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Rising Insurance Premiums Inflict Pain, Require Pushback

D&O prices spike as insurers respond to a surge in claims following a Supreme Court decision.

Rising insurance premiums had treasurers and assistant treasurers at a recent NeuGroup meeting using plenty of colorful language to describe the current market for coverage and the pain some carriers have caused with their initial pricing proposals.

D&O prices spike as insurers respond to a surge in claims following a Supreme Court decision.

Rising insurance premiums had treasurers and assistant treasurers at a recent NeuGroup meeting using plenty of colorful language to describe the current market for coverage and the pain some carriers have caused with their initial pricing proposals.

  • Among the tamer comments, one member said the directors and officers (D&O) market is the “ugliest in years” and that “a lot of frustration” erupted in her department when the first price quotes arrived. She added that she’s seeing increases in “all areas” of coverage and that her company “almost dropped” its primary D&O carrier.
  • Another treasurer whose company buys insurance in the UK said insurers in that market that had been mispricing D&O coverage have reversed course and are raising premiums.

Sources of pain. Among the reasons for rising D&O premiums, members say insurers are citing an increase in claims and more lawsuits following a 2018 US Supreme Court decision known as Cyan that actuarial consultant Milliman says, “allows 1933 Act lawsuits to proceed in state courts, which eliminates the ability to consolidate cases. This doubles the number of cases and costs to the offending company.”

Time-consuming pushback. One treasurer said negotiating lower premiums required repeatedly “going back” to the insurer and that “it took a monumental amount of time to get it down.” Another participant said renewing property insurance “takes months” while a third said his company recently put out an RFP for property coverage.

  • The insurer for one company wanted to raise its D&O premiums 37% but the treasurer said the actual increase ended up being “much less” after lots of back-and-forth.
  • Several treasurers said their frustration with price increases partly reflects that their companies have paid millions of dollars in premiums to insurers over the years but have never made a claim—or have made very few—one of the arguments they make in negotiating lower increases.
  • Some companies are moving away from buying “ABC” coverage for D&O and are just buying side A, which covers D&O liabilities that cannot be indemnified by the company.

Bigger picture. The bleak picture of the commercial insurance market for corporates that emerged at the meeting is consistent with trends captured by the Marsh Global Insurance Market Index:

  • Global commercial insurance prices rose by 7.8% in the third quarter of 2019, the eighth consecutive quarter of price increases. The third-quarter rise in pricing was the largest year-over-year increase in the index since its inception in 2012.
  • In the US, financial and professional (FinPro) liability pricing increased by 11%, driven by directors and officers (D&O) pricing. “Factors contributing to the market firming include increased litigation with event-driven lawsuits expanding to areas such as #MeToo, cyber breaches social media and safety,” Marsh said. Cyber insurance pricing increased by nearly 3%.
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The Art—Not Science—of Matching Capital Allocation to the Situation

Treasurers discuss their palette of ways to achieve balance sheet flexibility amid binary events and M&A.

Decisions about capital allocation help treasury pave the way for the road ahead and may take on added importance for businesses generating lots of cash—as well as for those whose growth is downshifting. Treasurers at a recent NeuGroup meeting of life sciences companies shared approaches to the challenges of allocating capital during a variety of scenarios and situations.

Treasurers discuss balancing the need for liquidity with keeping cash levels moderate as business ebbs and flows.

Decisions about capital allocation help treasury pave the way for the road ahead and may take on added importance for businesses generating lots of cash—as well as for those whose growth is downshifting. Treasurers at a recent NeuGroup meeting of life sciences companies shared approaches to the challenges of allocating capital during a variety of scenarios and situations.

Optimal capital allocation amid uncertainty. One treasurer told the group that his team is taking “a step back” to consider the optimal capital structure for the circumstances facing his life sciences company, including binary events where the outcome is either a win or a loss:

  • A patent challenge that could lead to generic competition earlier than anticipated on a top-selling drug.
  • Waiting for the FDA to approve or reject a new drug that could significantly broaden the product line.
  • Bonds maturing and a revolving credit facility up for renewal in 2020.

Flexibility desired. Given the number of possible outcomes, the treasurer wanted to position the company to have “balance sheet flexibility.” He asked how others in the group are looking at leverage to construct a capital structure flexible enough to “do large business development” but not carry “too much cash.”

  • After considering various scenarios, the treasurer is considering raising the company’s leverage while avoiding having its ratings lowered.
  • If it were just up to him, he would let the company’s revolver expire and not renew it because of a considerable cash balance and the fact that its capital markets issuance will likely be limited to “one big bond deal” in the next five years.
  • He’s confident that given the company’s credit rating he will almost always be able to access the capital markets—or obtain funding through banks, based on the large number of them soliciting business.
  • About a month after the meeting, the company’s board authorized a $5 billion stock repurchase program, “adding additional share repurchase capacity to the toolbox,” he said.

Share buybacks. The subject of stock repurchase programs like the one approved by the company referenced above generated a range of commentary at the meeting, including one member who said life sciences companies that are enjoying a surfeit of cash because of large profit margins often decide to buy their own stock because if they don’t, “someone else”—an activist shareholder—will force them to do it.

  • The perceived threat of activist shareholders was among the reasons another treasurer at the meeting cited for actions his company took in the wake of selling an asset for billions of dollars a few years ago. “We did have some activists sniffing around because when you have that much cash, they want a return vs having it foolishly spent in the eyes of investors,” he said.

Adapting to change. This treasurer described the transition from “running the tanks fairly dry” in terms of cash before the sale of the asset to having a switch flipped, forcing the company to decide how to redeploy a surplus of cash. It considered business development, debt paydowns and shareholder returns. Contemplating the different combinations involved questioning the market’s view of the company’s identity. “Are we still growth pharma or are we something else,” the treasurer said. 

Seeking guidance. This company sought the advice of rating agencies and engaged with their advisory services as it weighed how much cash to keep. Because it had sold assets that were accretive to EBITDA, it elected to pay down billions of dollars in debt so its leverage ratio didn’t spike, focusing on term loans that allowed the treasurer to “delever the balance sheet quickly.” He added that EPS dilution is another issue to consider when a company sells accretive assets and contemplates share buybacks.

Dividend dynamics. In addition to expandingits share buyback program, this company decided to initiate a dividend (after deciding against a major acquisition). This, too, came after treasury consulted with credit rating agencies to make sure its ratings wouldn’t be lowered after initiating the dividend.

  • In discussing the size of dividends, one treasurer said that “no one cares” about a dividend that is too small. Another made the point that investors expect dividend growth and that once you start paying one “you can’t shut it off.” For that reason, a third person said that stopping a dividend can have bigger implications than curtailing a share buyback program.
  • One treasurer said his company was once considered a growth company by investors but not so much any longer; but it doesn’t pay a dividend, something investors expect from a value stock. He said this raises the risk that the company is viewed an “orphan”—one investors don’t know how to classify.

Communicating with shareholders. The company whose cash levels soared after selling the asset received lots of questions from investors, including activists. Leadership communicated its capital allocation plans and leverage ratio goals on earnings calls.

  • Another treasurer said addressing cash balances and capital allocation are major priorities, has discussed the issue with the board, and for the first time the company “verbalized” its capital allocation strategy on an earnings call and announced the initiation of a $1 billion stock buyback program. Management also stressed that investing in internal research and advancing the pipeline remains its top priority.

A pipeline priority, a cash flow model. One treasurer who described his pharmaceutical company’s capital allocation process and model emphasized that it starts with “the pipeline” and “how the business uses cash.”  He said that like other members, the goal is to have the flexibility to respond to business needs quickly by anticipating how much liquidity could be required for different scenarios. He noted that tax reform in late 2017 represented a milestone in the company’s approach to cash and capital allocation.

This cash flow-based model approach involves:

  • Examining the business’s R&D, M&A and collaboration needs.
  • Determining the right amount of leverage and desired credit ratings after establishing relationships with rating agencies.
  • After determining how much is needed to satisfy those cash flow needs, the company decides how much to allocate to shareholder returns through buybacks and dividends.

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Reimagining the Finance Future in 2020

Founder’s Edition, by Joseph Neu

Five items for finance leaders to focus on in 2020 and beyond.

2020 is upon us and the year itself has vision and foresight in its name. Accordingly, it affords us all an opportunity to seek clarity on not just what the year will bring but also a view of what’s in store for the new decade. For finance practice leaders, I see five issues to focus on starting this year and for the coming ten.

