Twenty Treasury Actions for 2020!

Twenty Treasury Actions for 2020!

The start of a new year (not to mention a new decade) is a natural moment to reflect on the past and look forward to the year(s) ahead. How should you, as a treasurer, prepare for the uncertain future? What will be the main trends for the coming year? Most importantly, what can your company, and the treasury organization specifically, do to add value by recognizing the trends?

This article sets out what we at Zanders see as the hot topics for treasury in 2020. We provide some insights into how to incorporate these ideas into your company’s treasury business plan. To make this article as practical as possible, we have captured the main recommendations in twenty action points for 2020.

1. Continued Geopolitical and Economic Unrest

Geopolitical tensions and economic unrest will continue to impact companies worldwide in 2020. This is driven by, among others, the increased tensions in the Middle East, the potential escalation of the trade war between the US and China, initial signs of diminishing economic growth in some western economies (indicated by lower or even negative GDP growth figures and worsening industry confidence figures) and last, but not least, Brexit. After the approval by the British parliament of the Withdrawal Agreement Bill (WAB) last December, the UK will leave the EU on 31st January 2020. With this, the UK will enter a post-Brexit transition period during which new trade negotiations will take place. These, and details of the UK’s future relationship with the EU, as well as the continuing negotiations between the US and China, are likely to lead to continued volatility in the financial markets due to the uncertainty around the possible impact the trade deals can have on business.

This multitude of geopolitical and economic uncertainties is causing companies to re-evaluate their business models, for example, where to locate new manufacturing sites, start new CapEx projects, or setup new business lines. As a strategic business partner, treasury is well equipped to advise senior management on these questions by analyzing the treasury, risk and financial impact of the business locations on cash management, capital allocation, (e.g. trapped cash, location and ease of opening bank accounts), and its financial risk exposure (e.g. change in foreign exchange risk, currency restrictions and/or effect on the country/credit risk of business partners).

Treasury Action 2020 Item 1:

Develop comprehensive Risk Adjusted Return on Capital model in which the true economic value add of (new) business can be determined as the gross margin is corrected for all underlying financial risks.

Subsequently, pressure on EBITDA and the capital structure, due to a possible business downturn, can impact the financial ratios which are critical to ensure availability to funding. A financial covenant dashboard would help treasury to provide insights into the current ratio limits (e.g. leverage ratio and interest coverage ratio) to the CFO.

Treasury Action 2020 Item 2:

Stress testing of agreed financial covenants for being potentially at risk under different specific business and more general economic scenarios.

In addition to the business model impact, potential economic headwinds are increasing financial market risks. On the one hand, this could result in a lower appetite from banks to lend money and an increase in company default rates. We have already seen the first defaults in the Chinese market of privately held companies and this could lead to a knock-on effect on government supported corporations. In turn, this will have a detrimental effect on the Chinese economy. On the other hand, the continuation of the current monetary policy by the Federal Reserve Bank (FED) and European Central Bank (ECB) makes corporate borrowing cheaper than ever. We expect that investment grade companies can mostly continue to benefit from the high supply of capital (and related low funding costs). However, for non-investment grade companies, investors will focus more on companies’ business risk and volatility and therefore it is paramount for non-investment grade companies to educate lenders carefully on the underlying business risks to realize a successful transaction.

Treasury Action 2020 Item 3:

Assess whether the capital structure of the company is still optimal in the light of changing markets conditions. Determine the optimal capital structure through the lens of leverage ratios, financial flexibility and liquidity risks.

Treasury Action 2020 Item 4:

Create a risk-based and quantitative information memorandum that outlines the company’s business risk and volatility to inform investors when raising new debt.

Another trend, which will continue to impact the funding market, is the adoption of sustainability or ‘green’ classifications in financing documentation. With the recent approval of the taxonomy regulation by the European Parliament, the adoption of sustainable classifications will only increase. The taxonomy regulation describes the environmental objectives that are evaluated to determine the sustainability of an economic activity. Financial activities that claim to be sustainable should now adhere to the taxonomy regulation. A mechanism that is frequently embedded in financing documentation is a reference to the company’s Environmental, Social and Governance (ESG) score.

An improvement of the company’s ESG score reduces the interest rate spread, while a decrease of the ESG score would increase the interest rate spread. Besides potential interest savings, companies participating in large tender processes may find themselves disqualified in more cases if they have not implemented an ESG company policy.

Treasury Action 2020 Item 5:

Include ESG metrics, based on the new taxonomy, in the monthly treasury reporting / KPIs.

Treasury Action 2020 Item 6:

Identify how ESG elements can be incorporated in the company’s financing arrangements.

In the face of potential increased market risk, treasury as an organization should look to be more flexible. The treasury function should not only ensure the company is robust by increasing its risk bearing capacity, but also remain sufficiently flexible to adapt and thrive in changing market conditions. To become a more adaptive organization, treasury should first have the right information available to provide alerts to changing market conditions. Alerts could relate to external factors, such as movements in the financial markets, as well as to internal factors, such as changing cash flow forecasts (CFF). Real-time and accurate reporting that displays the core metrics should be in place to provide treasury direction.

