERM processes for non-‐ financial companies. At that time it was apparent S&P was not yet certain of the best way to approach such a review and how to integrate it into its rating review process. As from the third quarter 2008, they will start including ERM in their discussions with customers, with the inclusion of commentary related thereto in their reports from the fourth quarter 2008. It means, ERM by another external party are a reality. Therefore, it is better to be ready as soon as possible and to be prepared to answer S&P, and possibly Moody’s and Fitch in the coming months. Rating agencies want at least to increase transparency by providing the market with views on the ability of management of an enterprise to organize and to make effective ERM processes. With such analysis, providing it is serious and in-‐depth, S&P expects to assist elaboration of what if and sensitivity scenaroi forecasts. It also expects to form a more forward-‐looking rating opinion. Taking into account the feedback they received S&P has decided, for the moment, to focus on strategic risks, and on assessing the prevailing risk culture and governance. It also admitted that it needs a minimum number of reviews to enable an effective formal scoring approach to be formed (i.e. “weak”; “adequate”; “strong”; “excellent”). After having conducted enough reviews (likely in early 2009), they hope to be in a position to establish a credible benchmark as well as evaluation criteria. Although, they do not expect changes of existing credit ratings in the initial reviews, they don’t exclude the possibility to penalize customers at a later point in time if and when necessary. (For new up-‐grades from S&P, please see: www.spnewactions.com)

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6.12.2 Creation of more systematic framework for an inherently subjective topic Everybody can reasonably accept that whatever the review process articulated by S&P, it will remain highly subjective and judgmental. But the same persons also admit that this is not a reason for not addressing the ERM issue. S&P have indicated it will take a scorecard approach based on a view drawn from using a structured questionnaire and interviews conducted with select personnel from an enterprise. The difficulty resides in their finding the right balance between straight forward closed questions and more open ones to rightly capture and assess the risk culture and appetite of the company. The recourse to a generally accepted risk-‐management standard like COSO (promulgated by The Committee of Sponsoring Organisations of the Treadway Commision) or AS/NZS 4360 (promulgated by Australia & New-‐Zealand Joint Committee OB/7) would be considered but is neither a prerequisite nor is having adopted such a framework of itself sufficient evidence of a sound fit-‐for-‐purpose ERM process. They have indicated they will compare practices among peers and will be open-‐minded in their analysis. Who could contest ERM is more than an approach to assure the management is attending all risks, more than a method to fulfill board responsibility or even more than a nice toolkit? Clearly, all non-‐financial companies should shift focus from a singular focus of “cost/benefit” to “risk/reward”. All companies must communicate with stakeholders on risk management, despite a common and natural reluctance to disclose sensitive information, including risks and how they monitor and mitigate them. However, ERM is neither a recipe for eliminating all risks, nor a simple risk mapping. ERM is not a replacement for internal controls of malfeasance and it is not a simple compliance necessity. As explained above, S&P has decided, as an initial measure, to concentrate on assessing the risk culture & governance as well as strategic risks. They have chosen to delay the assessment of other elements of an ERM, specifically the two others topics listed in their November document, being: control-‐risk management and emerging risks. These last two major issues will be addressed and reviewed later. We can expect S&P to start analyzing these two topics in last quarters of 2009 or the latest early 2010.

6.12.3 Sector diversity issue

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6.12.4 Recommendation: be prepared!

