Treasury and Trade Solutions September 2015 Dealing with Volatile Markets Advanced Liquidity and Risk Management Techniques
Speakers Ron Chakravarti (Speaker) Global Head, Treasury Advisory and Solutions, Treasury and Trade Solutions, Citi Email: ron.chakravarti@citi.com Tel: +1 212 816 6909 Ron leads a global team responsible for supporting clients in defining and achieving treasury and working capital best practices. The team also structures solutions for advanced treasury constructs. He is based in New York City. His experience prior to Citi includes treasury and risk management consultancy at Treasury Strategies, Inc., leadership roles in transaction banking at ABN AMRO and Standard Chartered, and corporate banking at NationsBank (now Bank of America). Ron s career spans Asia, Europe, North America and Latin America. He is a frequent speaker at treasury conferences around the world and has authored numerous research papers and articles on treasury, risk, and working capital management topics. Ron holds an MBA from the University of Massachusetts, Amherst and a BA (Hons) from the University of East Anglia. Michael Botek (Speaker) Market Manager, Liquidity Management Services, Treasury and Trade Solutions, Citi Email: michael.botek@citi.com Tel: +1 212 816 0283 Michael is focus on advising clients on global liquidity and investment solutions, as well as on identifying client and market trends to shape Citi s product development. Previously, he held roles in FX, Fixed Income and Derivatives as well as Liquidity Management at both JPMorgan and Deutsche Bank. Michael joined Citi in 2005 and holds his Series 7 and 63 licenses and CTP. 1
Today s Agenda Geographic Scope Functional Scope Netting Pooling Capitalization Technology Regulations Benchmarking Advanced Treasury Structures 1. 2. Liquidity Management New Strategies Technology Regulations (- vet) Interest Rates Risk Management China Liberalization USD Appreciation Market Volatility Geo-Politics RMB New Ideas Risk Management 3. 1
1. Advanced Treasury Structures What are companies doing? Where Next?
In House Bank (IHB): Evolution Evolution usually driven by desire to create process efficiency, optimize Treasury resources and obtain positive cost/benefit outcomes through increased centralization. Centralization Cross-entity Liquidity Management Global II. Cross-entity Liquidity Management- Regional III. Centralize External Investments IV. Centralize Cash Forecast & FX Risk Mg V. Intercompany Netting - Cashless VI. POBO & ROBO IHB (Integrated with Business Units) IHB (Treasury Functionality) I. I/C Fixed Loans & Deposits Segregated Liquidity Management (no co-mingling) Netting - Cash Settlement Finance Company Range of Services 2 Advanced Treasury Structures
In-house Banking Practices Best in class entities use an in-house bank to facilitate the best and most transparent use of funds among the enterprise. In-house Banking In-house Banks are Used by 44% of firms in the Survey Use IHB Netherlands Belgium Ireland Switzerland 11% 10% 9% 8% Top IHB Locations 44% 24% of firms leverage their IHBs to account for more than 95% of their Inter-company Transactions Luxembourg Singapore 7% 7% Best In Class Firms leverage Treasury Technology for IHBs 54% of respondents record their IHBs participant s positions using virtual/ledger accounts in TWS / ERP systems IHB Accounted for Inter-company Transactions Best in Class Over 95% 24% 75 94% 22% 51 74% 18% 62% of respondents calculate and apportion interest across inter-company positions using interest bearing ledger accounts in TWS / ERP systems 26 50% Under 25% 15% 17% Source: Citi Treasury Diagnostics 3 Advanced Treasury Structures