The adaptiveness of the treasury function should also be expressed in the Treasury Target Operating Model (TTOM). In parallel, the robustness of the company can be improved by reducing the liquidity needs. This can be achieved by improving the CFF process, utilizing instant payments (e.g. Faster Payments), optimizing and centralizing global cash management structures and through the implementation of virtual accounts, for example.

Treasury Action 2020 Item 7:

Perform a treasury benchmarking scan and determine a roadmap to ensure the treasury organization, and supporting processes and systems, is future proof.

Treasury Action 2020 Item 8:

Set up a pro-active reporting, alerts and escalation process to provide direction to treasury on business/market developments.

Treasury Action 2020 Item 9:

Formulate a clear Treasury Target Operating Model and communicate this to all business stakeholders.

2. Regulatory Changes

Regulatory changes, including IBOR reform and Know your Customer (KYC), will continue to have a direct and indirect impact on the treasury function.

IBOR – As long ago as 2013, the G20 governments asked the Financial Stability Board (FSB) to review the use of benchmark rates in the financial industry. This resulted in the FSB recommending the phasing out of the Interbank Offered Rate (IBOR) and the move to a more transparent benchmark for setting interest rates. In 2017, the UK’s Financial Conduct Authority (FCA), which regulates the London Interbank Offered Rate (LIBOR), stated it would no longer require banks to submit LIBOR rates beyond 2021. Instead, the Bank of England Working Group approved the use of the Sterling Overnight Index Average (SONIA) as the short-term interest benchmark. Similar initiatives and reforms have been enacted by regulatory authorities in countries such as the US, Japan, Switzerland, in the Eurozone and beyond. While changes in various products and jurisdictions will likely occur at different times, alternative benchmark rates, near risk-free rates (RFRs) based on more liquid overnight lending markets, are already being published for GBP, USD, JPY, EUR and CHF. IBOR’s replacement globally impacts over $350 trillion in open derivatives, capital markets transactions, investments, loans, leases and other financial instruments. For years, IBOR has been the benchmark rate used to price financial instruments and its replacement will have a far-reaching effect on financial institutions, corporates and system vendors.

Corporate treasury functions need to prepare for the numerous challenges resulting from IBOR reform. One of the first steps is to identify and quantify your exposure to IBOR. The financial impact of the change must be assessed as the change in rate will affect the price and fair value of instruments on the balance sheet. Loan agreements may need to be rewritten to include fall back language in the absence of an IBOR rate. Collaboration between treasury, accounting, legal and tax will need to exist as changes in the IBOR rate may affect various aspects of tax, such as withholding tax, and hedging relationships, if they exist. Systems will also be impacted as new reference rates will need to be maintained, new yield curves constructed, and new accruals calculated when floating rate transactions reach their next fixing date. Treasurers need to start preparing for the discontinuation of IBOR rates and not wait until the last minute to transition.

Treasury Action 2020 Item 10:

Draft an IBOR assessment & replacement transition action plan.

Treasury Action 2020 Item 11:

Engage with counterparties to agree which changes are required to financial agreements with IBOR references.

KYC – Another bank driven regulatory trend, Anti-Money Laundering (AML), has resulted in significant fines being levied by regulators on many of the largest cash management banks globally. This led to increased scrutiny of banks’ KYC processes. Consequently, there is a direct impact on treasury, as banks close bank accounts (sometimes without notice), request additional information to update the KYC file on existing accounts and perform thorough analysis when new bank accounts are opened. Due to the huge amount of KYC work to be performed by banks, and the lack of KYC analysts, companies are finding it can take 3-9 months to open a new bank account. This directly impacts companies that require a bank account to be opened at short notice to accommodate, for example, the requirements to have an account in a project-based tender process, or to facilitate the capital injection requirement for newly incorporated legal entities.

As many banks face this KYC burden, it is often proposed to centralize and standardize the KYC process at an independent third-party leveraging blockchain technology. However, until regulators come to a conclusion on the best approach, treasury should manage bank relationships carefully and evaluate which banks have the most efficient bank account opening processes.

Treasury Action 2020 Item 12:

Create an open dialogue with your cash management bank to understand their processes and expected time required for opening new bank accounts.

Treasury Action 2020 Item 13:

Assess business impact and advise internal stakeholders on the implications for the business of opening new bank accounts, e.g. when setting up new legal entities.

Treasury Action 2020 Item 14:

Strengthen own AML and sanction screening process for payments.

3. Technology

The treasury technology revolution is disrupting the way companies conduct business. The next generation treasury organizations will need to work in real-time, through highly integrated and automated systems, to keep pace with the changing digital technologies. Treasury teams will need to adapt to an increasingly digital landscape and expect to develop capabilities beyond the current treasury management technology landscape. For 2020, we see treasury teams starting to investigate how disruptive technologies can address the age-old challenges across the treasury function.
We read and hear a great deal in treasury circles in relation to emerging treasury technologies such as Robotic Process Automation (RPA), Artificial Intelligence (AI) and Distributed Ledger Technology (DLT), also known as blockchain. These are developments that treasurers should certainly be thinking about. One area that is particularly ripe for change over the next year in this context is reporting and leveraging data.