Although the approach adopted by S&P in the first instance will be lighter than initially expected, we know it will require some preparation from the corporate side. Management of an enterprise will need to prepare answers and explanation ahead of discussion with the rating agency. Wouldn’t it be a fantastic opportunity to review internal ERM processes in order to check whether or not we are “compliant” with S&P expectations? No one could contest that prior preparation would go a long way to prevent misunderstanding resulting in the potential for a negative impact on a company’s rating (admittedly not at inception but later on when processes of review will be improved and benchmarking set up). Therefore, whatever your management position and views on ERM processes (e.g. is it worth having ; why build a complex assessment of ERM processes? ; as quantification of risks is difficult, why run such a long review for mapping risks? Etc…), when rated, your company needs to disclose information about its ERM process. If the company wants to benchmark its process and to review it in order to better rate it (according to S&P new proposed grading for ERM), there are a limited number of specialists who could help. AVANTAGE is one of them (cf. www.avantagecapita.com). They have developed a comprehensive benchmarking model named “IRPM”, short for an Integrated Risk and Performance Management. They use a two-‐step questionnaire mapped to the COSO framework (general and then detailed questionnaire) to help visualizing where you are and the potential weaknesses in your current processes. The recommendations are priority actions the non-‐financial company could undertake to improve existing ERM processes. The Venn diagram (spider chart in former chapter) identifies the state of development of ERM processes. The objective is to deliver an enhanced understanding of the enterprise reviewed, including the entity level objectives (the diagnostic can be performed at an entity level); risk appetite; and, identification of “priority risks”, which together help Avantage to form a view of the Board’s desired (target) risk management capability. The diagnostic tool, whatever the consultant used, should enable you to identify potential gaps and areas for improvement, as well as playing a role of rehearsal for agencies interviews and questionnaires. To having such a snapshot diagnostic of your ERM process provides a perspective from which you can build a consensus of priority risks, of current gaps with respect to risk measurement and management for these same risks, and as importantly, develop a plan of action for closing the gaps.

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ERM remains a relatively new concept and as such corporates have some difficulties in setting up and in measuring, with any degree of sophistication , the risks, and comparing existing practice against good practice (notably vis-‐à-‐vis their peers or also in terms of market “best practices”). Absence of track records, of clearly identified leading edge ERM practices and diversity of industries make the task highly complex for non-‐financial institutions. Recourse to specialists in ERM assessment and evaluation can be a solution to transform a new threat into an opportunity to better manage risks. We only can recommend you start thinking on how to best present the ERM processes in place, and of how to potentially improve it and to rehearse to be ready for interviews with the respective rating agency. The better a company will be prepared, the higher its ERM process will be ranked, and (supposedly) the truer the credit rating.

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7 General Conclusion "You can stop invading armies, but you can't stop invading ideas" (Victor Hugo) The treasurer's job covers tasks that the general public often does not understand well, but which are nevertheless essential to business. The treasurer's role has increasingly become a crucial one in the structure of finance departments of all major groups. After these last few years of upheavals and turmoil, nobody would dare suggest that this function was not crucial. The job has changed radically, partly for these reasons and also because of technical developments, particularly IT developments. The matters of concern to treasurers and the challenges facing them are no longer what they used to be. This book aims to tackle the current themes that affect the profession. The job has become more complex, with a more wide-‐ranging role. Although technical advances have improved productivity, the job has become more varied. More than ever, treasurers are very busy people, much looked-‐to by people outside the company, but also by people in it, and they gravitate around them. Whatever changes there may be around the corner, the technician role of treasurers and their ability to handle many specific financial problems by bringing together a varied, effective and unconventional set of skills make them key colleagues, drawing them ever closer to Chief Financial Officers. However, much progress still needs to be made in treasury matters. This progress will become apparent in the next few years. The biggest challenge for treasurers will be being able to adapt to this evolving environment and to new technologies.

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8 List of Acronyms ASP = Application Service Provider BSP = Business Service Providers CP = Commercial Paper EACT = European Corporate Treasurers Association ECP = Euro Commercial Paper ERP = Enterprise Resource Planning FAS = Financial Accounting Standards GAAP = Generally Accepted Accounting Principles HER = Hedging Equity Reserve IAS = International Accounting Standards IASB = International Accounting Standards Board IFRS = International Financial Reporting Standards IGTA = International Group of Treasury Associations IOSCO = International Organization of Securities Commissions ISDA = International Swap Dealers Association IT = Information Technology OCI = Other Comprehensive Income OTC = Over-‐The-‐Counter PER = Price Earning Ratio S&P = Standard & Poor’s SEPA = Single European Payment Area STP = Straight Through Processing TMS = Treasury Management System

