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Justin Jones In FX, Talking Shop, Technology

Talking Shop: Benchmarking Cash Flow Hedging

Editor’s note: NeuGroup’s online communities provide members a forum to pose questions and give answers. Talking Shop shares valuable insights from these exchanges, anonymously. Send us your responses: [email protected].

Member question: “Here are some benchmarking questions about cash flow hedging:

1. “What percentage of cash flow exposures do you hedge?
2. “What instruments do you use to hedge?
3. “How far into the future do you hedge?
4. “Given the current strength of the US dollar, are you contemplating changing your FX hedging program?”

Member question: “Here are some benchmarking questions about cash flow hedging:

Peer answers, question 1 (hedge ratio):

a. “We follow a layered and rolling approach that goes from 80% in the nearest quarter to 70% two quarters out, down to 10% eight quarters out.”
b. “Most currencies are 70%-80% hedged. There is one high-cost currency that we hedge 50%-60%.
c. “For us it can go as high as 95%.”
d. “We hedge up to 85% for the nearest quarter and as low as 25% for four quarters out.”
e. “We hedge about two-thirds of foreign earnings, primarily through seven key currencies.”
f. “Our goal is a rolling, layered approach, getting up to a hedge ratio of 80%-100%.”

Peer answers, question 2 (instruments):

a. “We use a combination of forwards and option collars. This allows us to have the flexibility to choose the instrument that will best protect us. We also have a small budget for option collar premium cost, so we can play around with strike rates based on where we want the protection and/or participation to be.”
b. “Primarily forwards, with some zero-cost collars fairly soon.”
c. “We use FX forwards only, but are in discussions on incorporating options to the program.”
d. “We use forwards and put options mostly. Options are used on the longer tenors.”
e. “We’re aiming for a base case of forwards, with the ability to use purchased options or zero-cost collars based on a framework around spot relative to long-term fair value, as well as skew, carry and vol.”

Peer answers, question 3 (time frame):

a. “Three years.”
b. “We layer out, with our longest hedge about 15 months.”
c. “Tenors are out 18 months, with most of the program in place for the year before we issue guidance.”
d. “Two years maximum.”

Peer answers, question 4 (program changes):

a. “Given USD strength, we are considering making some changes. We are looking at hedging foreign expenses out at least six quarters, instead of the normal four, and at an initial higher hedge ratio coverage. And we are considering increasing our premium cost to create a more favorable strike rate band on our billings and revenue hedges.”
b. “We hedge expenses, so the current market is quite favorable, relatively speaking.”
c. “Our current hedging program is not adjusted based on market dynamics, but that’s something we are considering changing.”
d. “We have been following our existing layering schedule but continue to analyze whether to make any changes.”
e. “Under our proposal, the instrument we select could possibly change based on the level of USD, but not the overall strategy.”
f. “No fundamental changes are being contemplated at the moment.”

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Justin Jones In Cash & Working Capital, Technology

The Undiminished Prominence of Excel

Why the overwhelming majority of treauries producing cash flow forecasts still use Excel and won’t likely stop anytime soon.

Despite decades of technological advances, Excel remains the predominant tool that treasury teams use to generate cash flow forecasts, according to the results of NeuGroup’s May 2022 Cash Forecast Survey (see chart below). That includes teams that have a treasury management system but use Excel along with it because the TMS doesn’t offer the same degree of modeling flexibility.

Yes, a TMS is a more effective solution to automating the collection of data than Excel, which is a lot more cumbersome and prone to error. But “the TMS does not have enough flexibility in analysis, scenario planning and reporting,” a member of NeuGroup for Growth Tech Treasurers said.

Why the overwhelming majority of treasuries producing cash flow forecasts still use Excel and won’t likely stop anytime soon.

Yes, a TMS is a more effective solution to automating the collection of data than Excel, which is a lot more cumbersome and prone to error. But “the TMS does not have enough flexibility in analysis, scenario planning and reporting,” a member of NeuGroup for Growth Tech Treasurers said.
Given that cash forecasting efficiency and effectiveness has been a perennial challenge, many in treasury are disappointed by the lack of progress by TMS vendors. However, many are also skeptical about vendors’ ability to provide more robust functionalities.
- The survey revealed that less than half of treasury teams expect to invest in new forecasting technologies in the next year, either because they already implemented a TMS or they don’t intend to.

The opacity of data. One reason it has been so hard to automate the curation of data to support the cash forecasting process is that cash data resides in disparate source systems.

While some data can be pulled from banks and ERPs, this approach provides only a limited picture because additional data resides outside of those sources. There is also the issue of “black box” areas, e.g., international accounts that are outside the cash pooling or IHB structures. Another is M&A.
“Our main challenge is visibility. Access to actuals is a very big impediment because it involves the automation of collection of data from multiple sources’ systems,” one survey participant said.
That’s why treasuries continue to use a combination of direct and indirect forecasting methods. While treasury would prefer a direct approach, it needs to fill in the gaps with information from the business and other systems.

In real time? For TMS vendors and users of other solutions, there is good news. While system connectivity and data “fetching” had traditionally required expensive integrations, with the advent of APIs, some data compilation can be more easily automated.

Current applications of APIs are primarily related to gathering actual information, e.g., bank balances. They have not yet developed into supporting the forecasting process, e.g., by building a direct link to analytics solutions.

The next generation. Technologies are catching up with treasury’s complex forecasting requirements. A handful of respondents to the survey have already deployed AI and machine-learning tools to facilitate data collection, develop more reliable models that continuously learn from experience, and produce customized reports.

While the use of AI/ML may be rare, this is a good time to present treasury use cases. “You have to take advantage of the entire company’s digital transformation process and resources,” said one member.

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Justin Jones In Cash & Working Capital, FP&A, The NeuGroup Insights Interview

How the FP&A Team at WM Is Preparing for Recession

Looking back, looking forward: WM’s Eric Davis on how data and analysis guides planning as the economy weakens.

How do the best corporate financial planning and analysis (FP&A) teams rise to the current, critical challenge of planning, budgeting and guiding corporate leaders in periods of high uncertainty and volatility as recession fears mount?

To answer that question, we turned to Eric Davis, vice president of finance at WM, formerly known as Waste Management. Listen to his response by hitting the play button on the video clip below.
Mr. Davis has been at WM for nearly 25 years, including six as director of FP&A. In his current role, he oversees FP&A, capital management, internal reporting and investor relations.
He describes how FP&A at WM blends insights from past recessions with analysis of current economic data to determine what parts of WM’s business are most likely to be hit by recession, helping business leaders decide where to focus their attention and what action to take.

You can listen to a full interview with Mr. Davis by NeuGroup’s Nilly Essaides by heading to the Strategic Finance Lab podcast on Apple and Spotify.

Looking back, looking forward: WM’s Eric Davis on how data and analysis guides planning as the economy weakens.

How do the best financial planning and analysis (FP&A) teams rise to the current, critical challenge of planning, budgeting and guiding corporate leaders in periods of high uncertainty and volatility as recession fears mount?

To answer that question, we turned to Eric Davis, vice president of finance at WM, formerly known as Waste Management. Listen to his response by hitting the play button on the video clip below.
Mr. Davis has been at WM for nearly 25 years, including six as director of FP&A. In his current role, he oversees FP&A, capital management, internal reporting and investor relations.
He describes how FP&A at WM blends insights from past recessions with analysis of current economic data to determine what parts of WM’s business are most likely to be hit by recession, helping business leaders decide where to focus their attention and what action to take.

You can listen to a full interview with Mr. Davis by NeuGroup’s Nilly Essaides by heading to the Strategic Finance Lab podcast on Apple and Spotify.

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Justin Jones In Pension and Benefits

Pension Surpluses: Nice to Have Except for the Potential Tax Hit

Pension funds have recovered dramatically but the surpluses many face are a quandary.

Pension plans have not been immune to financial market turmoil this year. The funded status of the 100 largest corporate defined benefit pension plans fell by $13 billion during June, according to the Milliman 100 Pension Funding Index.

But stellar asset returns in the last several years—including from private equity investments—as well as rising interest rates that reduce a plan’s liabilities mean that many companies still have pension surpluses. Milliman data show the average funding ratio of large plans stood at 106.3% in June—up from 97.9% in January.