Data and Reporting – Treasury reporting has always been a pain point for treasury departments. Increased volatility in the financial markets has meant that the need for clear and concise reporting is back at the top of the treasurer’s agenda. Next to that, our fast-changing world requires reporting to be flexible and hence an ‘easy to maintain’ solution is needed. The major concern for any reporting solution is the availability of data across the company. More specifically, a wide variety of systems, all creating and maintaining their own data, is the key issue for many corporates today. Zanders sees the adoption of data warehouses to store, validate and present data for the treasury function as a developing trend that will continue in 2020. Setting up a data warehouse is easier said than done. The accuracy, completeness and timeliness of data are the key drivers for a successful data warehouse implementation. When the basics are set up, moving from data gathering to data analysis through the use of data visualization software (e.g. Tableau, PowerBI, Tibco), becomes possible. Interactive, user customizable analytics provide an immersive user experience and help to improve risk management by identifying previously unseen patterns.

Treasury Action 2020 Item 15:

Optimize the current treasury IT system setup by focusing on standardization and automation of traditional technology such as ERP, TMS and bank connectivity.

Treasury Action 2020 Item 16:

Assess which treasury processes can benefit from a companywide Business Intelligence (BI) tool or data lake initiative.

So, what are the other key emerging technology themes and how can they be applied by corporate treasury functions in 2020?

RPA, AI and DLT/Blockchain – Technologies such as RPA and AI are starting to be adopted by treasury functions. Within most treasury functions, there are activities performed by the team that are low value, low risk, manual and repetitive, meaning these activities are ideally suited for efficiency improvements through RPA. Collating data for cash flow forecasting can be manual and time intensive. RPA can be used to consolidate all cash flow forecasts around the group quickly and efficiently as well as update forecasts automatically as new input arrives. AI can then be used to identify unusual trends in cash flow forecasts, enabling meaningful follow up discussion with the business(es) concerned. AI can also be used to adjust forecasted cash flows based upon the historical patterns behind actuals and forecast variances.

Blockchain is now perhaps less of a new technology, but the benefits of it have not been felt to any great extent within treasury. One of the benefits we have seen however and expect to see grow in the future, is the set-up of private blockchains between banks and customers for KYC, trade finance and smart loan contracts. In addition, we have started to see blockchain technology challenge existing payment solutions such as SWIFT to enable real time payments with extended data and enhanced tracking and tracing, at a lower cost. For this to take off further in 2020, we need to see more financial institutions adopt the technology.

Industry 4.0 to Treasury 4.0 Revolution – The fourth industrial revolution, or Industry 4.0, is promoting innovation across all industries through automation and information exchange. This is achieved through combining technologies and processes with human and machine intelligence to deliver interconnectivity, machine learning, automation and real-time data exchange. In turn, this leads to new solutions and opportunities, resulting in the potential for fast-paced change across businesses. As part of the Industry 4.0 revolution, treasury will go through a technological transformation (Treasury 4.0). For 2020, we see a common theme across all regions: treasury teams are observing and starting to investigate practical and cost-efficient real-world applications of the disruptive technologies to leverage digital capabilities, which introduce new opportunities for efficiency gains in their operations. The advancements will be monitored closely, along with the adoption rates in areas such as the internet of things (IoT), application programming interfaces (APIs), machine learning (ML), big data and advanced data analytics, cloud computing, cybersecurity and the earlier mentioned AI and DLT/blockchain technologies for further new innovation. Treasury teams will evolve from a business-enabling function performing daily operational work to a strategic partner able to provide granular business insights and greater value, by leveraging intelligent tools.

Treasury Action 2020 Item 17:

Ensure treasury is aligned and can benefit from the initiatives taken in relation to your IT function’s digitalization strategy.

Treasury Action 2020 Item 18:

Identify standardized and repetitive tasks that can be automated using RPA.

Treasury Action 2020 Item 19:

Assess the technology skill gap and determine the training required in the treasury team.

The scope of the treasury organization will continue to expand into 2020 and beyond. With changing mandates and disruptive technologies, treasury teams will need effective leadership in these rapidly evolving market conditions. The treasury function will need to keep pace with the advancements in technology by encouraging and developing new skills and competencies across existing roles, as well as when hiring new talent. A move towards a digital workforce will require talent that is expected to increasingly focus on data and analysis, in order to manage and enhance the application of digital technologies to stay ahead of the curve.
With all these trends evolving in 2020, it promises to be another exciting year for the treasury community. Be prepared and ready to thrive in these exciting times!

Treasury Action 2020 Item 20:

Ensure you have the requisite expertise you need to take advantage of and deliver against the Zanders’ Twenty Treasury Actions for 2020!