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9 Definitions: AMF: “Autorité des Marchés Financiers” is the French supervisor of all financial markets. It also gives definitions of (short term) money market funds with precise criteria to be respected. It is in charge of controlling money market funds and their management. CRD (IV): The Capital Requirements Directive (CRD) for the financial services industry will introduce a supervisory framework in the EU which reflects the Basel II rules on capital measurement and capital standards. Member States had to transpose, and firms of the financial service industry have to apply, the CRD from January 1, 2007. Institutions could choose between the current basic indicator approach, that increases the minimum capital requirement in Basel I approach from 8% to 15% and the standardized approach that evaluates the business lines as a medium sophistication approaches of the new framework. The most sophisticated approaches, Advanced IRB approach and AMA or advanced measurement approach for operational risk will be available on the beginning of 2008. From this date, all EU firms will apply "Basel II". Following publication of CRD II and CRD III, the Commission published further consultations on amendments to the CRD, in February & October 2010 (February 2010 consultation and October 2010 consultation). These consultations focused on amendments such as the definition of capital, further counter-‐cyclical measures, quantitative liquidity standards, counterparty credit risk, systemically important financial institutions, and countercyclical buffers. Following this consultation, the Commission published its proposed legislation for the Capital Requirements Directive (CRD) and the Capital Requirements Regulation (CRR), which together form the CRD IV package, on 20 July 2011. As well as reflecting the Basel III capital proposals, the CRD IV package also includes new proposals on sanctions for non-‐compliance with prudential rules, corporate governance and remuneration. eBAM: Bank Account Management is currently a very manual and paper-‐based process. EBAM -‐ Electronic Bank Account Management -‐ aims to help corporates and banks automate this process. EBAM covers the electronic opening, maintenance and closing of accounts, and the reporting on account and mandate structures. Account maintenance includes the maintenance of the operational mandates on accounts. A higher level of automation will allow banks and corporates to reduce EBAM-‐related costs, and to increase the speed of processing EBAM instructions. The SWIFT EBAM offering consists of a set of 15 ISO 20022 XML messages to capture standardised EBAM information that needs to be exchanged between banks and corporates. The offering allows corporates to attach electronic documents to these XML messages, and transport the messages

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with or without the attachments over FileAct. The XML messages and/or the attachments are digitally signed at personal level. EMIR: European Market Infrastructure Regulation (EMIR) The Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties (CCPs) and trade repositories (TRs) (EMIR) entered into force on 16 August 2012. The Commission Delegated Regulations (EU) No 148/2013 to 153/2013 of 19 December 2012 supplementing EMIR were published in the Official Journal on 23 February 2013 and will enter into force on 15 March 2013. The implementing technical standards were published in the official journal dated 21 December 2012. ERM: Enterprise risk management (ERM) in business includes the methods and processes used by organizations to manage risks and seize opportunities related to the achievement of their objectives. ERM provides a framework for risk management, which typically involves identifying particular events or circumstances relevant to the organization's objectives (risks and opportunities), assessing them in terms of likelihood and magnitude of impact, determining a response strategy, and monitoring progress. By identifying and proactively addressing risks and opportunities, business enterprises protect and create value for their stakeholders, including owners, employees, customers, regulators, and society overall. ERM can also be described as a risk-‐based approach to managing an enterprise, integrating concepts of internal control, the Sarbanes–Oxley Act, and strategic planning. ERM is evolving to address the needs of various stakeholders, who want to understand the broad spectrum of risks facing complex organizations to ensure they are appropriately managed. Regulators and debt rating agencies have increased their scrutiny on the risk management processes of companies. ERP: Enterprise resource planning (ERP) systems integrate internal and external management across an entire organization—embracing finance/accounting, manufacturing, sales and service, customer relationship management, etc. ERP systems automate this activity with an integrated software application. The purpose of ERP is to facilitate the flow of information between all business functions inside the boundaries of the organization and manage the connections to outside stakeholders. ERP systems can run on a variety of computer hardware and network configurations, typically employing a database as a repository for information. ESMA: The European Securities and Markets Authority (ESMA) is a European Union financial regulatory institution and European Supervisory Authority located in Paris. ESMA replaced the Committee of European Securities Regulators (CESR) on 1 January 2011. It is one of the three new European Supervisory Authorities (ESAs) set up within the European System of Financial Supervisors. ESMA works in the field of securities legislation and regulation to improve the functioning of financial markets in Europe, strengthening investor protection and cooperation between national competent