Founder’s Edition, by Joseph Neu

Five items for finance leaders to focus on in 2020 and beyond.

2020 is upon us and the year itself has vision and foresight in its name. Accordingly, it affords us all an opportunity to seek clarity on not just what the year will bring but also a view of what’s in store for the new decade.

For finance practice leaders, I see five issues to focus on starting this year and for the coming ten:

  1. Get serious about digital workers. There has been a lot of hype and fanfare, fits and starts when it comes to robotic process automation and AI in the finance function. But this is the year and decade where it starts to get real. And the finance function is a great petri dish to see how it grows because (1) much of what finance practitioners do is numbers or logic driven and (2) much of finance is seen as a cost center where productivity, scale and cost mitigation are critical, and, in the front office, speed and rapid processing of data gives machines an advantage. Starting this year, make sure you are scaling your human team and refocusing their work on where they can thrive by giving them digital assistants and co-workers to better support them.
  2. Be ready to phase out Libor. While you may think you have until the end of 2021 to prepare, the more important date may be when liquidity shifts from Libor-quoted instruments to those quoted in the secured overnight financing rate (SOFR) or other “ibor” replacement rates. Regulators will be deploying more stick than carrot now to ensure regulated institutions move off Libor and thereby incent the rest of the market to follow their liquidity and do the same. Corporates may see a similarity to the efforts to move derivatives to central clearing. While you won your exemption there, I still wonder about the liquidity premium you are paying to trade OTC. With Libor, I don’t think you will get an exemption beyond the ability to translate Libor references in commercial contracts to a common translation to SOFR, so you don’t need to renegotiate each one. Something like that for outstanding loan agreements made prior to a viable alternative reference rate being available might be helpful, too, but less likely. Be ready for when the market shifts.
  3. Think differently about bank relationships. The digital disruption of banks and financial services should accelerate this decade. With this happening, finance practitioners need to think differently about their bank relationships, the types of services they should expect from them and how they should pay for them. Different thinking about banks best starts with the credit relationship and a bank’s willingness to commit to a credit facility as the key driver of the relationship and allocation of spend (wallet). The promise of open banking and APIs to allow more seamless interoperability between providers, be they banks or non-banks, will not be fully realized until the paying for bank credit via other means fades away.
  4. Think differently about sources of funding. The digital disruption of funding and related corporate finance services goes hand in hand with decoupling bank relationships from credit commitments. Data and insight, plus predictive foresight about a firm’s business and resulting cash flows, current and potential, will increasingly drive credit analysis and access to funding. This will transform credit pricing and availability. How can you manage a bank wallet where the pricing and nature of credit and funding is transforming while the pricing and nature of services to pay for the credit and funding is similarly transforming at an exponential pace? You cannot do it, so don’t.
  5. Rethink the finance function. Considering all the above, including the replacement of a fundamental touchstone like Libor, it is hard to see how the finance function at the end of this decade should look the same as it does now. Especially if you consider all I haven’t said about digital transformation for all organizations and the finance functions to support them. Time to up the pace of change. There has been significant attention paid to reorganizing, optimizing and re-skilling the finance function in recent years, but it may be time for a clean sheet rethink of why a corporate finance function exists, what is seeks to accomplish, for whom and how best to go about this. At a minimum, many of the silos, especially between technical/specialist areas like treasury and tax, probably should be broken down. If you were to create a greenfield finance function at a start-up growing extremely fast, what would that look like? And would you let it evolve to one like a Fortune 100 company’s today or something much different? 

Seeing 2020 written, it seems to me like we should be closer to the imagined future than we are in too many ways. Let’s get caught up to the future we’ve imagined.

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CECL Important for Nonfinancial Companies, Too

Nonfinancial corporates extending credit must also prepare for CECL.

Calendar year companies must apply new accounting for credit losses at the start of the year, in Q1 2020 financial statements, and that includes nonfinancial corporate creditors engaged in a variety of transactions.

 

Nonfinancial corporates extending credit must also prepare for CECL.

Calendar year companies must apply new accounting for credit losses at the start of the year, in Q1 2020 financial statements, and that includes nonfinancial corporate creditors engaged in a variety of transactions.

The Financial Accounting Standards Board’s new current expected credit losses (CECL) methodology replaces the incurred-loss method, which recognizes losses when they become probable. CECL, instead, requires lenders to recognize credit losses expected over the life of a loan on day one, and while the new accounting standard has been mostly associated with banks, nonfinancial corporates engaged in credit arrangements will also be affected.

Tom Barbieri, a partner in PwC’s national office, said CECL may cover a range of corporate exposures, including trade receivables, employee receivables, where companies grant loans to employees, and credit guarantees. Rather than looking at historical loss rates, companies will have to consider current conditions and a reasonably supportable forecast in order to recognize upfront the credit losses expected over the life of the a loan.

More judgment. With trade receivables, for example, companies will have to try to anticipate the state of the economy over its forecast period as well as the state of the company the receivable is from and its specific industry. The longer a company’s forecast period, the more judgmental it becomes. “Corporate finance should be thinking about how it will determine those judgments and whether they’re reasonable, and quite frankly whether they’re explainable to the marketplace if the number is significant,” Mr. Barbieri said.

Business impact. The longer the life of the receivable, the higher the potential for losses and consequently the loss recognized upfront. Mr. Barbieri noted that may impact the life of receivables or other credit transactions companies engage in. “Those types of decisions will play a part in decisions going forward when companies extend credit,” Mr. Barbieri said.

A strange animal. Credit guarantees, where a company is guaranteeing that a joint-venture or other partner will repay its bank loans, are not funded loans. However, existing GAAP requires recording such guarantees at fair value on day one, and CECL adoption will require a reserve then. “So you have two liabilities on day one, which can be a bit counterintuitive for most nonfinancial services companies,” Mr. Barbieri said.

Sound controls. Treasury, accounting and other relevant parts of finance must jointly ensure that controls and procedures over the CECL process are sound, including the assumptions as well as the completeness and accuracy of data being used, Mr. Barbieri said.

Talk to your banks. Banks must also recognize upfront the potential losses on their loans, and that may impact the loans they provide. “When banks have higher CECL reserves, they’ll have to put away additional capital, and that may affect terms in loan agreements. Bank may be incented to provide shorter-term borrowerings,” he said.

Testing now. Companies with more sophisticated finances, especially longer dated ones, should probably have already started running the two accounting methods in parallel. “To the extent the CECL transition amount is material, it should be disclosed in year-end 10K reports.”

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Corporate Finance Ranks Most Concerned About 2020 Risks

What, me worry? Yes! Finance execs most worried about risks in the new year.

Corporate finance executives have jumped to the lead in terms of companies’ top executives concerned about the magnitude and severity of risks their organizations face in 2020, with economic conditions and regulatory scrutiny their top concerns.

What, me worry? Yes! Finance execs most worried about risks in the new year.

Corporate finance executives have jumped to the lead in terms of companies’ top executives concerned about the magnitude and severity of risks their organizations face in 2020, with economic conditions and regulatory scrutiny their top concerns.

On a scale of one to 10, chief financial officers’ impression of risk faced by their companies in the year ahead jumped to 6.5 from 6.0 in last year’s survey. That puts them in the lead from fifth place last year, out of seven categories of surveyed executives that comprised board members and six types of C-suite executives. Dr. Mark Beasley, professor and director of the Enterprise Risk Management Initiative (ERMI) at N. Carolina State University, noted that chief audit officers’ assessment of risk also increase noticeably from last year, and chief risk officers’ bumped up slightly, to 6.0 from 5.9.

Chief executives officers and boards of directors instead saw their concerns about risk lesson in this year’s study compared to last year’s.

The research was conducted by ERMI and consultancy Protiviti, and co-authored by Mr. Beasley and Ken Thomas, a managing director in Protiviti’s Business Performance Improvement practice. The survey received responses from 825 C-Suite executives and directors in companies across the globe. The top five concerns for CFOs were:

Economic conditions. Although the second concern overall, CFOs marked economic conditions starting to restrict some growth opportunities as their top concern, a big jump from last year’s survey when it was not even among the top 10 risks.

Regulatory changes and scrutiny. CFOs worry that an emphasis on regulations may increase and noticeably affect the manner in which their companies’ products and services will be produced or delivered. Mr. Beasley noted that the regulations extend beyond financial requirements to areas such as privacy, with European privacy regulations already in effect and those in California arriving in 2020, and increased government scrutiny of business models such as the big technology firms’.