Key Functions Of IHB The IHB intermediates cash, foreign exchange, and funding transactions between subsidiaries and external banks. Once in place, the infrastructure also facilitates centrally managing and responding to changes in markets, regulation, corporate transformation/m&a, etc.. Cash Concentration Liquidity Management FX Management IHB becomes global pool header to centralize cash, short term funding of subsidiaries, and net investing Adoption of POBO/ROBO further reduces fragmentation of liquidity, saves FX spreads, improves forecasting Subsidiaries execute FX trades (convertible currency pairs) with IHB - which nets positions - materially reducing external trades Centralized portfolio of exposures at IHB can be better managed and hedged Investments Cash Forecasting POBO/ROBO Netting Risk Management Hedging Subsidiary Funding Sub capital structure optimized by repatriating more retained earnings to HoldCo, with IHB providing long term debt funding, within country thin cap limits for tax deductibility Short term (Working Capital) Long term (Capital Structure) 4 Advanced Treasury Structures
Path To Centralized Liquidity and Risk Management MNCs adopt best in class practices typically by centralizing their global liquidity and risk management in a phased manner. The IHB can play a key role. Decentralized Partially Centralized Centralized Sub Banks Sub Banks Sub Sub Banks Sub RTC Banks Sub IHB Bank Sub Banks Sub Banks Sub Liquidity and risk managed primarily at Subs level Management of liquidity and risk exposures moves to regional hubs, e.g. RTC Management of liquidity and risk moves to central In House Bank (IHB) or similar structures Risk Management Manual Processes Sources: Subs Types: Booked Trades mostly booked by Subs (some trades may be by Treasury centrally) Partial Automation Sources: Subs, ERP systems, RTC Types: Booked, Anticipated up to 1 year RTCs trade on behalf of Subs. Regional FX positions may be managed on portfolio basis Centralized solution extensions Sources: ERP systems, Global TMS Types: Booked, Anticipated Subs execute FX trades with IHB, which manages net exposures with banks Liquidity Management Manual Processes Subs manage liquidity and bank cash positions Partial Automation Subs may maintain bank cash positions, however RTCs have control over liquidity/funding on their behalf Centralized solution extensions Subs place liquidity or obtain funding with IHB, which solely manages net liquidity with banks Likely Effects Inconsistent liquidity and risk management Poor oversight of exposures and liquidity, ineffective processes Good regional oversight and cost synergies However, potential incorrect perceptions of global liquidity positions/funding needs, risk management inefficiencies Maximizes global funding and risk mitigation efficiency Benefits in FX, liquidity/funding, counterparty risk and free cash flow global oversight 5 Advanced Treasury Structures
2. Liquidity Management What is disrupting the status quo?
Treasury Priority: Optimizing Liquidity Management Evolving commercial and market realities are making legacy liquidity management practices sub-optimal. Changing Commercial Flows Diverging Rates and FX Volatility Improve Liquidity Mg Rationalize Account Structures Assess Advanced Solutions Technology ERP TMS Connectivity Cash Management Processes Cash Management I/C Lending Risk Management Key Performance Indicators People Treasury Centers Netting Centers In House Bank Changing Regulations & Tax Rules Alignment of People, Processes and Technology in support of the evolving needs of the corporate growth agenda 6 Liquidity Management
From Diverging ZIRP (and to NIRP*: Negative) New Interest Challenges Rates Treasury Considerations of NIRP* FX Revaluation losses On foreign currency assets and liabilities Intercompany Loans Cash flow deltas arising from differences in spot rates on hedge rollovers Tax Arms Length Principles Need to ensure alignment with transfer pricing guidelines on intercompany loans and pooling benefit Operational & Organizational Treasury KPIs & Budgets pressure on returns, use it or lose it Technology need to ensure treasury technology capable of dealing negative rates Organizational internal hurdles when subsidiaries receive negative rates for intercompany deposits Counterparty Management process challenges of investing with more local providers Cash Management Processes Improve cash positioning accuracy Reassess daily investment & funding positions: e.g. funding outflows Swap out where implied rates attractive Reset cash pool interco rates Maintaining consistency with liquidity objectives Tsy Centralization Profile Improve cash flow forecasting Optimize banking structures: centralize management of cash, but hold multi-domestic Reassess economics of working capital financing to avoid excess cash Balancing control, counterparty, and yield considerations Corporate Finance Initiatives Reevaluate business commercial terms, invoicing currencies Reassess interco lending programs and hedge policies Review policies for earnings repatriation, local debt raising vs. interco funding Integrating broader enterprise perspectives *NIRP: Negative Interest Rate Policy 7 Liquidity Management