Pension funds have recovered dramatically but the surpluses many face are a quandary.

But stellar asset returns in the last several years—including from private equity investments—as well as rising interest rates that reduce a plan’s liabilities mean that many companies still have pension surpluses. Milliman data show the average funding ratio of large plans stood at 106.3% in June—up from 97.9% in January.

A nice problem to have. Of course, treasury teams face worse challenges than pension fund surpluses. But what to do with surpluses has become a conundrum because corporates with capital remaining when a plan terminates face steep taxes.

The issue arose at a recent meeting of NeuGroup for Pensions and Benefits where the director of global pensions for one company noted the difficulties in finding alternative uses for surplus capital.
The advantage of surpluses, said a peer, is they provide a capital buffer if, for example, actuaries make a mistake or a company needs to cover future costs related to a pension risk transfer. But what is the correct surplus level?

Alternatives to a brutal tax hit. US pension plans terminate when the last pension beneficiary dies, the director of global pensions noted. At his company, the remaining capital including any surplus would face an excise tax of 50% and a blended federal and state tax rate of 25%.

“So doing nothing benefits the tax collectors,” he said.
His team has looked to reduce the surplus by transferring pension risk to insurance companies. It has also used it to fund 401(k) matches and to enhance retirement benefits.
One approach was offering to reduce employee bonuses by 5% while increasing the company’s retirement plan match to 6%. It was an easy sell, given the extra 1% in employees’ pockets, he said, but those efforts “barely made a dent in the growing surplus.”
Roger Heine, senior executive advisor at NeuGroup, asked if a setting up a captive insurance company and transferring the pension’s liabilities, assets and surplus to the captive could reduce the tax burden.
The director said captives are used for that purpose in Europe, but he is unaware of a US company using that strategy. “There are consultants who claim you can do it with a US captive and even a global captive that would have multiple countries under it,” he said. “But that’s the mother of all questions.

No credit for funny money. Given the difficulty in managing surpluses, are they at least viewed favorably by credit analysts?

The short answer from the director was no, since analysts typically just look at assets and liabilities. The corporate may have a pension surplus overall, but some of its individual plans may still have deficits, and in most cases analysts will consider the deficits to be true liabilities because the company will need to fund them at some point.
“But they don’t give us any credit for the surplus, because they think it’s a kind of ‘funny money’ that the company will never get its hands on,” he said.

Secondary market sales. One member said not all of his company’s plans are frozen and so his team retains some growth assets while liquidating volatile ones, leaving the fund holding mainly illiquid private equity investments. However, liquidity needs may arise, whether to manage the surplus or other elements of the fund, and he asked if anyone had pursued selling private equity stakes in the secondary market?

The director noted doing so when private equity exceeded the pension plan’s asset allocation limit, and the sale took more than six months. He didn’t know the discount at which the assets were sold, and a peer chimed in that he had heard a 15% to 20% haircut is typical.

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Justin Jones In Compliance, Crypto, Technology

KYC: Know Your Crypto

Conversations with members reflect a need to screen for sanctioned accounts and illicit activity. Here are some options.

With no end in sight to the war in Ukraine and sanctions on Russia, corporates eyeing cryptocurrency opportunities are asking pressing questions about screening and investigating counterparties in transactions involving crypto.

At a recent meeting of NeuGroup’s digital assets working group, one member expressed concerns that an NFT his company had sold could be resold to someone in Russia, with a portion of the proceeds headed back to the corporate, which receives royalties on all resales.
Peers with cryptocurrency experience offered clear advice: Companies setting up digital wallets to make or receive crypto payments, even in small amounts, should have a defined compliance process to prevent payments to or from sanctioned and blacklisted parties in Russia and beyond.

Conversations with members reflect a need to screen for sanctioned accounts and illicit activity. Here are some options.

At a recent meeting of NeuGroup’s digital assets working group, one member expressed concerns that an NFT his company had sold could be resold to someone in Russia, with a portion of the proceeds headed back to the corporate, which receives royalties on all resales.
Peers with cryptocurrency experience offered clear advice: Companies setting up digital wallets to make or receive crypto payments, even in small amounts, should have a defined compliance process to prevent payments to or from sanctioned and blacklisted parties in Russia and beyond.
It’s not simple. A member who works at a cryptocurrency business said screening cryptocurrency payments “is the hardest challenge, even for us. Sanctions is a very hard problem to solve since there are no usernames or no logins, just a wallet.”

Crypto compliance basics. Tools employed directly by the corporate or a third party will screen payments by analyzing all data from the address associated with the crypto wallet, which is publicly accessible on the blockchain.

Wallets that have confirmed interaction with sanctioned regions, or any suspicious activity, are flagged, as are all the addresses that interact with that wallet.
So if a corporate is considering a transaction with a wallet the tool flags as connected to Russia, for example, the company would have the opportunity to investigate the wallet and, if necessary, cancel the transaction.
But it’s not always so straightforward: some wallets are flagged for activity that could be linked to money laundering, so it’s up to compliance team investigators to look into the counterparty, not always an easy task.

Three compliance options. Here are three options for corporates in need of crypto compliance requiring screening and investigation:

Use third-party screening tools and minimal expansion of a compliance team. A company’s current compliance team can work directly with cryptocurrency screening tools from vendors including Chainalysis and TRM Labs. Members and experts say this option makes most sense if the corporate’s use case for crypto requires processing relatively few transactions (e.g., monthly payments to a contractor or a small batch of NFT sales). Also if the company wants to minimize risk and cost by controlling compliance itself.
- This option may not require much—if any—expansion of a large corporate’s compliance team, which will investigate flagged wallets among other tasks.
- One member stressed that not all tools are the same, so don’t settle for a less reliable solution to cut costs. If worst comes to worst and the tool fails, you’re going to want to tell regulators you used one of the top names in the industry.
Use third-party screening tools and start building a much bigger compliance team. This one’s for companies starting a new, customer-facing cryptocurrency business with potentially hundreds of thousands of payments. “If cryptocurrency is going to be a large-scale arm of the business, that will require aggressive expansion of the compliance team—even with a tool,” one member said.
- Another member estimates that some companies will need “a few thousand” investigators using third-party tools and other means to vet all transactions flagged as sanctioned or suspicious.
- A former compliance head at a cryptocurrency exchange told NeuGroup Insights that a corporate could also outsource the cryptocurrency compliance work to a dedicated compliance team, similar to a shared service center, but the cost would “still be in the millions.”
Find a third party that will assume full compliance responsibility. Some members are searching for third parties that will take on the entire compliance process, including screening and investigations. For example, one company is in negotiations to set up an interim wallet where all payments would be vetted by an NFT marketplace before being transferred to the company.
- Corporates can also work with consulting firms like Deloitte, which can train a corporate’s compliance team or provide staff that will take on the process. Either way, consultants are a more expensive option.
- Tim Davis, who leads the blockchain and digital assets practice for Deloitte’s Risk & Financial Advisory business, said, “We start by working with the business, understanding its regulatory requirements, then work up. We could have Deloitte in a co-source role directly assisting with monitoring cryptocurrency screening tools and investigating any red flags; or we can help to train staff hired by the company.”
- Filling cryptocurrency compliance roles can be difficult, in part because it’s foreign territory to those who only have experience in traditional finance. “The tools available are great, but each company will need people who know what they’re looking at,” Mr. Davis said.

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Justin Jones In FX, Regional

Righting the FX Hedging Ship After a Perfect Storm

Lessons learned and changes made after a plunge in JPY reveals cracks in communication and processes.

The plunge of the Japanese yen (JPY) this year to its lowest level against the US dollar in more than two decades (see chart) revealed communication problems at one NeuGroup member company between FX risk managers in treasury and the sales team in Japan—problems that could have resulted in a painful financial outcome. Instead, the company’s treasurer came away with valuable lessons for any corporate with exposure to currency swings.

Lessons learned and changes made after a plunge in JPY reveals cracks in communication and processes.