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authorities. The idea behind ESMA is to establish a “EU-‐wide financial markets watchdog”. One of its main tasks is to regulate credit rating agencies, such as Moody’s. IFRS: (former IAS – International Accounting Standards) International Financial Reporting Standards (IFRS) are designed as a common global language for business affairs so that company accounts are understandable and comparable across international boundaries. They are a consequence of growing international shareholding and trade and are particularly important for companies that have dealings in several countries. They are progressively replacing the many different national accounting standards. They set of rules to be followed by accountants to maintain books of accounts which are comparable, understandable, reliable and relevant as per the users internal or external. IFRS began as an attempt to harmonize accounting across the European Union but the value of harmonization quickly made the concept attractive around the world. They are sometimes still called by the original name of International Accounting Standards (IAS). IAS was issued between 1973 and 2001 by the Board of the International Accounting Standards Committee (IASC). On April 1, 2001, the new International Accounting Standards Board took over from the IASC the responsibility for setting International Accounting Standards. During its first meeting the new Board adopted existing IAS and Standing Interpretations Committee standards (SICs). The IASB has continued to develop standards calling the new standards International Financial Reporting Standards (IFRS). IMMFA: The Institutional Money Market Funds Association (IMMFA) is the trade association which represents the European triple-‐A rated money market funds industry. Its member funds have over €520 billion in assets under management. All IMMFA members must abide by the Code of Practice and obtain a triple-‐A rating for their funds. ISO 20022: is the ISO Standard for Financial Services Messaging. It describes a Metadata Repository containing descriptions of messages and business processes, and a maintenance process for the Repository Content. The Repository contains a huge amount of financial services metadata that has been shared and standardized across the industry. The metadata is stored in UML models with a special ISO 20022 UML Profile. Underlying all of this is the ISO 20022 metamodel -‐ a model of the models. The UML Profile is the metamodel transformed into UML. The metadata is transformed into the syntax of messages used in financial networks. The first syntax supported for messages was XML Schema. ISO 20022 is widely used in Financial Services. Organizations participating in ISO 20022 include: FIX Protocol Limited (FIX), ISDA (FpML), ISITC, Omgeo, SWIFT, and Visa. ISO 20022 is the successor to ISO 15022; originally ISO 20022 was called ISO 15022 2nd Edition. ISO 15022 was the successor of ISO 7775. MiFID: The Markets in Financial Instruments Directive 2004/39/EC (known as "MiFID") as subsequently amended is a European Union law that provides harmonized regulation for investment services across the 30 member states of the European Economic Area (the 27 Member States of the European Union plus Iceland, Norway and Liechtenstein).

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The main objectives of the Directive are to increase competition and consumer protection in investment services. As of the effective date, 1 November 2007, it replaced the Investment Services Directive. MiFID is the cornerstone of the European Commission's Financial Services Action Plan whose 42 measures will significantly change how EU financial service markets operate. MiFID is the most significant piece of legislation introduced under the 'Lamfalussy' procedure designed to accelerate the adopting of legislation based on a four-‐level approach recommended by the Committee of Wise Men chaired by Baron Alexandre Lamfalussy. There are three other 'Lamfalussy Directives' — the Prospectus Directive, the Market Abuse Directive and the Transparency Directive. MiFID retained the principles of the EU 'passport' introduced by the Investment Services Directive (ISD) but introduced the concept of 'maximum harmonization' which places more emphasis on home state supervision. This is a change from the prior EU financial service legislation which featured a 'minimum harmonization and mutual recognition' concept. 'Maximum harmonization' does not permit states to be 'super equivalent' or to 'gold-‐plate' EU requirements detrimental to a 'level playing field'. Another change was the abolition of the 'concentration rule' in which member states could require investment firms to route client orders through regulated markets. The MiFID Level 1 Directive 2004/39/EC, implemented through the standard co-‐decision procedure of the Council of the European Union, and the European Parliament, sets out a detailed framework for the legislation. Twenty articles of this directive specified technical implementation measures (Level 2). These measures were adopted by the European Commission, based on technical advice from the Committee of European Securities Regulators and negotiations in the European Securities Committee with oversight by the European Parliament. Implementation measures in the form of a Commission Directive and Commission Regulation were officially published on 2 September 2006.[ RFP: A request for proposal (RFP) is a solicitation made, often through a bidding process, by an agency or company interested in procurement of a commodity, service or valuable asset, to potential suppliers to submit business proposals. It is submitted early in the procurement cycle, either at the preliminary study, or procurement stage. The RFP process brings structure to the procurement decision and is meant to allow the risks and benefits to be identified clearly up front. The RFP presents preliminary requirements for the commodity or service, and may dictate to varying degrees the exact structure and format of the supplier's response. Effective RFPs typically reflect the strategy and short/long-‐term business objectives, providing detailed insight upon which suppliers will be able to offer a matching perspective. Similar requests include a request for quotation and a request for information. In principle, an RFP: informs suppliers that an organization is looking to procure and encourages them to make their best effort.

