Key Takeaways from NeuGroup's 2019 H1 Treasurers' Group of Thirty Large-Cap Edition
T30LC members discussed the art and science of centralizing treasury, managing succession and other talent challenges, ESG finance, capturing and hedging FX exposures and more at a meeting sponsored by Deutsche Bank in Minneapolis.
Centralized vs. Decentralized Treasury: Striking the Right Balance
Many multinational corporations have centralized treasury over the past decade to increase control, improve forecasting, gain efficiencies and boost their ability to scale. The push to centralize has led many MNCs to establish both regional treasury centers (RTCs) and shared services centers (SSCs) across the globe. At the last T30LC meeting, members heard about one company's centralization journey and raised some questions about its concurrent, dramatic reduction in treasury head count.
Do a review, make a plan, execute it. In 2012, the company hired a consulting firm to evaluate its highly decentralized treasury organization. Following the consultant's review, a plan was set to transform from a transactional, decentralized, cash focus to establishing a global treasury operations structure. The member traveled the globe to question regional finance leaders about their activities. A key step was adopting a new treasury management system (TMS), putting everyone on the same platform: Reval. By 2018, the company had created regional treasury hubs and a global SSC that handles bank account administration and fee analysis, intercompany funding and TMS administration and security.
Partner with local teams. Members agreed on the need to strike the right balance between centralizing treasury and maintaining close ties with local business teams who know the lay of the land financially and otherwise, especially in emerging markets. One treasurer stressed that amid centralization you can't underestimate the value of face-to-face communication. And while technology can bridge the gap between headquarters and local teams, one member said it's vital to have people who need training in the same place as their instructors.
The risk of cutting too deep. The presenting member said that along with the move to decentralize, management cut treasury head count by half. One member said that looking at the far-flung operations of the presenter's company, the deep cuts suggested that going forward, no one in the slimmed-down treasury team would have time to do any strategic thinking. A slightly more positive note was struck by a member whose very large treasury team shrank a bit while realigning into three groups: treasury advisory (focused on credit), treasury markets and treasury services. The member said the focus is on being more intellectual and having more purity of roles. Some functions moved to FP&A. She credited a CFO who came from outside the company with "really opening our eyes" to the value of reorganizing along these lines.
Talent Challenges: Succession and Technology
Coping with reduced or stagnant head count amid growing responsibility is not the only talent management or organizational challenge facing T30LC members. Here are two other issues that surfaced at the spring meeting:
1. Succession planning. The treasurer of a large health care company said planning for the future is an issue "near and dear" to him because he is confronting "a race for the door" as two senior people in his organization prepare to retire. He doesn't want to look outside the company for their replacements, but will be forced to because his treasury team is fairly small and doesn't have a lot of turnover.
2. Data scientists, data governance. The push to automate and make better use of data analytics means treasury teams are among those searching to find data scientists to help lead finance into the future. One member said it's hard for his company to find people with this hot skill while another said she lost an insurance person on her team and is backfilling with a data scientist. And the value of data is creating another organizational challenge for finance teams: figuring out who owns it and who is responsible for data governance. "We need to make a big push in that space," one treasurer said. Another said, "You need to have governance over the data; otherwise, it's just junk." A third member said her company is trying to address the data tug-of-war between treasury and the business units by establishing centers of excellence. "We're trying to get everyone on board," she said.
Digging into the Details of ESG Finance
"Sustainability finance" is how one member described his top priority coming into the T30LC meeting. He wants treasury to help drive progress toward the company's goal of becoming carbon neutral. One reason is the consumer-facing company hopes to gain reputational benefits from pushing environmental, social and governance (ESG) initiatives.
Understand the ways and means of going green. Beyond the acronym is where ESG gets interesting, but more complicated. So the treasurer wants to evaluate the risk/return profiles of various deal types, including a power purchase agreement (PPA), a virtual power purchase agreement (VPPA) and tax-equity deals for renewable energy projects. As Bloom-berg explained in a recent article, "In tax-equity deals, companies passively invest in power projects in return for using renewable-energy credits that offset their own tax liabilities."
The green bond calculus. This treasurer would like to issue a green bond (see "Selling a Green Bond: How and Why to Do It" on iTreasurer.com) but doesn't have enough uses for the proceeds to qualify at this point. Another member explained his company's stance as follows: "We are interested in having an appropriate/good ESG score, but when it comes to bond issuances, we have not seen there is an economic advantage to having the bonds rated as green bonds, so we have issued traditional bonds." A third said while her company wants to help shape public perception of its product, treasury doesn't see the economic value of issuing a green bond and doesn't want to do a lot of extra reporting that may come after issuing the bond.
Where are you on the green brick road? The member whose company aims for carbon neutrality has a sustainability committee, while less than half of participants at the meeting said their companies have chief sustainability officers. One member, who noted that her company is debating whether to proactively manage its ESG score as more investors adopt ESG criteria, said, "It's coming; it's going to be an important factor down the line."
Hedging FX Exposure: Making a Tough Task More Manageable
Treasurers at multinational corporations that hedge risks posed by foreign currency swings face numerous challenges, often starting with gathering information about their FX exposures, a process that usually involves business units and FP&A. Members of the T30LC discussed some of the challenges and got insights on solutions from experts at Chatham Financial and Deutsche Bank. Following are some of the key takeaways.