Storms and fire drills. In addition to the yen’s steep drop, several other factors combined to create the challenge facing the company’s treasurer. “We had the perfect storm and it caused a big fire drill because it was going to be a big hit to revenue,” he told NeuGroup Insights in a recent interview. Among the causes of the storm:

Supply chain problems made forecasting shipments and revenue in Japan more difficult.
The difficulty of forecasting made treasury very cautious on placing hedges (forwards) because it didn’t want to risk over-hedging and the possible loss of hedge accounting.
Revenue from Japan jumped by tenfold in one quarter, ballooning the company’s exposure to JPY.
The resignation of the company’s FX manager required an assistant treasurer to address the problem.
The business team had changed the process by which it locked in an exchange rate with a major customer.

Deeper, more frequent communication. As a result of the change in the rate lock process, the yen price of the customer’s order had been fixed a year earlier, before the yen’s decline. But the revenue would be converted at the current exchange rate, when the shipment was accepted, meaning the company would receive far less revenue in dollars than forecast.

Treasury learned about the rate lock process change late in the game, necessitating the fire drill. “We realized that our visibility to their processes and our underlying exposures was not as good as it should have been,” the treasurer said.
The good news is the customer agreed to change the price based on a more current exchange rate, helping the treasurer’s company avoid the revenue shortfall. In addition, the company placed forwards to hedge against further declines in JPY.
To help avoid future pitfalls, treasury now checks with the sales team in Japan at least three times a quarter to get updates on the revenue forecast, up from two so-called checkpoints previously.
To get more context than is provided by internal revenue forecasting tools, the checkpoint discussions with the sales team are much more detailed than before, and the teams are communicating between the checkpoints.
“We have righted the ship,” the treasurer said. “Everyone is aligned and understands the problem, so as soon as things change or when issues come up, we’re being notified, which wasn’t happening. Everyone was kind of waiting for these formal checkpoints before.”

Find the micro impact in the macro. The storm also underscored for the treasurer the need for more analysis of possible impacts of rapid changes in global economics and monetary policy and how, for example, Japan’s decision not to raise interest rates as the Fed hiked rates would affect the company’s exposure given forecasting issues and hedging policies.

Treasury is now having more proactive, internal conversations to review market intelligence, including close tracking of exchange rates.
“We need to ask the right questions and make sure we aren’t missing anything,” the treasurer said.

Lessons learned. After weathering the storm in Japan, the NeuGroup member identified these key takeaways a that can be broadly applied to how FX risk management teams work internally and collaborate with the business.

Adopt a more seamless and flexible approach to FX hedging. The company used to layer in hedges twice a quarter; now it’s “doing it more seamlessly across the quarter as we get better information,” the treasurer said.
Actively involve business partners in finding solutions. Team efforts that incorporate the views of all key stakeholders to address challenges produce better results than relying primarily on treasury knowledge.
Don’t get complacent. Continuously question processes that may seem to be working fine, finding cracks as you ask how new market information may impact those processes and determine what needs to be done differently. “When something like this happens, it highlights all the places you have cracks in your processes,” the treasurer said.

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Justin Jones In FX, Sponsored Content

Reducing FX Risk: The AtlasFX Vision

AtlasFX CFO Scott Bilter discusses the implications of a possible commodity bull market for FX risk managers in an interview with NeuGroup CEO Joseph Neu.

Managing foreign exchange risk at multinational corporations is never easy. But it’s definitely harder during periods of market volatility and economic uncertainty—like the one roiling FX markets now.

Among the recent challenges facing NeuGroup members who manage FX risk: The US dollar has soared against the euro and the Japanese yen as the Federal Reserve raises interest rates to fight inflation—including price spikes for energy and other commodities that correlate closely with some currencies.

Tools to FX manage risk. Among the tools that FX risk managers rely on to identify exposures, hedge risk and understand variances is AtlasFX, a platform that uses advanced data analytics to help treasury, FP&A and accounting teams to optimize balance sheet and cash flow hedging programs.

In a video interview you can watch by clicking here or by hitting the play button below, Atlas Risk Advisory CFO and co-founder Scott Bilter tells NeuGroup CEO Joseph Neu how AtlasFX allows risk managers to see a combined, full picture of their FX and commodity exposures and hedges.
Mr. Bilter also discusses the role and limitations of using artificial intelligence (AI) in managing FX risk as well as why he believes a centralized treasury can often manage FX risk more efficiently than at companies where multiple teams spread across the globe take on the task.
You can watch the first portion of the interview, in which Mr. Bilter explains the origins of AtlasFX, here.

AtlasFX CFO Scott Bilter discusses the implications of a possible commodity bull market for FX risk managers in an interview with NeuGroup CEO Joseph Neu.

Among the recent challenges facing NeuGroup members who manage FX risk: The US dollar has soared against the euro and the Japanese yen as the Federal Reserve raises interest rates to fight inflation—including price spikes for energy and other commodities that correlate closely with some currencies.

In a video interview you can watch by clicking here or by hitting the play button below, Atlas Risk Advisory CFO and co-founder Scott Bilter tells NeuGroup CEO Joseph Neu how AtlasFX allows risk managers to see a combined, full picture of their FX and commodity exposures and hedges.
Mr. Bilter also discusses the role and limitations of using artificial intelligence (AI) in managing FX risk as well as why he believes a centralized treasury can often manage FX risk more efficiently than at companies where multiple teams spread across the globe take on the task.
You can watch the first portion of the interview, in which Mr. Bilter explains the origins of AtlasFX, here.

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Justin Jones In Cash & Working Capital, Technology

Cash Never Lies—but Data May Not Tell the Whole Truth

More than two-thirds of respondents to a NeuGroup survey ranked the difficulty of producing the cash flow forecast at 6 or above on a scale of 1-10.

Rising rates and a slower economy present treasury with a challenge and an opportunity. The challenge is safeguarding the company’s liquidity. The opportunity is investing excess cash to earn higher yields. In both cases, treasury teams must have a line of sight into how much cash is on hand, and how much more (or less) is in the pipeline.

With a recession looming, it’s critical to get a handle on current and future cash flows, yet most treasuries still find producing the forecast difficult or very difficult, according to the results of a NeuGroup’s May 2022 Cash Forecasting Benchmarking Survey (see chart below).
A major source of difficulty: the data treasury collects from scattered sources to tell the cash story doesn’t always tell the whole truth.

More than two-thirds of respondents to a NeuGroup survey ranked the difficulty of producing the cash flow forecast at 6 or above on a scale of 1-10.

With a recession looming, it’s critical to get a handle on current and future cash flows, yet most treasuries still find producing the forecast difficult or very difficult, according to the results of NeuGroup’s May 2022 Cash Forecasting Benchmarking Survey (see chart below).
A major source of difficulty: the data treasury collects from scattered sources to tell the cash story doesn’t always tell the whole truth.

Treasurers as chief liquidity officers. After a decade of abundant liquidity and frenzied debt issuance, cash and working capital are again front and center in CFOs’ minds. Access to external funding may dwindle as borrowing becomes more expensive. Meanwhile, zero or negative growth will put a squeeze on earnings. Producing a reliable forecast is essential for companies’ financial resilience during hard economic times, as we learned during the 2008-09 recession.

Obstructed view. The survey found that the most-cited impediment to generating the forecast is lack of visibility and the unpredictability of cash flows (see chart below). Tied for second: access to data. The two are interrelated and impact treasury’s ability to see cash as it flows across the customer-to-cash process.

An archipelago of systems. Getting access to bank balances is the smaller problem, although in some cases, accounts are outside the purview of the TMS or the cash pool. The larger problem is collecting data about cash, because the data sits in disparate source systems. Pulling that information is often manual and always time consuming. While a TMS automates some of the work, participants in post-survey focus groups say they have not yet found a system that provides comprehensive cash forecasting functionality. That’s why 93% of treasuries are still using Excel, often in combination with the TMS. Only 53% said they are using their TMS for cash forecasting. Even fewer, 18%, are using ML/AI tools.

The impact on reliability. The upshot is that cash forecasts are often inaccurate, undermining their role in supporting liquidity management decisions. In our survey, only 41% of organizations achieved a forecast-to-actuals variance within +/- 5%. The majority were +/- 10% or above. Additional analysis of the practices of the most accurate cash forecasters (those that scored accuracy at +/- 5% or better) revealed that accurate forecasts are not necessarily harder to produce: 56% of the accurate forecasters ranked the degree of difficulty at six or above, compared to 67% for the overall sample.