Resistance to change. As innovative technology is deployed at an ever more rapid pace, CFOs are concerned about their organizations’ ability to embrace that change and remain competitive.

Top talent. Related to the previous concern, CFOs are concerned about their companies’ ability to attract and retain top talent in a tightening talent market, and consequently their ability to achieve operational targets. “How does [corporate finance] move from more production-type activities to more machine learning and other artificial intelligence technologies, taking people away from the analytics they used to spend time on and using that talent in the most efficient way,” Mr. Thomas said.

Cyber, of course. Pervasive across companies, cyber-risk concerns keep CFOs awake at night worrying about whether their organizations are sufficiently prepared to manage cyber threats that could significantly disrupt core operations and/or damage the company’s brand. Mr. Thomas noted that finance departments’ increasing use of technology-driven analytics ingests pulls data from multiple sources, heightening the risk. “Companies are moving to more tech-driven activities and operations that rely ever more on sources of data that can be impacted,” he said.

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Among Execs, CFOs Most Worried About 2020 Risks

CFOs are more worried about 2020 risks than others in the C-Suite: study.

Corporate finance executives are leading the pack in terms of company executives most worried about the magnitude and severity of risks to their organizations in 2020, according to a study by the Enterprise Risk Management Initiative (ERMI) at North Carolina State University and Protiviti.

On a scale of 1-10, with 10 being most concerned, chief financial officers’ impression of risk faced by their companies in the year ahead jumped from last year’s survey, up to 6.5 vs. 6.0 last year, putting them far ahead of their fifth-place slot last year. This is out of seven categories of surveyed executives made up of board members and six types of C-Suite executives.

CFOs are more worried about 2020 risks than others in the C-Suite: study.

Corporate finance executives are leading the pack in terms of company executives most worried about the magnitude and severity of risks to their organizations in 2020, according to a study by the Enterprise Risk Management Initiative (ERMI) at North Carolina State University and Protiviti.

On a scale of 1-10, with 10 being most concerned, chief financial officers’ impression of risk faced by their companies in the year ahead jumped from last year’s survey, up to 6.5 vs. 6.0 last year, putting them far ahead of their fifth-place slot last year. This is out of seven categories of surveyed executives made up of board members and six types of C-Suite executives.

Dr. Mark Beasley, professor and director of the ERMI, noted that chief audit officers’ assessment of risk also increased noticeably from last year, and chief risk officers bumped up slightly as well to 6.0 from 5.9. Meanwhile, chief executive officers and boards of directors saw their concerns about risk decrease in this year’s study.

The research was co-authored by Dr. Beasley and Ken Thomas, a managing director in Protiviti’s Business Performance Improvement practice. The survey received responses from 825 C-Suite executives and directors in companies across the globe.

The top five concerns for CFOs were: 

  • Economic conditions. CFOs saw economic conditions starting to restrict growth opportunities as their top concern, a big jump from last year’s survey when it was not even among the top 10 risks.
  • Regulatory changes and scrutiny. CFOs worry that an emphasis on regulations may increase and noticeably affect the manner in which their companies’ products and services will be produced or delivered. Mr. Beasley noted that the regulations extend beyond financial requirements to areas such as privacy, with European privacy regulations already in effect and those in California arriving in 2020, and increased government scrutiny of business models such as the big technology firms.
  • Resistance to change. As innovative technology is deployed at an ever more rapid pace, CFOs are concerned about their organizations’ ability to embrace that change and remain competitive.
  • Top talent. Related to the previous concern, CFOs are concerned about their companies’ ability to attract and retain top talent in a tightening job market, and consequently their ability to achieve operational targets. “How does [corporate finance] move from more production-type activities to more machine learning and other artificial intelligence technologies, taking people away from the analytics they used to spend time on and using that talent in the most efficient way,” Mr. Thomas said.
  • Cyber, of course. Pervasive across companies, cyber-risk concerns keep CFOs awake at night worrying about whether their organizations are sufficiently prepared to manage cyberthreats that could significantly disrupt core operations and/or damage the company’s brand. Mr. Thomas noted that finance departments’ increasing use of technology-driven analytics ingests pulls data from multiple sources, heightening the risk. “Companies are moving to more tech-driven activities and operations that rely ever more on sources of data that can be impacted,” he said.
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Deutsche Bank: Floating-Rate Debt’s Historical Attractiveness vs. Fixed Is Falling

A falling term premium suggests fixed-rate debt is a better bet for issuers; but the evidence is mixed.

Backtesting shows that issuing floating-rate debt has been cheaper than fixed-rate for corporates over the long run. But the co-head of Deutsche Bank’s risk management solutions team for North America told treasurers at a recent NeuGroup meeting that floating-rate debt currently does not look nearly as attractive relative to fixed as it once did.

“Whatever you thought about fixed vs floating before, on a relative basis, floating rate is less attractive,” Matthew Tilove, Deutsche Bank managing director, said in a follow-up interview. “Looking forward, it is hard to see how floating-rate debt can outperform fixed by the historical average of 200 basis points or more.”

A falling term premium suggests fixed-rate debt is a better bet for issuers; but the evidence is mixed.

Backtesting shows that issuing floating-rate debt has been cheaper than fixed-rate for corporates over the long run. But the co-head of Deutsche Bank’s risk management solutions team for North America told treasurers at a recent NeuGroup meeting that floating-rate debt currently does not look nearly as attractive relative to fixed as it once did. 

  • “Whatever you thought about fixed vs floating before, on a relative basis, floating rate is less attractive,” Matthew Tilove, Deutsche Bank managing director, said in a follow-up interview. “Looking forward, it is hard to see how floating-rate debt can outperform fixed by the historical average of 200 basis points or more.” 

Term premium falls. One basis for that conclusion—and a way to measure the relative attractiveness of floating vs fixed rates—is the term premium, the excess yield that investors require to commit to holding a long-term bond instead of a series of shorter-term bonds.

As the term premium rises, so does the attractiveness of floating-rate debt relative to fixed for issuers. But the term premium has been falling steadily and, Mr. Tilove notes, appears historically low. Reasons for this include very low inflation and demand for long-dated fixed-rate assets.

Mixed signals. The low level of the term premium, then, suggests that fixed-rate debt is relatively more attractive now than floating. In theory. I would say that every indicator that we could use to evaluate fixed versus floating is saying you should be fixed, given that there is currently the lowest term premium ever,” Mr. Tilove said.

  • “However, it is also the case that those indicators have sometimes been totally wrong,” he added. Most notably, term premium was also at a historical low a year ago, yet Deutsche Bank’s analysis shows that a year ago would have been among the best times to swap debt to floating. 

What gives? One possible reason for the current disconnect between the low term premium and the recent outperformance of floating-rate debt, Mr. Tilove said, is that the market simply failed to anticipate the decline in rates over the past year. Another possibility is that the standard models that seek to estimate the term premium are flawed. If this is the case, perhaps the term premium is not really as low as it seems, and floating-rate debt may indeed be expected to outperform fixed.

Bottom line. Despite the caveats and qualifiers, the takeaway remains that floating-rate debt does not offer the same cost-saving advantages it once did, which will come as no surprise to treasury teams that have been terminating fixed-to-floating-rate swaps and locking in ultra-low fixed interest rates as they refinance higher-yielding issues. Going forward, Mr. Tilove expects the term premium to return to more historical norms—meaning floating-rate will regain some of the luster it has lost. That said, he believes the term premium will be “permanently lower” in the future than in prior decades owing to changes in monetary policy, among other reasons.

Real world. But whatever happens with rates or term premiums, treasurers constructing a capital structure that best meets their companies’ needs have lots to consider, including cash flows, liabilities and the cyclicality of the business. All these factors—as well as their interest rate expectations—come into play when deciding the right proportion of fixed-rate vs. floating-rate debt.

As one NeuGroup member put it after hearing the Deutsche Bank presentation, the decision of whether to add more fixed-rate debt depends on the answer to the question, “What riddle are you solving with your risk management?”

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Taking a Leap: Learning to Become an Exponential Organization

Founder’s Edition, by Joseph Neu

Like so many companies, NeuGroup is rising to the challenge of becoming exponential.

The recent FinConnect event we helped facilitate for SoftBank’s Vision Fund I CFOs helped me to see NeuGroup’s own path to higher growth, thanks to the insights of the keynote speaker we enlisted (hat tip to Peter Marshall at EY). The speaker was the futurist Salim Ismail, author of Exponential Organizations.

 

Founder’s Edition, by Joseph Neu

Like so many companies, NeuGroup is rising to the challenge of becoming exponential.