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requires the company to specify what it proposes to purchase. If the requirements analysis has been prepared properly, it can be incorporated quite easily into the Request document. alerts suppliers that the selection process is competitive. allows for wide distribution and response. ensures that suppliers respond factually to the identified requirements. is generally expected to follow a structured evaluation and selection procedure, so that an organization can demonstrate impartiality -‐ a crucial factor in public sector procurements. SEC: “US Securities and exchange Commissions” is a Federal Agency which holds primary responsibility for enforcing the federal securities laws and regulating the securities industry, the nation's stock and options exchanges, and other electronic securities markets in the United States. It has defined the rule 2a-‐7, which defines what short term money market funds are. SEPA: The Single Euro Payments Area (SEPA) is a payment-‐integration initiative of the European Union for simplification of bank transfers. As of March 2012, SEPA consists of the 27 EU member states, the four members of the EFTA (Iceland, Liechtenstein, Norway and Switzerland) and Monaco. The project's aim is to improve the efficiency of cross-‐border payments and turn the fragmented national markets for euro payments into a single domestic one. SEPA will enable customers to make cashless euro payments to anyone located anywhere in the area, using a single bank account and a single set of payment instruments. The project includes the development of common financial instruments, standards, procedures, and infrastructure to enable economies of scale. There are two milestones in the establishment of SEPA: Pan-‐European payment instruments for credit transfers began on 28 January 2008; direct debits and debit cards became available later. By the end of 2010, all present national payment infrastructures and payment processors were expected to be in full competition to increase efficiency through consolidation and economies of scale. For direct debits, the first milestone was missed due to a delay in the implementation of enabling legislation (the Payment Services Directive or PSD) in the European Parliament. Direct debits became available in November 2009, which put time pressure on the second milestone. The European Commission has established the legal foundation through the PSD. The commercial and technical frameworks for payment instruments were developed by the European Payments Council (EPC), made up of European banks. The EPC is committed to delivering three pan-‐European payment instruments: (1) Credit transfers: SCT – SEPA Credit Transfer; (2) Direct debits: SDD – SEPA Direct Debit. Banks began offering this service on 2 November 2009; (3) Cards: SEPA Cards Framework To provide end-‐to-‐end straight through processing (STP) for SEPA-‐clearing, the EPC committed to delivering technical validation subsets of ISO 20022. Whereas bank-‐to-‐