Solutions—now and later. Cash forecasting has been a perennial challenge for treasury teams and remains so, despite the technological advances of the past decade. The longer-term solution is to overhaul the finance technology architecture, decommission legacy applications and integrate data sources into a single location, i.e., a data lake. That is the goal of the extensive transformation work NeuGroup sees among finance organizations. And it goes beyond treasury. In the short term, treasury teams may need to become more active users of RPA and AI/ML solutions that can scour the tech ecosystem for data, cleanse it and assume some elements of the predictive process.

To learn more about the survey results, join us on August 3 at 12:00pm ET for a special debriefing session.

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Justin Jones In FP&A, Technology, The NeuGroup Insights Interview

NeuGroup’s Strategic Finance Lab Podcast, Episode 5: Planning For a Recession: An Interview with WM’s Eric Davis

Step into a lab where innovation and digital transformation empower senior finance executives to become true strategic partners.

The likelihood of a US recession is raising the stakes for finance executives whose responsibilities include planning, forecasting and budgeting. And a critical first step to prepare for the future is to learn from the past. That’s among the takeaways from this podcast interview with Eric Davis, a vice president of finance at WM, the company formerly known as Waste Management.

Step into a lab where innovation and digital transformation empower senior finance executives to become true strategic partners.

Mr. Davis has been at WM for nearly 25 years, including six as director of financial planning and analysis (FP&A). In his current role, he oversees FP&A, capital management, internal reporting and investor relations. In the interview with NeuGroup’s Nilly Essaides, he shares valuable insights about the finance function’s strategic role.
For example, Mr. Davis describes how FP&A incorporates insights and analysis from past recessions to help the company decide “where we need to focus our attention within our business structure and cost structure” to prepare for the economic downturn that lies ahead.
You’ll also hear how the finance team at WM has evolved in recent years, upgrading its use of technology as it becomes more integrated into strategic decision-making by business leaders.

Please listen to the podcast by hitting the play button above or by heading to Apple or Spotify.

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Justin Jones In Senior Executive, Treasury Management

How Treasury Steps into the Strategic Limelight

Rising rates and a looming recession provide treasury with an opportunity to elevate its profile and and become a leader in board-level conversations.

Tough economic conditions have historically highlighted the critical role treasury plays as the champion of corporate liquidity. This happened during 2008-09 and will likely happen again if credit and cash flows begin to contract.

Rising rates and a looming recession provide treasury with an opportunity to elevate its profile and and become a leader in board-level conversations.

This is not new territory for treasurers, many of whom have already evolved to serve new and broader constituents, becoming more strategic, consultative and less transactional in nature.

Treasurers are getting more involved in M&A transactions. They orchestrate the capital structure, and are working more closely with business partners on issues such as liquidity structures, legal entity setup and taxes. Yet, at many organizations, treasury is still pigeonholed as a back-office function.

Now is the time for all treasuries to become active members in senior-level discussions, so it’s imperative that they rev up efforts to develop strategic capabilities to better assist the C-suite. “Sometimes you have to step out and take on more responsibilities, talk to the CFO, find out how you can help and let them know you’re there,” said one treasurer at the in-person spring meeting of NeuGroup for Retail Treasury.

Five Steps to Creating a Strategic Capability

In conversations with dozens of NeuGroup members, most recently at the retail meeting in Minneapolis, treasurers shared important action items that can help the function develop into a true business partner and produce greater insight to support strategic decisions.

1. Grab a seat at the table. At some organizations, treasury is already involved in supporting board-level decisions. At many, however, that is not the case. Treasury should not wait to be invited. Instead, it should ask to participate in board discussions, which is different from providing data and analysis for the CFO’s presentation. Instead, it means being present and engaged in the conversations, explaining the business implications and sharing scenario analysis of the effects of higher rates, reduced inflow of cash, and the potential deterioration in AR quality.

2. Dismantle silos. There’s typically a natural tension between treasury and FP&A because both build a cash flow forecast but in different ways. FP&A usually takes a more high-level approach by pulling information from existing data sources like the ERP, whereas treasury takes a more granular approach with the objective of ensuring liquidity. To increase its sphere of influence, treasury should collaborate with FP&A to sync the forecasts, or at least spot and understand any discrepancies, to inform decision-making.

In an effort spearheaded by treasury to improve forecast accuracy at one member’s company, the treasury team has a quarterly meeting with the CFO and the FP&A team to align treasury’s cash- forecasts with FP&As longer-term forecasts, which the member said are more P&L-focused.

3. Determine the service-delivery model. Treasuries need to define a clear operating model vision: One approach is to adopt a generalist mindset, using rotations through other finance functions to build broader expertise. Another is to opt for a specialist model and develop deep subject matter expertise to support other parts of the finance function and the business. Both can work, but to work well it’s important treasurers make a conscious decision and drive their culture by recruiting the right talent, providing necessary training and establishing clear roles and responsibilities as well as a career path.

4. Speak the language of the business. Treasurers should put a stronger emphasis on developing soft skills such as storytelling and influencing. It’s one thing to understand a complex transaction and another to translate it to someone else in terms senior and business leaders can understand. To develop this fluency, treasury should engage with business unit leaders and understand their main pain points, e.g., tightening margins, and then provide context and narrative around data and analyses.

“As you shift to pushing more soft skills, it gets into, how do we avoid just telling people what we know? How do we influence and shape the next generation of treasury? It isn’t always easy, especially in a hybrid environment,” one member said.

5. Widen the path into treasury. Because few colleges offer treasury-specific tracks, treasury has traditionally hired junior staff from banks, recent finance majors and promoted internally. As the scope of the role expands, communication, critical thinking and intellectual curiosity are becoming core job requirements. Like other parts of finance, treasury should look beyond finance and business majors or practitioners and hire staff with nontraditional backgrounds, e.g., liberal arts, data analytics and technology. It should also expand its talent pool by offering remote or hybrid positions.

Finally, hiring managers should add some marketing “zing” to job posts, job fairs presentations and interviews, to highlight the exciting aspects of the role, e.g., working with business partners, predicting cash flows and getting engaged in designing the company’s capital structure.

A recession and spiking rates, combined with extreme market volatility, are tall challenges for finance organizations. However, they are also an opportunity to demonstrate the value finance and treasury can add to steer the company forward.

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Justin Jones In Treasury Management

The Great Reconsideration: Improving Culture To Improve Retention

While the flexibility provided by remote work is an important factor, the organization’s culture can be the biggest draw.

The pandemic triggered a significant shift in employees’ expectations, making finding and retaining talent a top priority for finance executives. Higher employee turnover rates are prompting companies to kick-start new efforts to craft corporate cultures that make people feel welcome and ensure they stay on long-term. It’s not easy.

“The labor market is still a challenge, and recruitment is a challenge,” one treasurer said at a recent meeting. “Especially if you’re not based in a large city, you have to do more to get people in; it’s hard.”

While the flexibility provided by remote work is an important factor, the organization’s culture can be the biggest draw.

“The labor market is still a challenge, and recruitment is a challenge,” one treasurer said at a recent meeting. “Especially if you’re not based in a large city, you have to do more to get people in; it’s hard.”

A Confusing Reality

Offering remote and hybrid work arrangements presents opportunities and challenges for finance departments. For example, while flexible hybrid work policies that mandate a certain number of days in the office per week attempt to capture the best of both worlds, the need for in-person staff to join virtual meetings can leave them feeling disconnected. One member said, “How could we ask people to come to the office and spend their whole day on Zoom?”

On the flip side, forcing everyone to come into the office can backfire. Several Silicon Valley companies that adopted strict return-to-office policies have experienced attrition, and some have since gone back on these mandates. One member reported having difficulties hiring at his Virginia-based office, which mandates an in-person only environment.

Employees are increasingly demanding greater flexibility, and employers must be responsive to remain competitive, while ensuring employees’ focus, productivity and team spirit. As remote work becomes the norm, “spontaneous collaboration is becoming rarer, and it’s not always easy to foster,” according to the CFO of a member company.

Another issue that arises from little to no in-person interaction is the difficulty for leaders of gauging the attitudes of their staff. Because they may not be able to be responsive to the needs of an unhappy employee, that person may end up quitting. To better assess employee engagement and satisfaction, one company has launched randomized anonymous surveys as a “little pulse-check” on how everyone at the company is doing—but is still seeking ideas on how to measure individuals’ moods.