The recent FinConnect event we helped facilitate for SoftBank’s Vision Fund I CFOs helped me to see NeuGroup’s own path to higher growth, thanks to the insights of the keynote speaker we enlisted (hat tip to Peter Marshall at EY). The speaker was the futurist Salim Ismail, author of Exponential Organizations.

  • Mr. Ismail advises companies on how to achieve exponential growth and thrive rather than be disrupted by digital technology and the transformative forces it is unleashing on almost every type of business. His research has identified 11 attributes that define exponential organizations (aka ExOs) or those likely to scale successfully.

What’s our MTP? According to Mr. Ismail, you need at least four attributes of an ExO to succeed and the most important is to have a massively transformative purpose (MTP), which is a higher aspirational objective that captures hearts and minds inside and outside the organization. TED’s “Ideas Worth Spreading” is one example.

We took a big step in this direction by being all about the success of our members and those who serve them to reach their full professional potential with connect, exchange and distill: Connecting you to share and learn, and distilling insight from those exchanges for mutual success. Yet, that’s not massively transformative enough, simple enough nor aspirational enough to grow to our potential. So look for this to change. 

Suppress the immune system. The other important takeaway is that to succeed with exponential thinking and achieve unthinkable growth you must overcome the immune system that exists in any organization, which not only resists change but works actively to kill it and stop the transformation from happening.

Knowing that this is the case in every organization makes it easier for me to lean into the effort to change—and it should help you change, too. Why not ask every stakeholder to help embrace a new, massively transformative purpose and help you fight the natural organizational immune system and transform your organizations?

Help us help you. We are here to help you do this. And since we value those who give to get, I am also asking you to help me transform NeuGroup to reach its full potential and embrace a more transformative purpose to connect all finance professionals who want to share and learn—not just peer group members—everyone, everywhere, in any way we can imagine.

Mutual value. In this way, we encourage every financial professional to help your companies become exponential organizations and embrace a digital mindset. This will also shift finance leaders from being naturally associated with being part of the immune system (e.g., “What you’re proposing is not in the budget plan.”)

  • We pledge to help you with our unique knowledge, insight and connections. And if you also help us scale our ability to source new connections and insight validated via knowledge exchange, we will in turn create more mutual value and wealth for our entire community—and the crowd beyond it that shares our mission.

Coming to this insight (don’t be afraid of a massively transformative purpose and realize that it is natural for the immune system in your organization to fight your effort to embrace exponential thinking) has been liberating.

  • I hope every organization reading this can, like me, be liberated and gain the confidence needed to transform. I expect 2020 to be the most transformative year of my entire career for everyone who is part of NeuGroup. 

Thanks for being a part of it.

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Preparing to Plow Through The Next Recession

How one company survived the Great Recession, and advice on how to prepare for the next downturn.

With an economic slowdown looming—even if no one knows exactly when it will occur or how severe it will be—companies must prepare for the worst. It doesn’t get much worse than the slump Caterpillar Inc. experienced in 2009, when sales and revenue plummeted. But the company remained profitable and maintained its dividend. How did Caterpillar achieve its remarkable performance?

How one company survived the Great Recession, and advice on how to prepare for the next downturn.

With an economic slowdown looming—even if no one knows exactly when it will occur or how severe it will be—companies must prepare for the worst. It doesn’t get much worse than the slump Caterpillar Inc. experienced in 2009, when sales and revenue plummeted. But the company remained profitable and maintained its dividend. How did Caterpillar achieve its remarkable performance?

Recession planning was the focus of a recent NeuGroup meeting, where Ed Scott, senior executive advisor at NeuGroup and retired treasurer at Caterpillar, discussed the global company’s recovery methodology. He also noted some questions for treasury executives to ponder before the storm hits:

  • What approach is your company taking to prepare for a possible recession?
  • What are your company’s critical success factors that must be protected?
  • What levers/workstreams are necessary to protect those factors?
  • What is treasury’s role in the company in planning for and fighting a recession?

During the Great Recession, Caterpillar’s sales fell 37% and its profit dropped to $895 million from $3.6 billion. The company took a $3.4 billion charge to equity, and debt as a percentage of debt and equity soared to 59.7%, well above the company’s preferred maximum of 45%.

Caterpillar’s single-A rating, necessary to fund its captive finance company, was in jeopardy. So the company pursued the MAST methodology, which Mr. Scott said can be applied to virtually any significant project or initiative:

  • Meaning. Why take action? For Caterpillar, it was to remain profitable, avoid cutting its dividend, and protect its rating.
  • Action. Establish workstreams, which in Caterpillar’s case numbered 10 and included reducing inventory, closely monitoring the financial health of critical dealers and suppliers, aggressively pursuing collections and increasing liquidity as needed. Mr. Scott noted that each workstream had a designated owner.
  • Structure. The cadence to make sure the plan is carried. Caterpillar’s CFO, treasurer and controller met every Friday at 6:30 a.m. with all the workstream leaders to review and document progress over the last week and discuss the week ahead. “Why so early? Because nobody has a meeting at that time, so everybody had to show up,” Mr. Scott said.
  • Truth. Metrics for each workstream were key to tracking progress and eventual success. “It’s very important to define the critical success factors and the metrics to achieve that,” Mr. Scott said. 

In terms of preparing for a recession, Mr. Scott said, analyzing how much sales will likely drop, or trough planning, is key, and pressure testing is also important. “Think about what the company could do if it had a 20% or 30% drop in sales,” he said.

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Group Therapy for FX Systems Pain: Misery Loves Company

FX managers for the most part like their systems. But there’s always that one thing that creates a headache.

Leo Tolstoy famously posited that “All happy families are alike; each unhappy family is unhappy in its own way.” That line from “Anna Karenina” can definitely be applied to treasury practitioners and their systems.

  • In a discussion at a recent NeuGroup meeting jokingly dubbed the systems “misery montage,” three FX managers members shared their biggest pain points, most of which derive from the fact that the FX function depends on several different systems vendors to manage the workflow end-to-end, and they don’t always “talk to each other” all that smoothly.

FX managers for the most part like their systems. But there’s always that one thing that creates a headache.

Leo Tolstoy famously posited that “All happy families are alike; each unhappy family is unhappy in its own way.” That line from “Anna Karenina” can definitely be applied to treasury practitioners and their systems.

  • In a discussion at a recent NeuGroup meeting jokingly dubbed the systems “misery montage,” three FX managers members shared their biggest pain points, most of which derive from the fact that the FX function depends on several different systems vendors to manage the workflow end-to-end, and they don’t always “talk to each other” all that smoothly.

Must-do automation projects and bot opportunities. First up, a member with a specialist risk and hedge accounting system lamented the lack of an automated way to exchange data between that system and SAP, particularly end-of-month valuations, currently done on Excel, and said that it’s a “huge project to map entity names and trading, hedge accounting, EMIR and Dodd-Frank reporting from that module to SAP in the way that accounting wants it.”

  • A second big pain point is the lack of automation in daily cash management, which relies too heavily on reporting instead. For aggregating balance sheet exposure data, another member suggested using a bot.

Map out pros and cons and ID alternatives. The second member shared a detailed table of workflow tasks and the pros and cons of the system used for those tasks at the time — including cost, reliability, service levels and internal IT needs — as well as possible alternative vendors for those processes, a handy way to analyze the situation.

  • One of his pain points was netting for settlements. He also called out various areas where the hedge accounting system was buggy, for example in trade valuation and the journal entry process, not to mention that the vendor provided “poor customer service” on top of a “lengthy implementation.” Still, the pain may not have risen to merit the cost and time of switching to one of the alternatives.

Vendor-client process fit? The final member to present showed her systems setup, which overall she was happy with. However, one link in the chain was problematic. The hedge accounting vendor was rather “inflexible” about wanting all the company’s exposures “in their tool and then they want to tell you what your trade should be,” the member said. “But we have our own exposure tool and it’s not our process [to outsource hedge decisions].”

One of the breakout huddles at the meeting also tackled systems and automation; some of the takeaways included:

  • How do you quantify the business benefits of robotic process automation, especially if you have to fight for IT resources to complete automation projects? And, as one member pointed out, automation does not equal head count reduction, so it’s hard to prove.
  • A straightforward systems implementation can be complicated enough, but companies faced with a steady stream of acquisitions — like many in the group — are always catching up.
  • M&A in the systems vendor space complicates things further, especially the customer service issues that have arisen from consolidation and dislocation in that industry.
  • Some keys to implementation success:
    • Thorough testing. Test every currency pair, every type of transaction, every counterpart with a penny-value transaction. “We found so many issues that way,” said a member with a huge systems transformation underway.
    • Resourcing. Work to get buy-in for the project as business-critical at the highest level possible in the organization. That increases the chances of an adequate budget and it will attract the best people to the project.
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Back to the Future: Making Banks a Source for Innovative Solutions Again

Founder’s Edition, by Joseph Neu
 
Working to reverse the notion that banks are no longer a source for innovative solutions.