Regulatory Environment Reshaping Bank Balance Sheets Liquidity Liquidity Coverage Ratio Net Stable Funding Ratio Intraday Final Rule Proposed Final Rule Require banks to maintain adequate liquidity buffers to manage unexpected outflows as well as stable funding to support key businesses during periods of extended stress. Leverage Leverage Ratio Statutory Liquidity Ratio Final Rule Final Rule Establishes minimum capital requirements based upon total assets and lending commitments regardless of riskiness of those assets. Risk-Based Capital Tier 1 Capital Total Capital G-SIB Buffer Capital Conservation & Countercyclical Buffer Final Rule Final Rule Final Rule Final Rule Sets minimum capital requirements based upon riskiness of lending and other assets. SIBs must hold additional capital to absorb impacts of market stresses and continue providing services critical to marketplace without public support. With capital and funding models evolving, banks are reevaluating business activities. Even for operating services (which appear intrinsically attractive) nuances matter as banks have to assess balances based on regulatory value: how much of deposit is operating. Client deposits with high regulatory value will become viewed as providing return needed for credit extension Final Rule and Proposed based on rulings by the US Federal Reserve Board. A full progress report on the global implementation of the Basel III regulatory framework can be found at http://www.bis.org/ 8 Liquidity Management
Integrating Major EMs into Global Treasury Structures: China Backdrop Treasury Considerations Potential Actions Politically marching to own tune, hard to predict outcomes Capital Markets & Funding Integrating into global liquidity structures to alleviate trapped cash or funding needs Economy in state of transition, with moderating growth Concerns about soundness of financial system Currency movements widening RMB Internationalization reforms continue, but multi-faceted and complex Cash & Liquidity Management Treasury Controls & Operations Risk Management Changing invoicing currencies to create natural hedges or support growth Centralizing FX risk into RTC/IHB to aggregate and net positions But in consideration of the longer term: Crossing the river by feeling the stones 9 Liquidity Management
Other Developments: Impacts On Corporate Structures Evolving regulations and penalties/opportunity costs for non-compliance will drive changes and require technology and organizational alignment. Global Tax OECD/BEPS refocuses MNC attention on substance, establishment, transparency and deductibility Specific amendments to transfer pricing guidelines Reviewing and modifying trading models and intercompany pricing processes to comply and optimize within new and evolving boundaries Impacting intercompany lending, Netting, SSCs, etc.. with increased levels, frequency and consistency of reporting US Tax FATCA Increases reporting and compliance on US persons in the US and abroad Withholding timelines through 2017. Local legislation and guidance will lead to variations in the date and format for reporting Updating ongoing legal entity, products and services, payments and payee analyses so that withholding and reporting requirements are clear Reporting policies, procedures, governance structures, and systems need to keep pace Other Reform SEC 2a-7 Money Fund Regulation & EU Money Fund regulation Evaluating investment policies in consideration of expected reform to allow for optimized portfolio Segmenting cash portfolio to allocate cash buckets within policy for risk weighted returns 10 Liquidity Management