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bank messages are mandatory for use, customer-‐to-‐bank message types (pain) are not; however, they are strongly recommended. Because there is room for interpretation, it is expected that several pain specifications will be published in SEPA countries. Businesses, merchants, consumers and governments are also interested in the development of SEPA. The European Associations of Corporate Treasurers (EACT), TWIST, the European Central Bank, the European Commission, the European Payments Council, the European Automated Clearing House Association (EACHA), payments processors and pan-‐ European banking associations – European Banking Federation (EBF), European Association of Co-‐operative Banks (EACB) and the European Savings Banks Group (ESBG) – are playing an active role in defining the services which SEPA will deliver. Since January 2008, banks have been switching customers to the new payment instruments. By 2010, the majority were expected to be on the SEPA framework. As a result, banks throughout the SEPA area (not just the Eurozone) need to invest in technology with the capacity to support SEPA payment instruments. SEPA clearance is based on the IBAN bank-‐account identification and the SWIFT-‐BIC bank identifier. Domestic transactions are routed by IBAN; earlier national-‐designation schemes will be abolished by February 2014, providing uniform access to the new payment instruments. By February 2016 consumers must drop BIC sorting information for SEPA transactions, since it will be derived from the IBAN for all banks in the SEPA area. Multinational businesses and banks have the opportunity to consolidate their payment processing on common platforms across the Eurozone. They will benefit from the efficiency of choosing among competing suppliers, offering a range of solutions and operating across borders. The introduction of SEPA should increase the intensity of competition among banks and corporates for customers across borders within Europe. Software as a Service: (SaaS), sometimes referred to as "on-‐demand software", is a software delivery model in which software and associated data are centrally hosted on the cloud. SaaS is typically accessed by users using a thin client via a web browser. SaaS has become a common delivery model for many business applications, including accounting, collaboration, customer relationship management (CRM), management information systems (MIS), enterprise resource planning (ERP), invoicing, human resource management (HRM), content management (CM) and service desk management. SaaS has been incorporated into the strategy of all leading enterprise software companies. One of the biggest selling points for these companies is the potential to reduce IT support costs by outsourcing hardware and software maintenance and support to the SaaS provider. Straight-‐Through Processing: (STP) enables the entire trade process for capital markets and payment transactions to be conducted electronically without the need for re-‐keying or manual intervention, subject to legal and regulatory restrictions. The concept has also been transferred into other sectors including energy (oil, gas) trading and banking, and financial planning. Currently, the entire trade lifecycle, from initiation to settlement, is a complex labyrinth of manual processes, taking several days. Such processing for equities transactions is commonly referred to as T+3 processing, as it usually takes three

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business days from the "Trade" being executed to the trade being settled. Industry practitioners, particularly in the US, viewed STP as meaning at least 'same-‐day' settlement or faster, ideally minutes or even seconds. The goal was to minimize settlement risk for the execution of a trade and its settlement and clearing to occur simultaneously. However, for this to be achieved, multiple market participants must realize high levels of STP. In particular, transaction data would need to be made available on a just-‐in-‐time basis which is a considerably harder goal to achieve for the financial services community than the application of STP alone. After all, STP itself is merely an efficient use of computers for transaction processing. Historically, STP solutions were needed to help financial markets firms move to one-‐day trade settlement of equity transactions, as well as to meet the global demand resulting from the explosive growth of online trading. Now the concepts of STP are applied to reduce systemic and operational risk and to improve certainty of settlement and minimize operational costs. When fully realized, STP provides asset managers, brokers and dealers, custodians, banks and other financial services players with tremendous benefits, including greatly shortened processing cycles, reduced settlement risk and lower operating costs. Some industry analysts believe that STP is not an achievable goal in the sense that firms are unlikely to find the cost/benefit to reach 100% automation. Instead they promote the idea of improving levels of internal STP within a firm while encouraging groups of firms to work together to improve the quality of the automation of transaction information between them, either bilaterally or as a community of users (external STP). Other analysts, however, believe that STP will be achieved with the emergence of business process interoperability. SWIFT: The Society for Worldwide Interbank Financial Telecommunication (SWIFT) provides a network that enables financial institutions worldwide to send and receive information about financial transactions in a secure, standardized and reliable environment. SWIFT also markets software and services to financial institutions, much of it for use on the SWIFTNet Network, and ISO 9362 bank identifier codes (BICs) are popularly known as "SWIFT codes". The majority of international interbank messages use the SWIFT network. As of September 2010, SWIFT linked more than 9,000 financial institutions in 209 countries and territories, who were exchanging an average of over 15 million messages per day (compared to an average of 2.4 million daily messages in 1995).[2] SWIFT transports financial messages in a highly secure way but does not hold accounts for its members and does not perform any form of clearing or settlement. SWIFT does not facilitate funds transfer; rather, it sends payment orders, which must be settled by correspondent accounts that the institutions have with each other. Each financial institution, to exchange banking transactions, must have a banking relationship by either being a bank or affiliating itself with one (or more) so as to enjoy those particular business features. TMS: Treasury Management System includes management of an enterprise's holdings, with the ultimate goal of maximizing the firm's liquidity and mitigating its operational,