One of the trends we’ve seen in interacting with NeuGroup members recently is their concern that banks are no longer the source for innovation or solutions that tap the most innovative technology and digital thinking.

And banks seem to be hearing this message, prompting them to respond to counter that perception. Unfortunately, some banks find it easier to respond with platitudes about how they are adopting new digital mindsets, embracing open APIs and investing in digital innovation centers, rather than to actually rolling out game-changing new digital solutions to corporate clients.

In addition, we see banks: 

Founder’s Edition, by Joseph Neu

Working to reverse the notion that banks are no longer a source for innovative solutions.

One of the trends we’ve seen in interacting with NeuGroup members recently is their concern that banks are no longer the source for innovation or solutions that tap the most innovative technology and digital thinking.

And banks seem to be hearing this message, prompting them to respond to counter that perception. Unfortunately, some banks find it easier to respond with platitudes about how they are adopting new digital mindsets, embracing open APIs and investing in digital innovation centers, rather than to actually rolling out game-changing new digital solutions to corporate clients.

In addition, we see banks: 

  • Talking about the impact of digital disruption. Some banks are seeking to go a bit further and speak to examples of how digitalization is disrupting their business. For instance, electronic trading platforms that reduce bid-ask spreads, direct listings of equity and debt issuance migrating to electronic platforms, which in turn encroaches on underwriting fees; and digital wallets displacing retail and, increasingly, commercial payments. Identifying these areas of disruption and how they are responding helps buy time.
  • Helping foster digital thinking. Another tact is for banks to present the work they are doing to spark digital thinking and innovation in their own businesses and use this as a path to follow for corporate finance functions to foster digital thinking and innovation within their own organizations. This may be useful, but not nearly as useful as implementing the results from this new thinking to help customers.
  • Creating their own digital/challenger banks. Banks of all sizes have launched or are in the process of launching digital challenger banks to compete with and to an extent disrupt their own legacy business. Often these digital banks are given resources to invest in their own greenfield platforms, utilizing newer digital technology and/or partnering with financial technology companies who have promising tech but lack bank trust, KYC and other regulatory compliance capabilities (or a license to operate in a desired financial market). 

Let’s not forget, though, that it can be very difficult for a bank, or any organization, to disrupt itself. According to Salim Ismail, author of “Exponential Organizations,” a best-selling book that identifies how companies succeed by embracing the disruptive forces of digital technology and grow exponentially, the reason is that every organization has a natural immune system that not only stands in the way of change but actively seeks to destroy the initiatives driving it. Banks are no exception.

For 2020, NeuGroup would like to work with banks who want to restore corporate customers’ confidence in them as a source for innovative solutions, beyond innovative thinking. One way to start the process is to ask each of our bank partners:

  • What is the most innovative solution that you have introduced in the last 12 months or plan to introduce in the next 12 months?
  • What corporate client problem does it solve? Why do you think it is innovative?
  • How did the solution come about, including what clients helped develop and test it?

We encourage our members to ask the partner banks the same.

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No More Libor-SOFR 101, Please! Treasurers Want Implementation Details

Treasurers say they need specifics on market conventions to complete the SOFR risk puzzle.

Many treasury teams don’t want any more bank presentations on Libor-SOFR transition timelines or the basics of risk and fallback language—they want details from bankers, regulators and industry groups on various market conventions.

  • These include how exactly SOFR term rates will be calculated in the cash markets, specifics on any compounding methodology, settlement conventions like lookbacks, and the spread adjustment from Libor to SOFR.
    • “We need details about the market conventions to communicate to the systems folks,” said one treasury practitioner on a NeuGroup members-only conference call this week, echoing other participants. “We want to start getting into the details so we can move forward with transition. But we have a lot of unknowns—I think everyone has these questions.”

Treasurers say they need specifics on market conventions to complete the SOFR risk puzzle.

Many treasury teams don’t want any more bank presentations on Libor-SOFR transition timelines or the basics of risk and fallback language—they want details from bankers, regulators and industry groups on various market conventions.

  • These include how exactly SOFR term rates will be calculated in the cash markets, specifics on any compounding methodology, settlement conventions like lookbacks, and the spread adjustment from Libor to SOFR.
    • “We need details about the market conventions to communicate to the systems folks,” said one treasury practitioner on a NeuGroup members-only conference call this week, echoing other participants. “We want to start getting into the details so we can move forward with transition. But we have a lot of unknowns—I think everyone has these questions.”

Calculation calculus. The answers to these questions will play a critical role, he explained, in pricing of financial instruments or simply knowing standard conventions to settle a transaction, among other issues dependent on the establishment of standards.

Fear of hedge ineffectiveness. Unknowns about spread adjustments, derivative protocols, and market conventions make assessing the impact on hedge effectiveness and the impact on the P&L difficult to assess at this point, one practitioner said. “The risks are known, there’s just not enough information now to quantify those risks,” he added.

Wait and see. Several treasurers on the call said they’re taking a wait-and-see approach to issuing or buying SOFR-denominated debt until there are more details and a track record. One such practitioner who said her company has done no planning for the transition said the company assumes there will eventually be a protocol process that will work.

  • There’s no upside to being a first mover,” one person on the call said. Liquidity is insufficient, he said, to swap to SOFR at an attractive price. Another participant said while his company has been pitched issuing a SOFR bond, it’s not going to do that. “We have been told there would be a market; we’ve chosen to wait that out,” he said.

Pain points. One company has investments in floating-rate debt that will mature after 2021, when using Libor as a reference rate is scheduled to end. “We don’t know the financial impact of the transition,” the treasurer said. “At some point I’m going to have a problem if issuers don’t update their fallback language.” He wants to know what his outside investment managers are doing to manage this concern.

  • This treasurer said he wants to avoid a “one-sided situation” and being “locked into something we don’t agree with.” For those reasons, he wants fallback language that can be amended based on the ultimate details of the Libor-SOFR transition but that doesn’t require redoing the entire document.

No windfalls. In the same vein, other treasurers said the fallback language cannot result in financial windfalls for the banks. “We have started discussions with banking partners,” one said. Another asked if anyone has agreements with their banks on determining economic equivalence between Libor and SOFR. He wants to make sure it “doesn’t create a windfall for either party.”

Discussing disclosure. After discussing the issue with its auditors, one of the companies on the call added a Libor-based risk factor disclosure to its 10-K, modelling it on other companies that had adopted “fairly generic” disclosures, according to one member. One treasurer said his company has been including disclosures in its financial statement about the unknown impact to liquidity from the transition.

Let sleeping dogs lie. On the subject of commercial contracts that include Libor, the consensus on the call was to not open up existing agreements—to let sleeping dogs lie. “Don’t open a Pandora’s box” if Libor is not material to the contract, one treasurer warned. At his company, Libor appears in the late fee part of contracts, which are rarely used and not material, he said.

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When Treasury Needs to Blow Its Own Horn

How metrics help treasury teams market their successes in good times.

Treasury teams get plenty of attention in financially volatile times, but in the good times their more mundane if still critical activities—reducing bank accounts, hedging foreign exchange, etc.—tend to go unnoticed.

  • “If we don’t convey the value treasury provides in good times and in bad, no one else will,” said Ed Scott, senior executive advisor at NeuGroup and former treasurer at Caterpillar, who co-led a recent NeuGroup meeting of assistant treasurers. He added, “The losers are your people who are not getting the credit.” 

How metrics help treasury teams market their successes in good times.

Treasury teams get plenty of attention in financially volatile times, but in the good times their more mundane if still critical activities—reducing bank accounts, hedging foreign exchange, etc.—tend to go unnoticed.

  • “If we don’t convey the value treasury provides in good times and in bad, no one else will,” said Ed Scott, senior executive advisor at NeuGroup and former treasurer at Caterpillar, who co-led a recent NeuGroup meeting of assistant treasurers. He added, “The losers are your people who are not getting the credit.”  