The upside of remote work has completely reshaped workforce demographics because it expanded the available talent pool. One member noted that Denver, Charlotte and Atlanta are now significant talent hubs. Another said she opened applications to remote workers across the continent, which led to a new hire based in Ottawa, who has had an instant impact on her team.

Three Steps to Improve Hiring & Retention
Building a welcoming culture is critical to the success of hiring and retention programs. To entice new talent and encourage people to stay, members have taken a number of novel approaches designed to bring people into the office and enjoy it or bond from a distance. It’s therefore incumbent upon executives to get creative.

1. Enhance benefits. A finance executive at a business whose workforce quadrupled during the pandemic said his company resorted to offering more diverse benefits to attract the best people, including the option to work fully remotely or in its Boston offices with free lunch and a stipend for the commute. Another reported that his company saw an uptick in applicants when it implemented full remote positions with unlimited paid time off.

2. Bring back the fun. Often, the “missing ingredient” in the remote office is fun. Without celebrations for birthdays, weddings and personal events, or even water cooler conversations, the workplace can lose much of its focus on people. “Especially when you’re remote, you can’t just be work-driven, you have to be people-driven,” said one member.

3. Offer new incentives. One corporate with a flexible hybrid policy held a free professional photo day, so all employees dressed in their Sunday best and got new headshots, which “brought a ton of people into the office.”

Other ideas included virtual beer and wine tastings, location-based meetups for remote employees, and lunch & learn calls to get to know one another’s interests.
The most common and most effective approach members mentioned was food. “Free lunch just gets employees in the office,” one member said. Another noted that after her company, which provided restaurant-quality meals to employees, went remote-only, it had to offer a lunch stipend for all employees.

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Justin Jones In Crypto, Investment Management

The Inevitability of Crypto for Corporates

While the cryptocurrency market has imploded recently, treasury’s need to become crypto-fluent remains strong.

Sharp drops in cryptocurrency value have grabbed headlines and rattled investors. However, the reality for most corporates is that they must continue, and even accelerate, their efforts to understand the market’s mechanisms and dynamics. Companies’ strategic initiatives, such as issuing nonfungible tokens (NFTs), and rising demand for payment in crypto from a younger customer base, are forcing treasuries to come up the crypto learning curve.

According to one assistant treasurer (AT), it is important that peer companies spend time learning every day. One reason: “When your CEO or CFO comes to you and says the company wants to start accepting bitcoin, you don’t want to be caught off guard.”

While the cryptocurrency market has imploded recently, treasury’s need to become crypto-fluent remains strong.

According to one assistant treasurer (AT), it is important that peer companies spend time learning every day. One reason: “When your CEO or CFO comes to you and says the company wants to start accepting bitcoin, you don’t want to be caught off guard.”

Pressing questions. A recent poll of members of NeuGroup for Large-Cap Assistant Treasurers revealed that none have direct crypto capabilities; however, almost all had important questions, ranging from whether there are restrictions on corporates holding crypto to how long it would take to process crypto payments. Those questions will only become more pressing, as companies move further into the digital asset space.

One participant at a recent meeting said his company has pursued one-off sales of NFTs using a third party to manage the transaction and risk; “but just within the last week, questions came up about whether there could be regular, ongoing [NFT] sales.”
An AT whose technology company has purchased significant cryptocurrency to test the waters, shared some of the issues treasury must address when entering the crypto sphere, ranging from implementing the basic crypto-transaction infrastructure, to understanding the appropriate risk level for the company and the tax and accounting implications.

Inevitable. Recent volatility in the crypto market may have given some treasurers pause, and no one at the meeting reported that their bosses are pushing for immediate crypto capabilities. However, the market has always had steep peaks and valleys yet continued to expand, while increasingly attracting Main Street players. Financial institutions including Bank of New York Mellon and Fidelity are planning to offer crypto custody services this summer, and 74 governments worldwide are testing digital currencies.

Testing the waters. NeuGroup’s Matt Thomas, leader of a thriving digital assets working group, suggested treasury should get a head start. For example, one of the group’s members established a crypto wallet after the company’s first NFT to get ahead in case he is tasked with building the infrastructure to support those transactions. More members are considering doing the same. At one utility company, 72 customers are already paying in bitcoin.

By taking initial steps, treasury can find out firsthand how the market works. In the case of one member company, investing a tiny fraction of its assets in bitcoin has already provided insight into crypto assets’ distinct characteristics, for example:

Digital assets are accounted for as intangibles with indefinite lives, with different impairment tests. And the tax department has been routinely involved, since it remains murky what constitutes dispositions of the assets that would trigger a gain or loss.

Corporate governance is also key, to understand disclosures and even internal communications, since cryptocurrencies can be a “bit polarizing,” she said, “and employees want to understand what you’re doing and why.”
While the outlook for cryptocurrency price recovery is unclear, crypto evangelists predict a continued overall rise in value. This aligns with corporate treasuries’ longer-term perspective. The objective is not to jump in in significantly anytime soon; it’s to be prepared for this eventuality. Indeed, many of our members have already established cross-functional crypto taskforces mandated to research risks and opportunities.

NFTs: Gateway drug to crypto? The table above is a distillation of the crypto storyline for some NeuGroup member companies. It starts with a desire to have an informed answer if asked about the topic. How far beyond the middle stage member companies progress, as we emerge from the current downcycle, will depend on the business case for crypto, which often starts with NFTs. At the end state, crypto expertise (including DeFi and Web3) will integrate into treasury’s complete range of specialized knowledge, or a crypto treasury center of excellence may emerge as a standalone. This crypto COE, not unlike a captive finance company, would collaborate with the traditional finance treasury yet maintain a distinct team and, perhaps, entity structure.

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Justin Jones In Treasury Management

Former Intel CFO: Don’t Wait for an Invite to Impact Strategy

George Davis (left), here with NeuGroup founder Joseph Neu, urged treasurers gathered at a tech summit in California to dream big and weigh in on strategy.

In a keynote address referencing iconic daydreamer Walter Mitty, George Davis—the former CFO of Intel and Qualcomm and the former CFO and treasurer of Applied Materials—urged dozens of treasurers attending NeuGroup’s Tech Strategic Finance Summit Treasurer Day to dream big, take risks and not wait for invitations to apply treasury’s valuable perspective and skill set to a company’s strategic decisions.

Mr. Davis addressed members of NeuGroup for Tech Treasurers (known as Tech20 back when Mr. Davis was a member) and NeuGroup for Growth-Tech Treasury who gathered in person last week at The Ritz-Carlton in Half Moon Bay, California. RBC Capital Markets and Fitch Ratings sponsored the event.
You can watch portions of a video interview NeuGroup Insights did with Mr. Davis by hitting the play button below.

George Davis (left), here with NeuGroup founder Joseph Neu, urged treasurers gathered at a tech summit in California to dream big and weigh in on strategy.

Mr. Davis addressed members of NeuGroup for Tech Treasurers (known as Tech20 back when Mr. Davis was a member) and NeuGroup for Growth-Tech Treasury who gathered in person last week at The Ritz-Carlton in Half Moon Bay, California. RBC Capital Markets and Fitch Ratings sponsored the event.
You can watch portions of a video interview NeuGroup Insights did with Mr. Davis by hitting the play button below.

Swim with the sharks. The fictional character Walter Mitty, Mr. Davis said, is blessed with capabilities well beyond the needs of his day-to-day work, so he daydreams. In a similar vein, he told members, “You’re blessed with capabilities as a treasurer that are essential to your company. And my guess is that you’re still underutilized.”

To address that, Mr. Davis described his perfect treasury job as one where “treasury stuff” like cash management or liabilities and duration take up considerably less time than what the treasurer spends on activities that influence key strategic opportunities for the company—activities that “are the stuff of daydreams.”
- Those may include the company’s M&A agenda, investment prioritization (including R&D), dealing with activist shareholders and global risk management, including cyber risk.
He warned that branching out into areas that present important challenges and pain points to CEOs, CFOs and boards may mean treasurers end up “in rough waters” with potential dangers as people within the company defend what they see as their turf. “It’s going to be out of your comfort zone,” he said.
- To illustrate the point humorously, he showed a clip of “The Secret Life of Walter Mitty” (2013) starring Ben Stiller in which Mitty jumps into ice-cold, shark-infested waters.

