New rules force up price of money
The torrent of financial services regulation unleashed since the 2008 banking crisis may not have been directly aimed at corporate treasurers, but it has still rocked their world.
“Regulation features high among treasurers’ concerns because banks, effectively, are being restricted in what they can and can’t do,” says Michelle Price, associate policy and technical director at the Association of Corporate Treasurers.
The string of rules that banks – and therefore treasurers – have to contend with relate to derivatives trading, money laundering, tax and sanctions, among other topics.
No one is immune to the direct or indirect effects of Basel III
But, ultimately, the regulation that will probably have the greatest impact on banks and their corporate clients is the infamous (in the financial services world, at least) Basel III accord, which has already transformed the banking environment that treasurers operate in on a day-to-day basis.
As Bob Stark, vice president of strategy at treasury software provider Kyriba, puts it: “No one is immune to the direct or indirect effects of Basel III.”
Basel III, implemented in the form of Capital Requirements Directive IV in the European Union, requires banks to hold capital of at least 8 per cent of their risk-weighted assets. But not all capital is ranked as equal and banks are under particular pressure to hold so-called high-quality capital such as common shares and retained earnings. The idea is that, if necessary, this capital can be used as a buffer to absorb unexpected losses and to fund the bank’s ongoing activities.
Unfortunately, keeping capital on balance sheets is expensive for banks so they have started to pass this cost on to businesses. Already, companies have had to pay more for certain products, such as the derivatives, that they use to hedge financial risks.
Financial software provider Misys has encountered business challenges as a result of the capital ratios. “We’re highly levered,” explains Angela Clarke, the company’s head of treasury. “When the banks apply their ratios, they apply a credit charge. So what might be the right thing to do from the point of view of managing the organisation becomes prohibitive as a result of the costs that are being applied.”
Higher capital requirements have also had an impact on the availability of trade finance across the globe, according to Ruth Wandhöfer, global head of regulatory and market strategy at Citi Treasury and Trade Solutions. “A lot of trade finance is provided by the large banks, which have to hold more capital,” she says. “As a result, there is a risk that trade finance is starting to become restricted to those businesses that can afford it.”
It’s not just capital that banks have to worry about under Basel III. They will also have to meet its requirements in relation to leverage, liquidity and long-term funding. The accord’s leverage ratio sets the amount of capital that a bank needs to hold as security against its financing commitments. Meanwhile, the liquidity coverage ratio is intended to ensure that banks have enough eligible liquid assets to withstand a 30-day stress scenario. Finally, the net stable funding ratio aims to secure the bank’s long-term stability by forcing it to match the duration of its stable funding with the duration of its long-term assets more closely.
The leverage ratio and the net stable funding ratio are not due to be widely implemented by banks until 2018. But businesses have already started to feel some side effects from the liquidity coverage ratio, which was introduced at the start of this year. Banks now prefer to hold operational cash rather than investment cash on behalf of their corporate clients since operational cash is considered less of a flight risk in stressed conditions.
Indeed, such is the banks’ demand for “stable” capital that even large, well-established corporates can find it hard to put their cash on deposit for less than 30 days at present and some have had to accept negative interest rates. “A number of companies are very cash rich, but they are having difficulties finding the right investment options,” says Ms Wandhöfer. “The Basel liquidity regime has meant the liquidity value of deposits from corporates is not as high as it used to be.”
Meanwhile, the net stable funding ratio will disincentivise banks from making long-term loans since they will need to have long-term funding in place to support them. In the not-to-distant future, then, banks may end up becoming little more than providers of bridging finance for large companies that may predominantly have to secure longer-term funding from other sources, such as the capital markets.
Aside from the potential problems that this situation poses for smaller businesses that don’t necessarily have the knowledge – or the credit rating – to successfully tap the capital markets, it also relies on the capital markets themselves functioning well. Yet, as Ms Wandhöfer points out: “Financial markets don’t always act rationally – this is a risk that cannot be controlled by regulations.”
Although the world of financial services is changing around them, treasurers do not have to be victims of circumstance, however. They do have alternative sources of funding available, such as the corporate bond and private placement markets as well as peer-to-peer lending platforms. They also have alternative investment options, such as repos or repurchase agreements, corporate commercial paper and government bonds. A further possibility is making more use of their organisation’s own cash resources.
“Treasurers are increasingly looking to optimise their internal working capital rather than relying on external borrowing,” says Kyriba’s Mr Stark. “They can employ cash forecasting to get predictability of cash flows and greater visibility of what’s coming. They can look at intra-company structures, and use cash pooling and netting so the company uses its own liquidity to fund the business.”
The Association of Corporate Treasurers’ Ms Price believes that, while businesses have seen some of the impact of Basel III, they haven’t felt the full force of it yet. So she emphasises that treasurers need to be “reading up”. She adds: “They need to be asking their banks, how is this impacting you and what is the knock-on impact on business finance and risk management?”
Ultimately, regulators are hoping to make the financial markets safer. But is this the outcome that treasurers are seeing in practice? “It’s not all bad,” Misys’ Ms Clarke concedes. “Maybe when we’ll look back later, we will see the benefits. I hope that’s what happens.”
KEEP AN EYE ON EMIR
It’s not just Basel III that has proved to be a headache for treasurers. In 2014, many of them were thrown into a tailspin by the requirement under the European Market Infrastructure Regulation (EMIR) to report their over-the-counter derivative trades to newly established trade repositories.
The regulation, which affected every company that had one or more derivative, was a compliance nightmare for many corporate treasurers. This was mostly because there was a lot of confusion about the process and the approved trade repositories were announced at a late stage.
“We were a bit disgruntled by how it was rushed in,” says Pedro Madeira, assistant treasurer of Heathrow Airport, which has a £10-billion derivatives portfolio. “It was a long time in the offing, reviewed multiple times and then implemented before anyone was ready for it, which caused a mess.”
Unfortunately for treasurers, the nightmare isn’t entirely over since some of them will be affected by further rules that take effect in December. Those affected are likely to be treasurers who work for large energy companies that use derivatives to trade risk, rather than just hedge risk. Companies that exceed the clearing threshold will be obliged to clear over-the-counter derivative contracts through central counterparties and apply risk mitigation techniques, such as portfolio compression.
Mr Madeira acknowledges that EMIR has helped to improve the confirmation process for derivatives. But he says treasurers need to keep a close eye on how the regulation develops. “If you see something that’s going to affect you, talk about it,” he says. “Don’t expect everyone else to speak for you.”
Meanwhile, Angela Clarke, head of treasury at financial software provider Misys, questions what the reporting of derivative trades will ultimately achieve. “We have no insight into what is going to happen to that data,” she says. “It seems to be going into a black hole.”