Develop metrics. One peer group member said his treasury department recently completed a treasury transformation, implementing a treasury management system (TMS), rationalizing banks and creating pooling structures. A year ago it began developing metrics to measure progress and determine what had been done correctly or not.

  • It’s all about the data. Pursuing metrics, he said, can’t be successful without “good, solid information.” Define, measure, analyze, improve and control, or DMAIC, is the Six Sigma methodology his team uses. “It’s all about quality and continuous improvement. That’s where the metrics help us go,” he said.

He displayed 14 metrics his team applies today under the categories of cash, currency, credit cards, bank fees and insurance, and he noted several others under consideration in areas such as treasury-staff productivity and financial metrics including hedging performance, FX spreads and cash-flow forecasting accuracy. 

Trends, not points in time. The member said viewing a metric at a point in time provides little value. Instead, analyzing the trend is “where you really start to learn what you’re doing, and it generates lots of questions about the process,” he said. He noted activity-based metrics, such as how many banks the company has or its cash balances, provide important information. The most critical metrics to drive improvement are performance-based ones, such as how many banks and bank accounts have been eliminated, or how much interest was earned.

CFO stories. Mr. Scott noted that reducing the number of bank accounts also cuts fraud, bank fees and labor costs. “So how do you translate those things into the story your CFO wants to hear? What’s the value of doing that?” he asked the group.

The presenting member said treasury must create and monitor meaningful metrics that make a difference in the business and are actually read by the C-Suite:

  • Focus. Report what’s most important.
  • Display. Use effective graphics to deliver the message.
  • Be concise. Deliver a clear, easy-to-understand message.
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Five Key Steps to Supporting Strategic CFOs

Founder’s Edition, by Joseph Neu

What direct reports can do to help a CFO—and themselves—climb the strategic stairs.

We recently facilitated an event for growth-company CFOs where a lot of discussion centered on how the CFO should help get things done by being a strategic partner of the founder or CEO. Playing this role has also become a priority at more mature companies.

  • Bottom line:  If you report to the CFO, you’ll want help make that person a true strategic partner—as you simultaneously become one yourself.

Founder’s Edition, by Joseph Neu

What direct reports can do to help a CFO—and themselves—climb the strategic stairs.

We recently facilitated an event for growth-company CFOs where a lot of discussion centered on how the CFO should help get things done by being a strategic partner of the founder or CEO. Playing this role has also become a priority at more mature companies.

  • Bottom line:  If you report to the CFO, you’ll want help make that person a true strategic partner—as you simultaneously become one yourself.

For starters, focus on these five areas:

  1. Excellence inside and outside the box. The key takeaway is that CFOs have to be good at operating outside of the core finance function, or box, to be successful. That means they must have people they can rely on to handle what’s inside that box. So make sure the finance box functions phenomenally so that you, too, can support the CFO’s work outside it.
     
  2. Hire well and develop talent fast. To increase their span of control and become a strategic partner, CFOs need to hire the right people at the right time for key finance areas. That may always be true, but CFOs tend to struggle when they don’t recruit the right people at the right time for what’s needed next. Smarter hiring will let you take that next step.
    • The need to develop talent fast is in part generational, as millennials expect to progress faster. There’s also a supply-and-demand curve issue skewing finance talent younger. “Senior roles are filled by professionals, on average, six years younger than a decade ago,” a West Coast-based executive recruiter who specializes in finance executives said. A lack of supply for finance professionals with the right experience means that they have the ability to move up quickly. If you don’t promote them, they will leave. Your head of FP&A is someone else’s CFO. Don’t let that happen.
  3. Cultivate a direct line to the board. CFOs need to have a direct relationship with the board, usually with the chair of the audit committee, who can act as a sounding board, coach and networking advisor. Give them what they need to make the most of their board interaction and, as a key direct report, cultivate your own board relationships so that you are in the running as a successor.
    • Hint: The first step might be with a specialty sub-committee or advisory board. Start building your own network of advisors to make you a better and more valuable part of the CFO’s finance team.
       
  4. Set up solutions. A strategic CFO shows that he or she can offer more than information by proposing potential solutions and advancing the team to the 5-yard line, making it easier for the CEO to score the touchdown. Make it easier for the CFO to do this. Don’t be a passive data collector, but instead drive to solutions and, where appropriate, proactively take action.
     
  5. Be proactive about data as an asset. At more companies, data is becoming one of the most valuable assets; or it’s at the top of the list. Even if it’s not yet on the balance sheet, help the CFO to manage data well, leverage it for better decisions, and monetize it both to generate new revenue for the business but also as an asset with which to secure new capital.

Focus on these five things and you’ll likely see the strategic importance of the CFO’s role rise, and with it the strategic value of your role as controller, head of FP&A, vice president of corporate finance/treasurer, or chief audit executive.

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Prepare for a Surging Green Wave of ESG Products

By Joseph Neu

BNP Paribas highlights a veritable tsunami of sustainability-linked finance products.

 
“Treasurers should be preparing for a tsunami of sustainability-linked finance products,” one NeuGroup member treasurer told me recently in response to market events of the last year. To underscore the importance of that notion, Hervé Duteil, chief sustainability officer for BNP Paribas in the Americas, presented his view to NeuGroup’s Tech20 Treasurers’ Peer Group last month. He described three big waves, or “revolutions,” in sustainable finance:

By Joseph Neu

BNP Paribas highlights a veritable tsunami of sustainability-linked finance products.
 

“Treasurers should be preparing for a tsunami of sustainability-linked finance products,” one NeuGroup member treasurer told me recently in response to market events of the last year. To underscore the importance of that notion, Hervé Duteil, chief sustainability officer for BNP Paribas in the Americas, presented his view to NeuGroup’s Tech20 Treasurers’ Peer Group last month. He described three big waves, or “revolutions,” in sustainable finance:

1. Labelling the “use of proceeds.” This wave is most famous for green bonds, and it continues with Apple’s sizable euro-denominated green bond issue last month, but also includes other labelled or “thematic” bonds (or loans) for green, social, sustainable, sustainable development goals (SDG), and now transition financing. The guiding principle is that the use of proceeds from these loans is identified, or labelled, as being used for something specific to sustainability.

2. Linking returns with sustainability performance and impact. This wave’s focus is on sustainability impact and performance (with measurable KPIs) and originally driven by bank lenders.

  • Supply chain finance: This wave likely began in 2016 with sustainable supply chain financing, where the discount factor applied to supplier invoices is linked to sustainability performance verified over time—i.e., do right and you get paid earlier for less of a discount.
  • Loans and credit facilities: The wave has further extended to longer-term financing (mostly revolving credit facilities) in the form of sustainability-linked loans (SLLs), where the interest rate moves up or down in line with the achievement of sustainability performance targets, such as ESG score, greenhouse gas emissions, water intensity, waste intensity or gender ratios.
  • Swaps: The concept of a variable coupon tied to sustainability performance was also embedded in a swap derivative in August and more recently when BNP Paribas structured the first ESG-Linked FX forward swap for Siemens Gamesa.

3. Linking cost of risk (and funding) to sustainability performance and impact. The subtle difference between this and the second wave is that while in the former banks are accepting a lower return for sustainability gains, in the latter it is about investors asking to be compensated for the increased risk—credit or operational—from poor sustainability performance.

The risk-cost argument is likely to have an increasing impact. For one, rating agencies are starting to speak to a more formalized integration of ESG risk factors into credit assessments. This sets up a tension for them that was revealed at our Tech20 Annual Rating Agency Breakfast:

  • To what extent can issuers say that ESG is embedded in their normal rating as opposed to paying for a separate ESG rating? There is not yet a clear answer, other than that ESG factors have always been part of your credit ratings and they will continue to be a factor.

Banks have another risk-cost consideration. While banks have the same inclination as investors to steer the world in a more sustainable direction, they also are looking to strengthen the resilience of their corporate lending model and hedge their loan portfolios against systemic risks such as the emergence of carbon taxes or higher capital adequacy ratios for credit extended to carbon-intensive sectors (see BIS white papers and other central bank research for discussions of putting a higher RWA on credit products for unsustainable or so-called “brown” counterparties).

  • An asymmetric risk profile: This raises the point about the asymmetric nature of sustainability risk, i.e., providers and users of capital will increasingly be penalized from a cost of capital standpoint for brown activities more than they are rewarded for continuing to promote sustainable policies, supporting high ESG scores and acting green.

It will be interesting to see how quickly sustainability-linked finance shifts from rewarding do-gooders to imposing costs on firms that need to transition to become better ESG citizens. Such a move may create something of a catch-22, especially for capital-intensive businesses like oil and gas, mining and heavy industries.