Don’t wait for an invite to swim strategically. Treasurers need to take risks and venture into strategic waters, even when they’re not invited. “Getting invited is tricky. If you wait for an invitation you’ll be mostly in your box,” Mr. Davis said. “Most people I’ve seen who do this aren’t invited. So how do you get yourself invited? Well, you have to be willing to engage without being invited.”

He recommends telling the CFO you’re interested in weighing in on specific issues that fall outside your comfort zone. Another tactic: offer up a stand-out analyst on the treasury team to help on deals that will benefit from treasury’s ability to apply valuation methods and tools.
Treasurers who take the initiative to offer valuable insights—without seeking credit—will find fewer hurdles in getting a seat at the table in future strategic endeavors.
View the long hours that you and your team will put in when engaging in activism campaigns and deals as investments in satisfying, often fun work that will increase treasury’s value to the company.

Why inflation, recession and crypto make this a great time to be a treasurer. Several reasons Mr. Davis presented about why now is a great time to be a treasurer underscore his vision of the strategic value treasury is capable of providing to companies.

Inflation: “Very few of us are old enough to have inflation in our resume. It’s a time when there’s no muscle memory for how do you respond to this. So it’s very fair for the CEO and the CFO to look to the treasurer and say, ‘hey, how should we be thinking about it, what are the strategies that people have employed historically and successfully in the face of inflation?’
- “That’s a great opportunity. When there’s a problem, you want to be the solution and I think the treasurer can play a big role.”
Recession: “It introduces a lot of challenges for the company and the treasury portfolio and the skill sets that treasurers have are uniquely suited to thinking through strategies for getting through it. In a recession, the treasurer is definitely part of the solution.”
Crypto: “It’s a legitimate question as to where does crypto fit for a lot of companies—you have to have a view. People understand now that there’s a much broader dynamic in crypto and there’s no better individual in the company than the treasurer and the treasury organization to look at all the issues that come with where it fits.”

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Justin Jones In Capital Markets, Investment Management

Go Short: The Case for Short Duration Credit

One portfolio manager’s investment in ultra-short securities helps shed light on an underrated way to pick up yield.

Investment managers prospecting for opportunities to pick up yield as rates rise may find gold in the hills of short duration credit. At a recent meeting of NeuGroup for Cash Investment sponsored by investment management company Lord Abbett, the portfolio manager of a private university with a large endowment shared how he capitalized on rising yields for short-term investments by working with Lord Abbett at the start of the pandemic—and went back for more.

“You want to understand the volatility, and make sure the institution can tolerate that,” the portfolio manager said. “But looking forward, there is a yield pickup there,” he said of his investment in credit and other ultra-short duration assets.
Lord Abbett investment strategist Joseph Graham, who worked with the university on this investment, said, “Now, yields are up and spreads are wider, and as inflation ravages the purchasing power of cash portfolios, the case for short duration credit is even more compelling,” adding that the firm’s clients “are continuing to find value in our broad-based approach.”

One portfolio manager’s investment in ultra-short securities helps shed light on an underrated way to pick up yield.

“You want to understand the volatility, and make sure the institution can tolerate that,” the portfolio manager said. “But looking forward, there is a yield pickup there,” he said of his investment in credit and other ultra-short duration assets.
Lord Abbett investment strategist Joseph Graham, who worked with the university on this investment, said, “Now, yields are up and spreads are wider, and as inflation ravages the purchasing power of cash portfolios, the case for short duration credit is even more compelling,” adding that the firm’s clients “are continuing to find value in our broad-based approach.”

The client’s journey. The portfolio manager said the university had good deal of cash on its balance sheet in early 2020, when pandemic era policy rates combined with tight spreads meant traditional cash management options offered nearly no yield, leading him to be “more proactive with the management of this cash,” which was sitting in money market funds (MMFs) at the time.

After speaking with Mr. Graham and Samantha Scher, who leads Lord Abbett’s institutional sales team, the manager made an initial investment topping $100 million through a separately managed account with Lord Abbett that included credit and other short duration assets like treasuries, picking up 60 basis points of additional yield compared to the MMFs.
- Later in 2020, the university created a second, more conservative customized allocation of a similar size with Lord Abbett, picking up 20 basis points of yield over money market options.
Because of the university’s liquidity needs and the uncertainty of the pandemic, the manager was limited to a shorter term. “As we evaluated different strategies, we had good visibility for 12 months, but not beyond that,” he said. “So we had to focus on ultra-short.”
“The yield and spread environment [in 2020] was a driver of a more broad-based approach that included credit-sensitive assets for this cash management client,” Mr. Graham said. As yields rise at the short end of the market and spread volatility returns, an active, short duration, credit-focused strategy can compete with core and intermediate fixed income options.

The case for short-term investments. Though Mr. Graham conceded that turning to short-term investments for yield pickup is somewhat counterintuitive, he said “that is indeed the case if you look at the data.”

Lord Abbett presented the chart above comparing the performance of actively-traded US Treasuries from 2020 and now. Because the yield curve is steep through the first three years, then flattens out, short-term (one to three-year) securities make sense right now, particularly in light of uncertainty around the persistence of inflation, noted Mr. Graham.
“You can kind of think of this as an efficient frontier, with term as the biggest risk in fixed income and yield as the biggest component of return,” he said. “It’s tough to justify being anywhere but the one- to three-year area, as long as you have visibility into your liabilities and you’re matched appropriately.”

The case for credit. To help explain the viability of short-term credit investing, Mr. Graham compared it to the concept of matching liabilities and assets in liability-driven investing, instead using credit to offset liabilities. “The question becomes, how much can you really use credit to do this?,” he said. “Aren’t you exposing yourself to principal losses in addition to price volatility?”

The answer, he said, is that historically there aren’t many principal losses in short and high-quality credit investments. “The price volatility and liquidity risk is what you’re solving for,” he said. “By matching assets to liabilities, you can afford some of that price volatility and basically are monetizing the liquidity risk by having the ability to hold through it.
- “In times of volatility, because it’s short-duration and matures relatively soon, as long as a manager is doing good work underwriting credits and there are limited principal losses you do get that pullback to par as things start to reach maturity.”
Mr. Graham acknowledged the real risk of principal losses, but noted “one way to look at it is to compare the term structures of losses vs spreads: the spreads more than make up for the losses.”
- In the chart below, average annual credit loss rates, especially in the first three years, are relatively low for high grade investments, and are offset by spreads over the same period.

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Justin Jones In Crypto, Talking Shop

Talking Shop: Managing Credit Risk for Crypto Custodians

Member question: “How should corporates manage credit risk for cryptocurrency custodians?”

Peer answer 1: “We’ve thought a lot about this. One point to make: Anchorage Digital Bank is federally chartered by the OCC; most others are state chartered. We look at things like that. Most of these licenses have pretty high standards for capitalization, so it might be as simple as learning more about that.

“In addition, we looked at the probability of default on their loan portfolios (percentage of liquid collateral vs. loans outstanding), their ability to repay their obligations and what level of insurance they offer.
“Ultimately, we did purchase dedicated insurance on top of the insurance that the custodian holds. I’d also look at assets under management and if they can disclose any of their top customers. In my experience, they’re all willing to share their latest financials.
“We thought Fidelity had a less impressive solution from a technical standpoint, but it might be the easiest sell if you’re looking for a counterparty that fits within the traditional credit risk framework. We found that Anchorage had the best platform in terms of security and a really great leadership team.”

Member response: “All great thoughts, in line with what we are thinking. We think about credit risk from two angles: balance sheet and cash flow. Do the custodians function like a bank or a corporate? Are there any risk assets (loans or investments)? What is the debt/EBITDA ratio (your point on ability to replay the obligations)? By answering those questions, we think getting the latest financial statement is a start, then we can run credit analysis and categorize them as an IG or non-IG company.”

Peer answer 2: “Great question. Since it is really hard to ‘KYC’ someone in this space, our thought process was to ask our banking partners, who have strict KYC reviews, who in this space met their standards.

“Since the majority are not publicly traded companies, it is near impossible to get completely comfortable. To avoid credit issues as best we can, we currently have rules in place that immediately trade any crypto received to USD and then wire to our preferred banking partner.”

