By Paul Higdon
chief technology officer
It is now over two years since the full fury of the financial crisis struck. Its effects have reverberated throughout the corporate treasury industry, changing priorities in cash, treasury and risk management, and in the demands and requirements placed on the technology solutions that support these operations. More specifically, treasurers’ priorities have firmly shifted towards improving different elements of cash and liquidity management, and also towards counterparty risk management.
These new priorities are confirmed in PricewaterhouseCoopers’ (PwC) Global Treasury Survey 2010 (1.); for example this survey finds that post-crisis, over 70 per cent of respondents now regard cash and working capital management to be ‘very important’, compared with less than 40 per cent on a pre-crisis basis. The survey shows similarly striking changes in approaches to counterparty risk limit management, with growth in the monitoring of market-sensitive indicators such as bond yields, equity prices and CDS spreads as an emerging interest among corporates.
The IT2 2010 client survey revealed some interesting results (see Figure 1.), from which we learn that treasurers’ interest in enhancing cash visibility is a major priority over the next three years. As illustrated above, respondents anticipate a significant investment of time and effort over this period in several business areas generally relating to liquidity and working capital management.
Another area highlighted in IT2’s study is enhanced counterparty risk management. The study revealed that a significant majority of executive respondents – 70 per cent - anticipate increased investment in managing counterparty risk over a three year time horizon. Most of the rest (27 per cent) already felt that they had a strong solution in place for counterparty risk measurement and management. This leaves just 3 per cent who expect that counterparty risk to be a less significant issue in three years time.
The visibility of cash and counterparty risk are both areas that require strong supporting technology to provide best practice solutions. In the case of cash visibility, this is primarily because of the need to assemble and analyse data from a disparate number of sources, and to present this data in a timely and practical fashion. Risk management makes relatively heavy computation demands, for example in the valuation of exposures. In both cases, the underlying justification for making the necessary technology investment is the reduction in critical risks, whether related to diminishing liquidity or to exposure to counterparty with collapsing creditworthiness. The current trend in treasury technology has been to develop solutions that address these critical issues so that corporate treasuries can measure and manage them with confidence.
Cash visibility essentially requires the ability to compile and maintain an accurate cash position and forecast. The components of a cash position are derived from current bank account balances and the reported actual transaction flows, the impact of treasury transactions, and often of the committed commercial flows through integrating accounts payable and receivable information.
The key current trend is elevated interest in improved methods of obtaining bank account balance information. Many corporates have tended to depend on a range of balance reporting techniques, of varying degrees of dependability. The situation is complex because many operate multibanking arrangements, for relationship and liquidity reasons, as well as the requirement to fulfil certain banking needs such as tax payments through local banks. We are now seeing a general increase of interest in streamlining this process in multibanking environments, with a tendency to adopt more robust solutions, such as SWIFT, or the use of bank overlays, or of third party overlays such as FIDES. Other organisations have been able to take the simpler path of cutting down the number of banks and bank accounts with which they work to cut both costs and complexity; but, as we have seen, this route is not available to all.
The IT2 survey found that the estimated level of visibility of cash as a percentage of the total cash in the organization was 78 per cent, with a plan to increase, on average, to 91 per cent over the next three years. Talking to treasurers, it seems that there may not be an economic case for going for 100 per cent visibility, but there is a growing consensus that a figure of above 90 per cent is valuable - and achievable.
Full cash visibility adds the dimension of forecasting to the certainties of the cash position. The value of forecasting is a subject for continued debate. It is often the case that otherwise well-automated companies still struggle with spreadsheets for forecasting, and consequently make do with a solution that can fall short in terms of robustness and reliability. 60 per cent of the respondents to PwC’s survey identified forecasting as a ‘most important development’ – in fact, it was the main priority. It seems that the importance of forecasting in achieving fully effective cash management should encourage companies to actively investigate the means to achieve best practice in this area over the coming years.
A newer approach to cash visibility is represented by corporate interest in the general enhancement of bank account administration processes. This represents a logical future extension of the cash visibility issue: having a reliable central understanding of the organisation’s bank accounts - how many there are, where they are located – increases the dependability of the cash position information. Secure bank account management additionally reduces the enterprise’s level of operational risk, as the current status of authorised signatories is properly and transparently controlled. Furthermore, strong central control of bank accounts enhances the quality of counterparty exposure information, addressing the second priority revealed in PwC’s survey mentioned above.
The ideal bank administration solution for corporates addresses three areas: the maintenance of a central registry for bank account information, the adoption of a controlled workflow for opening and maintaining accounts, and achieving streamlined and secure electronic communication – eBAM. Present indications are that eBAM adoption is presently seen by most corporate treasuries as a possibility for the future rather than a current priority. Implementing eBAM is seen by some as a complex exercise, and many corporates want to see a broader level of adoption by banks before embracing eBAM themselves. We expect the level of interest in eBAM adoption to increase in the coming year, as its value becomes more widely apparent.
Counterparty Risk Management
Corporate treasury counterparty risk management was almost exclusively based on classic credit ratings prior to the financial crisis. The primary driver for improving counterparty risk management is that credit ratings alone were proved to be an inadequate tool for analysing an organisation’s creditworthiness on a day-to-day basis. This was clear at the time of the Lehman Brothers’ collapse – when the bank held an investment grade ‘A’ Standard & Poors’ rating. The response to this has been a diversification of the tools used by corporate treasuries to use more market sensitive indicators to evaluate counterparty creditworthiness and supplement credit ratings. Examples include monitoring counterparties’ equity and bond prices and indices, and also the relevant CDS (credit default swap) spreads. We anticipate that the use of such fast moving indicators will continue to increase, and become generally accepted treasury operations best practice. The practical application of enhanced counterparty risk management naturally extends to counterparty limit allocation and management to take the benefit of market sensitive tools.
The full evaluation and management of a counterparty exposure requires that every component is in fact included in the calculation. This means that items such as bank account balances and equity and bond investments should be added into the more traditional components of time deposits, FX deals and derivatives. .
The Technology Imperatives
Treasuries are often supported by ‘islands of technology’ in which specific solutions might be used to fulfil specialist requirements such as treasury accounting, hedge accounting, risk management and bank relationship management. At least in those treasuries that manage a relatively significant level of financial risk – perhaps with respect to liquidity, FX or counterparty exposure – such solutions may be seen to fall short of the ideal in terms of dependability, response time and robustness. If a rapid response to questions such as ‘what is the organisation’s cash position?’ ‘or what is the global exposure to counterparty X?’ is needed, the best practice technology solution requires a single central database and system, with the database - and key information displays – being updated automatically in real time when new information is input, uploaded or detected. Such technology can provide the information in real time if needed – or at least on demand.
It is often only when a crisis emerges, and treasury departments are put under intense pressure to produce instant and up-to-date reporting on the organisation’s liquidity or counterparty exposure position, that the real quality of the supporting technology is actively tested. It is in preparing to handle such events that the treasurer really needs confidence in the quality and dependability of their technology.
1. PwC Corporate Treasury Solution 2010 - http://download.pwc.com/ie/pubs/global_treasury_survey_2010.pdf