Figure out who owns the risk. One member said at his company, the business units usually take the risk of hedging onto their profit and loss (P&L) statements, a situation some participants said is ideal because it inevitably improves forecasts of exposures. Another participant said that at a former company, he issued an ultimatum about giving business units responsibility and the CFO signed off on it. One member said at her company, treasury sets the hedging policy and limits while the businesses own the risk, a model another member also follows. Partnering with accounting as well as business units is also important, one person said. In all, about half the participants indicated treasury has central control of hedging FX risk, which can improve aggregated visibility and netting across the organization.
Ask the right questions. Very few participants said they had nailed down a perfect forecasting and exposure identification process to manage FX risk. To help, Chatham's presentation included six challenging hedging issues that can be addressed in part by finding answers to these questions:
1. Forecast visibility. How much visibility and confidence do we have in our forecasts?
2. Access to data. Do we have access to the required data to gather relevant exposures?
3. Data format and accuracy. Is the data in the right format to process and can we evaluate its accuracy?
4. Resource availability. Who are the right resources to collect and verify the information?
5. Illiquid currencies. How can we tackle challenges associated with illiquid currencies?
6. Reporting rhythm. What is the internal reporting rhythm and audience?
Metrics matter. Part of identifying the objectives of your hedging program is picking the metrics that make the most sense given your stakeholders and their risk management goals. Then you need the right data to measure performance. Chatham shared a number of commonly used metrics noted below, which are often stress-tested through a value at risk (VAR) or cash flow at risk (CFAR) analysis to provide some statistical rigor.
Economic value added
EBITDA or EBIT
Internally defined
Be aware of competing metrics. Chatham showed a slide making the point that it's not uncommon for a company to care about multiple metrics but that these metrics "can lead to different strategic decisions." The example showed that on an EBITDA basis, a hypothetical company may show exposure of $45 million to the Canadian dollar (CAD) while on a net income basis the same company shows an exposure of negative $15 million CAD as a result of CAD-denominated interest expense impacting net income but not EBITDA. This type of situation will often trigger internal conversations around prioritization of metrics prior to initiating hedges.
The future of hedging. While many NeuGroup members make use of tools like FiREapps to improve FX risk management, Chatham envisions a future in which the moment an exposure is identified through a treasury workstation, online customer action or creation of an intercompany agreement, a system will automatically initiate an FX risk management transaction. The system would automatically deliver an analysis of hedging options, obtain leadership approval, execute the hedge and then handle all required documentation and reporting. The increased availability of standard APIs for integration and function-specific BOTs to accomplish unique tasks make this possible. Chatham is focused on advancing risk management automation by both creating systems featuring end-to-end, straight-through processing and leveraging APIs to establish seamless connections across treasury management tools.
Dual currency invoicing. The future may also mean increased use of dual currency invoicing, in which a US corporate issues an invoice in its preferred currency (e.g., USD). At the point of sale, the client chooses which currency they would like to pay in. If a foreign currency is chosen (e.g., EUR), an FX contract is automatically executed with a bank and funds are automatically reconciled with the original invoice.
Cash Repatriations and Stock Repurchases
Many companies only repurchase their own stock when the price dips below what they consider to be its intrinsic value. At the T30LC spring meeting, Deutsche Bank argued that waiting for dips is not the most effective way to repurchase shares. The bank also said that while companies have repatriated a lot of cash since US tax reform—much of it used to buy back shares—a surprising amount of cash remains on balance sheets.
Why wait? Dollar-cost averaging—spreading out purchases over time instead of buying all at once—is a popular theory among investors. But Deutsche Bank studies suggest that for almost all sectors, more shares are repurchased if companies buy as soon as cash becomes available instead of waiting until the stock declines.
The danger. "Management is notoriously optimistic about its undervaluation," one Deutsche Bank executive said. But given the commitment companies make to repurchase shares, they have to buy them back eventually, even if the dip never comes, he said. "So the danger is waiting."
Methodology. The back-testing studies assume that if the required dip does not occur after one year, the company starts spending incremental cash flow on share repurchases because "we assume that no more than one year of cash flow can be retained," the bank said.
Buyback slowdown. In late June, S&P Dow Jones Indices reported that share buybacks for S&P 500 companies in 2019 Q1 totaled $205.8 billion, a decline following four consecutive record quarters in 2018, when buybacks totaled $806 billion. Announced buybacks topped $1 trillion last year, according to TrimTabs.
S&P said the average share price during the first quarter increased 0.8% after Q4 2018's average price decline of 5.3%. Combined with the 7.7% decline in buyback expenditures compared to Q4, this resulted in approximately 20% fewer shares repurchased.
Repatriation slowdown. The slowdown in buybacks came as companies brought less cash back from overseas: Q1 2019 government data showed the pace of repatriations slowed to a seasonally adjusted $100.3 billion. That was the smallest quarterly amount since the tax law changes went into effect. Last year, companies repatriated $776.5 billion in foreign profits following the tax law overhaul.
Piles of cash. "It's high," the Deutsche Bank banker said of the amount of repatriated cash. "But companies are still sitting on massive piles of cash. And some companies have been increasing the amount of cash." Deutsche Bank said health care companies have been the most proactive in reducing cash balances. In all, Moody's Investors Service says corporate cash holdings totaled $1.685 trillion in 2018, a three-year low.
Reasons not to repatriate. The banker said it's surprising companies have not distributed more cash to shareholders, given that holding a lot of cash detracts from their valuation. One reason for the relatively large cash balances, he suggested, is that activist shareholders "don't seem to care anymore" about cash levels, at least compared to the past. Other reasons companies may be keeping cash offshore include losses they'd have to take if they liquidate positions that are underwater, the need to use the cash offshore for foreign acquisitions, and not wanting to draw scrutiny from politicians critical of companies using lots of repatriated cash for buybacks.