3. Risk Management Where are the opportunities to add value in this volatile market?
Corporate Risk Management Trends (Citi Treasury Diagnostics) Continued Centralization of Treasury risk management. Resource optimization, counterparty risk, hedging costs, exposure quantification. Consensus on risks created by strong dollar cycle. Limited action taken. EM Risk Management: bifurcated approach from G10 in both policy and execution. In some cases, subsidiary financing and risk mitigation remain outside scope of central Treasury decision making. Exposure quantification evolution: from traditional notional risk measurement to sensitivity-based analysis. Heavy preference for layered hedging programs. Limited hedging beyond 6 months. Focus on internal market risk visibility architecture. Move to review existing hedging programs. Unexpected jump risk in both earnings and key financial ratios. Earnings volatility, thin cap, tax, credit rating, re-capitalization. Required high degree of risk understanding across both financial and operational parts of the business. Limited effectiveness in reducing volatility and economic risk. Accounting based and economic earnings volatility. Higher operational and transactional costs. 11 Risk Management
Path To Effective Risk Management Probability Consolidate Transaction FX Flow to Portfolio Exp Level Centrally Manage All Exposure (Commercial cash flows and financial assets & liabilities) and hedges are tracked in treasury management system. Sub Sub Sub IHB Segment Risk Bank Instrument (e.g. forward, swap) Type (sales, purchasing, and various internal txn types) Financial exposure (e.g. bank cash or loans in non-functional currency Determine Value at Risk at Portfolio Level 50% 40% Value-at-Risk (Probability Distribution) Outcomes Linking FX risk and flow identification architecture to a rules-based cost effective risk management program Risk management objectives will be best met if each is properly understood, executed and monitored 30% 20% 5% Worst Case Loss 10% 0% Gain / (Loss) 12 Risk Management
FX Transaction Risk Practices: Hedge Maturity Profiles Layered hedging approach is the most common. However, the economic and risk reduction benefits expected have been limited due to short term hedging practices (1-6M). In G10, clients are now investigating the benefits of extending the hedging tenor past 1-year. Approaches to hedging forecasted exposures 78% 72% 72% Hedge 50%+ Static Hedges Rolling Hedges Proportion of forecasted exposures hedged 33% 44% 28% 21% Hedge 75%+ 7% 7% 7% 7% 7% Other 0 3 Months 3 6 Months 6 12 Months 12 24 Months 24 36 Months Greater than 36 Months Layered Hedging Frequency of hedge performance analysis Weekly 12% Never 12% Quarterly 23% Monthly 53% Source: Citi Treasury Diagnostics 13 Risk Management
Emerging Markets: Changing Mindsets? Early indications of a shift towards the bifurcation of hedging practices between EM and G10 exposures. Hedging costs and lack of liquidity continue to be main concerns cited by senior management. 100% of respondents reported having exposures to EM currencies Managing EMs differently than G- 10 currency risks 23% 14% 5% 5% 55% All Currencies Hedged the Same More Options Used for EM to Avoid Negative Forward Points G10 BS Exposure Hedged 100%; EM Very Sectively/Not at all Forecasted EM Risks are Hedged but for Shorter Tenors G10 Currencies are Hedged; EM Currency Risks are Not Percent of respondents with exposures to currencies outside the G-10 currencies 100% Hedging Costs/Negative Forward Points Lack of Liquidity Meeting Local Regulatory Approvals And Requirements 42% 58% 63% EM currency risk management concerns Basis Risk Between the On-Shore and Off-shore NDF Markets All of the Above 16% 37% Limited Hedging Instrument Selection 16% Other 11% Universe of respondents totals 23 companies Source: Citi Treasury Diagnostics Settlement Risk 11% 14 Risk Management
Intercompany Lending: Does This Keep You Awake At Night? Frequency of local discretion and focus on tax suggests need for further alignment to better address potential risk management implications. Policy Governing Intercompany Lending Activities 53% 17% No policy Governs the currency in which a Subsidiary may borrow 6% 24% 17% Yes, whenever possible in local functional currency Yes, always in parent functional currency No, local discretion allowed Other 83% Policy Rationale to fund via intercompany loan or a Third-party Local Bank Tax Considerations Local Regulations Cost of Local vs. Global 48% 52% 61% Mitigation of Cross-currency Risk Availability of Local Currency Financing Other 30% 35% 39% Mobilizing Incremental Credit Capacity 17% Source: Citi Treasury Diagnostics 15 Risk Management