Peer answer 3: “I echo several of the same sentiments of Peer 1. Here are some other points to consider:

“Regulation of custodians: How is the custodian regulated and by whom?
“Regulation of your firm: We had to work with our regulators to have our custodians approved. Our regulators spoke to the regulators of those custodians to feel comfortable. This would apply to broker-dealers and financial firms but unlikely to corporations.
“Strength of balance sheet: Typically this information is shared and is part of the counterparty due diligence process.
“Insurance policies.
“Business continuity policies/processes.
“SLAs on transactions.
“Executive team.
“Overall technical abilities of the custodian.
“Any adverse media.”

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Justin Jones In ESG, Internal Audit Executives, Risk Management

Internal Auditors Shine a Brighter Light on Climate Data Sources

Pending regulations prompt IA to validate companies’ climate-related claims and incorporate first and second lines of defense.

Several members of NeuGroup for Internal Audit Executives have recently or will soon conduct the first audits of their companies’ climate impact reports, and in a recent meeting they generally concluded that ESG group leaders may not understand much of the data behind their reports.

The vice president of internal audit at a corporate with supply chains stretching worldwide discussed his company’s annual climate impact report and several others related to specific supply chains.
- “We had never audited them,” he said. “So I told my team that we really need to take a look at the information in those reports: where the data comes from, can we validate it and are there controls in place?”

Pending regulations prompt IA to validate companies’ climate-related claims and incorporate first and second lines of defense.

The vice president of internal audit at a corporate with supply chains stretching worldwide discussed his company’s annual climate impact report and several others related to specific supply chains.
- “We had never audited them,” he said. “So I told my team that we really need to take a look at the information in those reports: where the data comes from, can we validate it and are there controls in place?”
The audit led to the development of a climate framework that will enable the ESG team to comply with anticipated European Union requirements as well the company’s businesses to better understand and control their climate impact.

Data skills lacking. The executive said his company’s sustainability team members may be passionate, but they didn’t have any background in setting up a so-called second line of defense structure, which ensures the proper handling of risk controls and compliance by first-line risk managers. In some cases, they weren’t well-versed in establishing policies and expectations.

After recently finishing an audit of her company’s climate impact report, another member noted there was no validated data for 40% of the numbers reported.
A third member said her team was beginning a climate impact audit shortly, along with its external auditor.

Out of the ashes. The session leader said his ESG colleagues were upset about the audit’s conclusions, but the group’s leader saw the value of putting in more rigor behind the data.

Now IA reviews every report before it is published and validates the data with limited testing, and has started to work with the ESG group to analyze its source data.
- A peer questioned whether that was excessive, and the session leader pointed to the potential for reputation risk and losing customers, adding that IA will review the reports until the ESG team sets up a functioning second line.
Also stemming from the climate audit is a climate risk assessment template that IA created to apply to each of the company’s businesses.
- “Our ESG team has adopted this and will use it going forward as their official guide,” he said. “We don’t intend to do risk assessments in this area unless they ask for our assistance.”
- He added that such risk assessments are expected to be a part of the European Union’s proposed legislation regarding climate impact.

Framework aspects. Responding to a peer’s request for key aspects of the risk assessment framework, the session leader recommended analyzing the data inputs in a specific process and where it is sourced from—often the supply chain—then building a risk register. Like any risk assessment, common criteria in terms of impact and likelihood were developed, to help prioritize all the data.

Climate change risk stands out because current frameworks typically divide it into physical and transitory risks; so, is it a factory at risk, or a change such as temperatures increasing that must be dealt with over time?
- Using a tool that predicts how climate change will impact businesses, “We can tell them here will be the impact on your business’s profitability.”

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Justin Jones In Capital Markets, Regional

The Fed Won’t Derail the Economy, UMB Tells Assistant Treasurers

The bank’s positive forecast addresses concerns about rates, inflation, growth and unknowns ahead.

UMB, the regional commercial bank, presented a surprisingly upbeat economic forecast for this year to assistant treasurers in a recent meeting, suggesting less likelihood they will face difficult choices to help guide their companies through a recession or skyrocketing inflation.

“On our side,” said an assistant treasurer attending the meeting of NeuGroup for Large-Cap Assistant Treasurers, “it’s fear of the unknown,” given the Fed failed to foresee the inflation spikes “and no one seems to understand what’s going on.”

The bank’s positive forecast addresses concerns about rates, inflation, growth and unknowns ahead.

“On our side,” said an assistant treasurer attending the meeting of NeuGroup for Large-Cap Assistant Treasurers, “it’s fear of the unknown,” given the Fed failed to foresee the inflation spikes “and no one seems to understand what’s going on.”
Addressing those unknowns, the bank’s director of research and fixed income, Eric Kelley, told the group that UMB forecasts GDP growing by 3.4% in 2022 (see chart), lower than last year but still high historically, and inflation will drop significantly over the next few months based on technical reasons alone.

Rate hike fears overblown. The Federal Reserve’s “dot plot,” illustrating board members’ votes on a time chart, indicates the central bank will raise the Fed Funds rate to 2.75% and perhaps 3% this year, and another quarter-point or two in 2023, then pause.

“Not enough to derail the economy; not even close,” Mr. Kelley said, and “The Fed believes that’s their new neutral rate, and it will be good enough to slow down economy.”
The market sees a slightly higher increase this year, at 3.25%, still historically low, Mr. Kelley said, adding that recent volatility in the bond and stock markets has stemmed more from the unexpectedly rapid nature of the rate hikes than longer-term concerns.

Deceptive headlines. US GDP decreased by an annualized negative 1.4% in Q1, but behind the headlines and excluding exports and inventory builds—both volatile components—the economy actually grew at 2.8%, Mr. Kelley said.

“I was surprised how that print did not cause much market turmoil,” noted a meeting participant, adding that Fed Chairman Jerome Powell effectively conveyed that context in his press conference.

Factors powering growth. A housing glut and bust prompted the Great Recession, but today’s housing market and the economic activity it generates show no sign of weakening, despite mortgage rates jumping more than 200 basis points this year, to around 5.25%.

A member asked where UMB sees mortgage rates topping out, and Mr. Kelley noted they tend to follow the 10-year Treasury which the bank forecasts increasing to 3.5% or possibly 3.75%.
- “That should put mortgage rates in the high 5s, maybe 6%,” Mr. Kelley said, adding that could impact first-time homebuyers but not overall housing demand, given historically low housing inventory that is unlikely to meet demand anytime soon.
Another factor powering growth is resilient households, bolstered by today’s strong job market and the accompanying higher wages.
- “We’re in a bit of a housing bubble in San Francisco,” commented a meeting participant, “But people are still buying up houses and spending.”
Assuming no more major surprises this year, UMB expects the S&P to end the year net positive, up 3% to 7%.

Inflation falling. Dramatic inflation numbers have prompted the Fed’s rapid rate increases this year and much of the volatility in the securities markets, but those numbers won’t last.

On the technical front, year over year price comparisons between the first months of 2022 and 2021, when much of the economy was in lockdown, resulted in annualized inflation reaching 8.5%. But prices began rising significantly last summer as the economy opened, reducing that month-to-month spread.
- “By year end, inflation should drop by at least 100 basis points, maybe 200, just because of the math,” Mr. Kelley said.
In addition, factors that have fueled inflation, including supply chain challenges and wage increases, are moderating, he said, adding that the Fed closely monitors the US 5-year/5-forward TIPS breakeven inflation rate, and it shows inflation resting in the agency’s comfort zone of 2.3% to 2.5%.

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Justin Jones In Accounting & Disclosure, Talking Shop

Talking Shop: FBAR Annual Reporting Requirements

Member question: “Do you know if companies need to report all ‘signers’ of foreign bank accounts or all ‘payment approvers’ to the IRS each year for FBAR (Report of Foreign Bank and Financial Accounts) purposes?”

Peer answer 1: “We interpret the FBAR authorized individual to be any employee known to the bank that can direct the bank to take action (including payments). As such, we report signers as well as the payment approvers in our bank portals.”

Peer answer 2: “We have the same interpretation as Peer 1. We report any individual with the ability to directly remit funds from a foreign bank account at his or her discretion where the individual is recognized by the bank as the remitter of the funds.