Accordingly, BNP Paribas’ Mr. Duteil sees transition finance as a necessary extension of green finance. It would apply to sectors that (1) are not green today; (2) cannot become green tomorrow; (3) but can and need to get greener (by which we mean less brown) faster; at a pace likely in line with recognized sustainable development scenarios; or at least within the scope of a disclosed comprehensive strategy road map that will get them back in line within an acceptable time frame.

It’s either this or making laggard firms easier targets for disruption by increasing their risk-adjusted cost of capital.

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ION Treasury’s Cross-Product Solutions Strategy Reassures Some TMS Clients

Company is highlighting innovations that work for all seven of ION’s treasury management systems.

In the latest example of its cross-product, multi-brand strategy, this month ION Treasury is launching a cash forecasting solution powered by machine learning for its Reval and ITS treasury clients. ION says the strategy is to build solutions like this once and deploy them to all of its treasury brands, including Wallstreet Suite, Treasura, IT2, Openlink and City Financials.

Cross-product solutions. The cash forecasting solution fits into ION’s road map of introducing innovations across its TMS portfolio, a strategy the company has actively shared with customers at a series of client meetings across the globe this year. The meetings—following a string of acquisitions that initially concerned some clients—are part of the company’s “unification” effort, ION Treasury CEO Rich Grossi said in a recent interview with NeuGroup Insights.

  • “The big message to our customers is our strategy will continue to focus on product innovation within each of our solutions, but we will also provide greater value from the larger portfolio of ION solutions,” Mr. Grossi said. “At our conference, we launched several cross-platform solutions as a proof point of our strategy. Overall, I believe our customers understood the vision and saw great benefit in our new offerings.”

By Antony Michels

Company is highlighting innovations that work for all seven of ION’s treasury management systems.

In the latest example of its cross-product, multi-brand strategy, this month ION Treasury is launching a cash forecasting solution powered by machine learning for its Reval and ITS treasury clients. ION says the strategy is to build solutions like this once and deploy them to all of its treasury brands, including Wallstreet Suite, Treasura, IT2, Openlink and City Financials.

Cross-product solutions. The cash forecasting solution fits into ION’s road map of introducing innovations across its TMS portfolio, a strategy the company has actively shared with customers at a series of client meetings across the globe this year. The meetings—following a string of acquisitions that initially concerned some clients—are part of the company’s “unification” effort, ION Treasury CEO Rich Grossi said in a recent interview with NeuGroup Insights.

  • “The big message to our customers is our strategy will continue to focus on product innovation within each of our solutions, but we will also provide greater value from the larger portfolio of ION solutions,” Mr. Grossi said. “At our conference, we launched several cross-platform solutions as a proof point of our strategy. Overall, I believe our customers understood the vision and saw great benefit in our new offerings.”

Reassuring clients. Anecdotal feedback suggests ION’s message is resonating, at least with some clients. Several NeuGroup members who are users of Reval and other ION systems say they learned important details at the client events about ION’s game plan after a period of relative silence and personnel disruptions as the company acquired and absorbed more TMS providers.

  • One NeuGroup member who did not like the company’s lack of communication following acquisitions spoke positively about the event she attended. “During the user conference, they laid out a well-thought-out strategy that was the first time we’ve ever really heard their strategy, and it all really made sense.”

Investing, not acquiring. “They specifically talked about how they are all done acquiring their core systems,” the member said in explaining her takeaways from the conference. “Their strategy now is to invest across products through ancillary solutions that can lay over these core solutions. Like bank connectivity, bank fee analysis, bank account management, money market fund portals, machine learning, mobile access. So that was encouraging.”

  • In October, ION announced the rollout of a bank fee analysis tool, part of its bank account management solution called IBAM. Looking ahead, Mr. Grossi said the company plans to introduce cross-product solutions involving clients’ connections to banks as well as other tools that make use of artificial intelligence and machine learning. All will ultimately be available to each TMS brand.

Client communication portal. As a final example of the company’s evolution and unification, Mr. Grossi described an online client communication portal for all ION users. “This tool allows clients to connect to receive updates on their software, to view road maps, to share our knowledge with other ION Treasury community users, to get information around the software, to report issues, to get documentation, to do some self-service. A really powerful tool that is exposed now to our larger community and not just a specific customer within.”

The road ahead. More than one NeuGroup member said while they liked what they heard, the jury is still out on the execution of the plan. One such member is eager to hear more about ION’s connectivity solutions. “I really want to see them do something around connectivity. That space is changing so quickly now. There’s definitely more solutions coming in that space through APIs. I’d really like to see that really be an area they invest in. That could be very transformative.”

  • Mr. Grossi says the company is listening closely to what clients want and partnering with them to make those solutions a reality. “We have a really powerful opportunity to advance our solutions. There is work to do, but I think this year was a real inflection point for us as it relates to not only communicating but demonstrating where we want to be from a from a solution provider point of view.”
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Chatham Financial Bolsters Euro Expertise with JCRA Acquisition

Chatham Financial recently announced that it has acquired a similar advisory firm headquartered in London, deepening its expertise in European derivatives and capital markets and related risk.

Chatham Financial recently announced that it has acquired a similar advisory firm headquartered in London, deepening its expertise in European derivatives and capital markets and related risk at a time when multinationals are mulling euro-centric issues like Brexit and negative rates.

Chatham has mainly grown organically and now has more than 650 employees worldwide, including 90 in its London and Krakow offices. The acquisition of independent risk advisor JCRA Group will increase its European staff by more than 50%, bringing on experts who, similar to Chatham’s staff, specialize in hedging and debt capital markets advice.

Chatham Financial recently announced that it has acquired a similar advisory firm headquartered in London, deepening its expertise in European derivatives and capital markets and related risk.

Chatham Financial recently announced that it has acquired a similar advisory firm headquartered in London, deepening its expertise in European derivatives and capital markets and related risk at a time when multinationals are mulling euro-centric issues like Brexit and negative rates.

Chatham has mainly grown organically and now has more than 650 employees worldwide, including 90 in its London and Krakow offices. The acquisition of independent risk advisor JCRA Group will increase its European staff by more than 50%, bringing on experts who, similar to Chatham’s staff, specialize in hedging and debt capital markets advice.

“One of Chatham’s purposes is to help make markets transparent, accessible and fair for all market participants. We’re excited about how, together with JCRA, we can have an even greater impact,” said Clark Maxwell, chief executive officer of Chatham.

Chatham pursued the acquisition primarily to increase its presence and breadth of expertise in Europe. At times it has competed with JCRA for business, but the firms tend to service a different corporate client base, according to Amol Dhargalkar, managing director at Chatham.

“The UK will remain one of the largest economies in the world and home to some of the most iconic and significant companies,” Mr. Dhargalkar said.

Sharing wisdom. Chatham has sought to apply the collective wisdom gained by serving thousands of clients in each engagement, enabling better, faster decisions. JCRA holds a similar philosophy with its mostly European client base, a benefit to Chatham’s existing customers dealing with issues impacting UK and eurozone derivative and capital markets.

“The merger will allow us to serve global clients facing challenges related to Europe even better, whether pricing on cross-currency swaps, nuances related to Brexit, negative rates, or accounting standard changes and the differences in applying US and international standards,” Mr. Dhargalkar said.

And technology. JCRA customers will, of course, have access to the collective wisdom of Chatham’s clients. In addition, the company has been one of the few firms providing advisory and operational support, as well as a technology platform supporting the accounting treatment, risk-analysis calculations and valuations for multiple asset classes. “We started our technology journey a long time ago and continually invested in it,” Mr. Dhargalkar said, adding, “Our combined team is excited to be offering the ChathamDirect platform and its capabilities to the European market.”

 

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Virtual Accounts—Not Ready for Prime Time?

 Notes from a discussion on a product that treasurers would like to use—when it’s truly ready.

A presenter from Societe Generale at a recent NeuGroup Global Cash & Banking Group meeting said this about virtual accounts (VAs): “Imagine a world where you can open and close accounts at a moment’s notice, set up zero balance account (ZBA) structures, and not deal with KYC. That’s where banks imagine virtual accounts to end up.” This is the ideal world. That is:

  • They’re like ZBAs in the US with all the reporting behind them, but they’re not real accounts; they exist on a book- basis only and can send money to all your entities.
  • One member has been told VAs will allow them to close approximately 2,000 bank accounts and cut account costs by 40%.
  • Could VAs work better than an in-house bank? Several members are looking at VAs as an alternative to IHBs.