Case Study: Value at Risk Portfolio Based Approach An auto-parts maker with manufacturing operations and sales in the Asia Pacific region CNY 4% USD -5% THB -16% Net FX Exposures INR 12% PHP -14% AUD 4% EUR 3% IDR 19% JPY -7% MYR TWD -10% 6% Currency 50% Single Hedge Ratio Optimal Hedge Ratio AUD 100% EUR 100% IDR 45% JPY 90% MYR 100% TWD 50% 100% PHP 56% THB 58% USD 0% CNY 0% INR 44% Post Hedge Vary (SGD) 308,363 308,363 Cost (SGD) 65,071 49,200 Original Approach o o Company manages its FX risk out of a Treasury Center in Singapore and against SGD Company currently has various foreign currency accounts receivables and payables of an average tenor of 2 months o Client uses only Non-Deliverable Forwards and currently hedges 50% of all outstanding exposures o The hedging cost on the portfolio can be high due to the presence of a number of emerging markets currencies Revised Approach o o Citi helped the company optimize forward hedging costs using a Valueat-Risk analysis where the portfolio risk level is kept the same but overall hedging cost is reduced Citi provides bi-weekly updates on the optimal hedge ratios for each currency dependent on the company s actual exposures Benefits o o After a trial of 6 months, the company reported a 40% cost improvement compared with their original strategy The Value-at-Risk limit set was not breached during the trial period 16 Risk Management
Citi Treasury Diagnostics Citi Treasury Diagnostics (CTD) is an award-winning, web-based benchmarking tool designed to assess the effectiveness of your company s treasury and working capital practices and processes against industry peers and best-in-class companies. Developed in 2009 and with over 600 completions to-date, CTD is the cornerstone of our Treasury Advisory suite of services CTD assesses, quantifies, and benchmarks your company along six key dimensions of treasury operations: Policy & Governance Liquidity Working Capital Subsidiary Funding & Repatriation Risk Management Systems & Technology CTD provides your company, via a customized benchmarking report, comparative insights on your performance versus what is deemed best-in-class to facilitate optimized treasury operations, enhanced efficiency, and speedier progress toward achieving a world-class treasury function Participants benefit from access to Citi s expert advisors, industry knowledge, and leadership position in the field of treasury and working capital management during an in-depth delivery of benchmarking results All survey responses are confidential between you and Citi, and only aggregate results are used when publishing benchmark metrics CTD has been the recipient of numerous industry awards, including: Winner Innovative Product Winner Model Bank Award Silver Winner Solution of the Year 19 Risk Management
20 Risk Management
IRS Circular 230 Disclosure: Citigroup Inc. and its affiliates do not provide tax or legal advice. Any discussion of tax matters in these materials (i) is not intended or written to be used, and cannot be used or relied upon, by you for the purpose of avoiding any tax penalties and (ii) may have been written in connection with the "promotion or marketing" of any transaction contemplated hereby ("Transaction"). Accordingly, you should seek advice based on your particular circumstances from an independent tax advisor. Any terms set forth herein are intended for discussion purposes only and are subject to the final terms as set forth in separate definitive written agreements. This presentation is not a commitment or firm offer and does not obligate us to enter into such a commitment, nor are we acting as a fiduciary to you. By accepting this presentation, subject to applicable law or regulation, you agree to keep confidential the information contained herein and the existence of and proposed terms for any Transaction. We are required to obtain, verify and record certain information that identifies each entity that enters into a formal business relationship with us. We will ask for your complete name, street address, and taxpayer ID number. We may also request corporate formation documents, or other forms of identification, to verify information provided. 2015 Citibank, N.A. All rights reserved. Citi and Citi and Arc Design are trademarks and service marks of Citigroup Inc. or its affiliates and are used and registered throughout the world. 2015 Citibank, N.A. London. Authorised and regulated by the Office of the Comptroller of the Currency (USA) and authorised by the Prudential Regulation Authority. Subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details about the extent of our regulation by the Prudential Regulation Authority are available from us on request. All rights reserved. Citi and Citi and Arc Design are trademarks and service marks of Citigroup Inc. or its affiliates and are used and registered throughout the world