“We interpret being recognized by the bank as your individual name or username (including password or signature) being attached to the payment. This includes those listed in banking resolutions, bank signature cards, and having approve/release capability in the banking portal.”

Peer answer 3: “We report all signers (US persons) and not electronic payment approvers to the IRS. I won’t comment on its correctness, but that is what we do.”

Peer answer 4: “We report both signers and approvers (viewed as a more conservative approach/interpretation of the guidance).”

Peer answer 5: “I’ve seen both. I think the guidance is to add those who have ‘authority’ on the account, so it’s open to interpretation. I suggest aligning with your tax team. We include payment approvers and signers.”

Peer answer 6: “We only report all US passport holders or people living in the US that are signers on any bank account.”

Peer answer 7: “We only report signers on foreign bank accounts.”

An IRS tax law specialist told NeuGroup Insights that anyone listed on an account, including all signers, must be reported on the company’s FBAR. She advised consulting the IRS FBAR Reference Guide, which states, “A US person must file an FBAR if they have a financial interest in or signature or other authority over any financial account(s) outside the US and the aggregate amount(s) in the account(s) exceeds $10,000 at any time during the calendar year.”

Peter Larson, a principal at Deloitte told NeuGroup Insights:

“Whether a person has ‘signature authority’ for FBAR purposes is fact specific, especially since each company will have different controls, systems and protocols for how their employees interact with the company bank accounts, and different banks will use different protocols as well.
“Basically, the rule is that a person must be able to communicate directly with a bank or other financial institution to dispose of funds for that person to be seen as having signature authority (even if it requires multiple people to communicate with the bank).”

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Justin Jones In Risk Management, Treasury Management

Musical Chairs: Where Should ERM Sit To Create the Most Value?

Some corporates are positioning ERM teams to sit under internal audit or corporate strategy.

Many enterprise risk management teams are at an inflection point as they aim to become strategic partners to the business. Some corporates are finding that ERM can add more value to the business by sitting within functions like corporate strategy or internal audit.

At a recent meeting of NeuGroup for Enterprise Risk Management, two members who recently experienced a shift in reporting—one to internal audit and the other to corporate strategy—compared their approaches and the impact on their ability to add value.

Some corporates are positioning ERM teams to sit under internal audit or corporate strategy.

At a recent meeting of NeuGroup for Enterprise Risk Management, two members who recently experienced a shift in reporting—one to internal audit and the other to corporate strategy—compared their approaches and the impact on their ability to add value.

The case for strategy. Last year, the head of corporate strategy at one member company assumed responsibility for the company’s ERM team due to a push from the CFO to make the function more strategic.

The strategy leader had no previous experience in risk management but was tasked to bring his broader view to a function that had up to this point been entirely tactical.
He now sorts all risks into three buckets: enterprise-level risks, audits and compliance, with audit as an independent function and compliance sitting within the legal department. This frees up time for the ERM team to “take on a few select enterprise strategic issues that cannot be adequately managed by other functions.”
- Though the new structure is still in its first stages, the ERM team has kick-started comprehensive sustainability risk tracking, including short-term reputational risks and long-term economic impacts.
There were two big reasons for the move, he said: “Number one: relevance. Is the function helping with managing risks that are relevant to today’s environment in today’s world?
- “The second, I call outcome orientation,” he said. “You had functions for a long time focused more on process without thinking holistically about the outcomes and the value derived from the process.”

The case for audit. One member who recently conducted a study of peers found that 40% of audit teams own their companies’ ERM programs, and most members at the meeting shared that they report to internal audit.

NeuGroup’s managing director of research and insight Nilly Essaides said that while moving ERM to reside within internal audit could potentially lead to an overly compliance-related focus, it all depends on whether IA has expanded to a broader risk perspective. “However, there is the risk that in some circumstances, IA is not a truly strategic partner and will therefore change the approach of ERM,” she said.
One member who heads her company’s audit team took on enterprise risk management when the chief accounting officer, who also headed the ERM team, left the company. It was more of a tactical decision at the start but led to a value-adding supervisory role.
“They thought IA was a perfect fit, since we have a large view of the company’s risk: strategic, financial, operational, etc.,” the member said.
- “What I’ve now done with the process is we facilitate it, but our executive leadership team owns the risks. So they have to present those risks and mitigation plans to our audit committee.
- “I’ve moved the activity to be owned more by the business, so they’re accountable for those risks.”

Other options, dotted lines. Others at the meeting also recently moved the position of the company’s risk management team, some with a more complex structure.

One ERM head now reports to the chief risk officer at the company, who has helped her think more strategically about how risk management ties into the company’s global operations. She now has quarterly calls with risk leaders for each team within the company, and said the “open dialogue allows us to challenge each other.”
Another company’s ERM function is housed within finance, but has a “dotted line” to the head of compliance.
- “I thought [ERM] should be directly under me, but this setup is actually better,” the company’s compliance head said. “From a personnel perspective, it’s hard to ask 20-25 non-lawyer finance types to be in legal, and we’ve also now been able to straddle the major functions of what an ERM team is ‘supposed’ to do.
- “On compliance matters, [ERM] works at my direction, but they also have a lot of involvement in dealing with financial risks and operational risks, which would be more under the CFO; so they have a foot in both worlds. Though a dotted line is always a little bit of extra work, I’ve been really happy with the coverage.”
One member agreed that having a dotted line connecting ERM to multiple functions can be very beneficial. At his company, ERM sits in internal audit, but has a dotted line to financial strategy and the CFO.
- “It’s been a fantastic complement,” he said. “We also work closely with our compliance office under the legal team, and it’s a great relationship. We do a lot of partner audits and reporting, and fundamentally, I’ve found to be a very good pairing.”

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Justin Jones In FX, Talking Shop

Talking Shop: What Is Your Hedge Horizon?

Member question: “For Neugroup members with an FX cash flow hedging program, what is your hedge horizon?

For context, we hedge up to two years and we’re looking to revise that horizon (potentially up to three years) in our FX policy.
Last, what determines your hedge horizon (e.g., budget cycle, product development cycle, contracts, other)?

Member question: “For Neugroup members with an FX cash flow hedging program, what is your hedge horizon?

“For context, we hedge up to two years and we’re looking to revise that horizon (potentially up to three years) in our FX policy.
“Last, what determines your hedge horizon (e.g., budget cycle, product development cycle, contracts, other)?”

Peer answer 1: “We manageour cash flow hedging program on a rolling 12-month basis until we set initial business plan rates for the next calendar year; we can extend to 15 months to cover the next full calendar year at that time.

“Outside of this normal duration, we can request CFO approval to hedge up to five years out for a portion of our long-term hedge exposure when there is a strong business case.”

Peer answer 2: “We hedge out to two years only, governed by the hedging policy. The policy allows us to hedge longer if the CFO approves. Our forecast goes out to three years, but we feel more comfortable with the accuracy of the forecast for nearer terms.”

Peer answer 3: “We hedge up to 13 months. Our focus is to build certainty in our operating plan for next year. So, in our operating plan, FX rates are mostly fixed.

“I would be very interested in hearing your rationale for revising the hedge horizon.”

Peer answer 4: “We employ a rolling cash flow hedge program with hedges not extending beyond rolling 13 months. For the majority of the cash flow hedge program participating currencies, we use average achieved FX rates to establish budget FX rates.

“I would be interested to learn what analysis method used by others in building recommendation to hedge specific currencies.”

Peer answer 5: “We hedge operating expense (opex) cash flows to lock our plan FX rates for the coming year. We hedge 12 months of opex and, since the plan rates are established two months before the end of the year, we trade forwards with tenors up to 14 months.”

Peer response: ”Just curious, do you hedge up to 100% and do you use the hedge rate as the budget rate?”
Peer answer: “We hedge 70% of the opex under our cash flow hedge program. This is to keep a margin of safety to avoid being over-hedged. We do not use the hedge rate as the budget FX rates, although we proposed this methodology to establish the plan rates, to have no slippage.
- “For most currencies, including all the cash flow hedge currencies, our budget rates are equal to the accounting month-end rates established at the end of the previous fiscal month (usually we open our hedges less than a week after those rates are established to minimize the slippage).”

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