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financial and reputational risk. Treasury Management includes a firm's collections, disbursements, concentration, investment and funding activities. In larger firms, it may also include trading in bonds, currencies, financial derivatives and the associated financial risk management. For non-‐banking entities, the terms Treasury Management and Cash Management are sometimes used interchangeably, while, in fact, the scope of treasury management is larger (and includes funding and investment activities mentioned above). In general, a company's treasury operations come under the control of the CFO, Vice-‐President / Director of Finance or Treasurer, and are handled on a day to day basis by the organization's treasury staff, controller, or comptroller. UCITS: “Undertaking for Collective Investment in Transferable Securities”, created by Directive 2001/107/EC and 2001/108/EC are a set of European Union Directives that aim to allow collective investment schemes to operate freely throughout the EU on the basis of a single authorization from one member state. In practice many EU member nations have imposed additional regulatory requirements that have impeded free operation with the effect of protecting local asset managers. The Management Directive 2001/107/EC, seeks to give management companies a “European passport” to operate throughout the EU, and widens the activities which they are allowed to undertake. It also introduces the concept of a simplified prospectus, which is intended to provide more accessible and comprehensive information in a simplified format to assist the cross-‐border marketing of UCITS throughout Europe. WAM: “Weighted Average Maturity” is the weighted average of the time until all maturities in Money Market Funds, for example. It is used to measure interest rate risk and is calculated by taking the average length of time to maturity or the next interest rate reset for each underlying money market instrument held by the fund, weighted according to the relative holdings per instrument.

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The job of treasurer has evolved significantly during the last years. At a time of globalization and the development of so-‐called business management, it is an essential service to businesses. Work in a treasury department now requires specialist knowledge and adaptability to a constantly changing environment quickly. This book attempts to describe what are the main changes which the Treasurer has faced, and the main problems it encountered in the practice of his profession. It addresses the new and emerging themes that occupy the corporate treasurer, as well as the reasons for these changes. Treasurer of the profession remains unknown to the general public. In some languages, there is not even a translation of the word "treasurer". It is therefore useful to describe the changes and financial and technical challenges that the profession faces. This book takes a look at some of the issues and themes that meets all treasurers in their daily activities.

François MASQUELIER

Head of Treasury, Corporate Finance and ERM at RTL Group Honorary Chairman of the European Association of Corporate Treasurers (EACT) President of the Association of Corporate Treasurers of Luxembourg (ATEL)

François Masquelier is Director of Group Treasury and Corporate Finance at RTL Group (Europe's leading media) since November 1997. Before joining RTL Group, he worked Sakura Bank in Brussels, then on behalf Eridania Beghin-‐Say (Coordination Center), and finally at ABN AMRO Bank in Belgium and Luxembourg. He holds a Bachelor degree in Law of University of Liège, in Economics and Management of Liège School of Business and is Doctor in Tax Law. He has a postgraduate Management acquired from the Solvay Business School (ULB). He specializes in the area of Corporate Finance, Structured Finance, enterprise risk management and internal controls. Since 1999, he is President of the Association of Corporate Treasurers of Luxembourg (ATEL), and since May 2002, the European Association of Corporate Treasurers (EACT) which is a founding member. François Masquelier regularly publishes articles in various magazines and journals in finance and treasury as TMI (Treasury Management International), ASSETS, The Treasurer's Letter, Magazine du Trésoriers, L’Echo, etc.... He is Director and Chief Editor of the Treasurer Magazine, a quarterly publication devoted to the treasury and corporate finance. François has already published 5 books in French on corporate treasury and international accounting standards. Follow François on: (1) www.atel.lu ; (2) @FrancoisMasquel or (3) http://mytreasurer.wordpress.com

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