Notes from a discussion on a product that treasurers would like to use—when it’s truly ready.

A presenter from Societe Generale at a recent NeuGroup Global Cash & Banking Group meeting said this about virtual accounts (VAs): “Imagine a world where you can open and close accounts at a moment’s notice, set up zero balance account (ZBA) structures, and not deal with KYC. That’s where banks imagine virtual accounts to end up.” This is the ideal world. That is:

  • They’re like ZBAs in the US with all the reporting behind them, but they’re not real accounts; they exist on a book- basis only and can send money to all your entities.
  • One member has been told VAs will allow them to close approximately 2,000 bank accounts and cut account costs by 40%.
  • Could VAs work better than an in-house bank? Several members are looking at VAs as an alternative to IHBs.

The real world: The first hurdle is payables. Certain banks can open a series of accounts down to four tiers and only take receipts. Banks are still trying to build out the payables side. And from the banks’ point of view, the greatest interest is in using the accounts for notional pooling.

  • One member said there is a reconciliation issue—intercompany loans are not trackable in an automated fashion and only reported on the physical account, a big limitation. Once that’s resolved, they could potentially have an automated loan process. Another member said the biggest implementation hurdle of the VA model is intercompany loans.
  • You can only open VAs in certain countries where the bank allows it, so they may or may not be compatible with your treasury structure.
  • One member has been attempting to get rid of bank accounts and implement POBO and ROBO by leveraging VAs in SAP. However, VAs have proven more painful than the company hoped.
  • SAP is the system of record. Unfortunately, banks in this process like to have their system be the record of who owes whom, “which doesn’t work for our business,” the member said.
  • Another member tried to do virtual accounts in India; the company’s first attempt didn’t go well.

VAs in China

  • One member talked to three banks and sees the potential beauty of using VAs for payments in China: When you pay into China, you must pay a beneficiary and not someone else, so the VA structure would work.
  • The problem: VAs are not allowed in China and are not accepted by the PBOC for payments. Cross-border payments for China are always physical.
  • Banks said they can do cross-currency, but the member would need a pre-agreed FX spread with them (usually not a good one).
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Concerns About the Transition from Libor to SOFR

Treasurers aren’t too happy about the fallback language for the Libor-to-SOFR switch.

Members at a recent NeuGroup meeting used some colorful language in discussing the challenging issue of changing fallback language in contracts that currently use Libor, the benchmark rate that’s scheduled to disappear after 2021.

The wording needs to specify what rate will replace Libor when it’s gone, what triggers the switch, and the pricing spread adjustment between Libor and the successor rate to account for differences between the two benchmarks.
Prepare for battle? One treasurer bemoaned the fact that regulators seem to “hope that people can agree” on the terms of fallback language and warned, “At worst, every contract could be hand-to-hand combat.”

(Editor’s Note–published November 29, 2019)

Treasurers aren’t too happy about the fallback language for the Libor-to-SOFR switch.

Members at a recent NeuGroup meeting used some colorful language in discussing the challenging issue of changing fallback language in contracts that currently use Libor, the benchmark rate that’s scheduled to disappear after 2021.

  • The wording needs to specify what rate will replace Libor when it’s gone, what triggers the switch, and the pricing spread adjustment between Libor and the successor rate to account for differences between the two benchmarks.

Prepare for battle? One treasurer bemoaned the fact that regulators seem to “hope that people can agree” on the terms of fallback language and warned, “At worst, every contract could be hand-to-hand combat.”

  • Behind that potential battle, of course, is the proposed transition in the US from Libor to the secured overnight financing rate (SOFR), a so-called alternative reference rate recommended by the Alternative Reference Rates Committee (ARRC). SOFR is a broad measure of the cost of borrowing cash overnight collateralized by US Treasury securities—the repo market.
  • A report from consultant EY describes issues that could fuel the combat: “The transition to [SOFR] may require renegotiating the spread due to the differences between LIBOR and [SOFR], such as credit and term premiums. If a bank comes up with its own approach for redefining the spread for its variable-rate instruments, the counterparties may find themselves on the losing end of the transition—which could lead to legal challenges and reputation damage.”

No term rates—yet. As an overnight rate, SOFR is not a direct replacement for Libor, which is typically quoted for one-, two-, three-, six- and 12-month terms. And one treasurer at the meeting said the biggest issue in his mind is the lack of SOFR term rates. He said when that issue is resolved, corporates will get serious.

  • But another treasurer noted that the ARRC has warned market participants not to wait for forward-looking term rates to develop before transitioning from Libor to SOFR.

Give your feedback. In early November, ARRC welcomed the release of a proposed publication of SOFR averages and a SOFR index. The New York Fed is requesting public comment on this so-called consultation by Dec. 4.

  • The consultation proposes the daily publication of three backward-looking, compounded averages of SOFR with tenors of 30, 90 and 180 calendar days. It also proposes a daily SOFR index to help calculate term rates over custom time periods. It plans to initiate publication of the averages in the first half of 2020.

SEC disclosure. In a final point about Libor’s demise, one treasurer noted that the Securities and Exchange Commission this summer gave guidance on responding to risks associated with Libor’s end. The statement says, “The risks associated with this discontinuation and transition will be exacerbated if the work necessary to effect an orderly transition to an alternative reference rate is not completed in a timely manner. The Commission staff is actively monitoring the extent to which market participants are identifying and addressing these risks.”

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Cloud Accounting May Require New Controls, Impact Covenants

Treasury executives whose companies are relying more and more on cloud services should confer with their accountants.

Companies are increasingly choosing treasury management systems (TMSs) and other applications via the cloud rather than installing the software in their own data centers. The Financial Accounting Standards Board’s (FASB) new accounting standard aims make the accounting between the two approaches more similar by requiring companies to defer and amortize cloud-related costs rather than expensing them right away, as they do under current accounting.

“For companies that have these [cloud] arrangements, they will have to defer certain of those implementation costs to future periods, and that could impact some covenants, whether free cash flow, EBITDA, and other metrics,” said Sean Torr, managing director of Deloitte Risk and Financial Advisory.

Treasury executives whose companies are relying more and more on cloud services should confer with their accountants about new requirements that potentially could impact loan covenants as well as operational elements tangentially affecting treasury.

Companies are increasingly choosing treasury management systems (TMSs) and other applications via the cloud rather than installing the software in their own data centers. The Financial Accounting Standards Board’s (FASB) new accounting standard aims make the accounting between the two approaches more similar by requiring companies to defer and amortize cloud-related costs rather than expensing them right away, as they do under current accounting.

“For companies that have these [cloud] arrangements, they will have to defer certain of those implementation costs to future periods, and that could impact some covenants, whether free cash flow, EBITDA, and other metrics,” said Sean Torr, managing director of Deloitte Risk and Financial Advisory.

On the plus side, said Chris Chiriatti, audit managing director at Deloitte & Touche, some companies may have avoided software as a service (SaaS) solutions if there was a sizable initial investment because under current accounting they have to expense those costs immediately. “Now they can defer those costs, and it may open up opportunities to use the cloud,” he added.

Challenges. One of the more challenging aspects of addressing the new accounting, according to Mr. Torr, is that management must exercise judgment over the costs to be capitalized. In addition, internal controls will be required to ensure that the capitalized costs are amortized to the P&L over the appropriate term.

“Additional processes and controls may have to be put in place to correctly identify the costs that need to be capitalized under the new standard,” Mr. Chiriatti said. He added that since under existing accounting a lot of those costs were expensed as incurred, companies didn’t need processes to identify and scrutinize their activities.

New controls. Under the new standard, companies entering into cloud contracts frequently and those with decentralized organizational structures should consider whether internal controls are sufficient to handle all cloud arrangements. Additionally, organizations should consider internal controls to ensure management’s judgment is consistently applied and costs are being capitalized appropriately. If those judgments are being made in a decentralized fashion, “then the rigor of the control needs to be greater,” Mr. Torr said, adding that companies will also have to have controls around what information they disclose in financial statement footnotes.

Companies may already have frameworks in place to determine what gets capitalized or expensed if they’ve built solutions on premise. However, for companies that have aggressively pursued cloud solutions, the framework may have gathered dust and become outmoded. “So for those companies there might be additional work because they may not have the processes currently in place that they can leverage,” Mr. Chiriatti said.

Effective date. The accounting goes into effect Jan. 1, 2020, for any company currently deploying software to the cloud, buying cloud services or presently incurring cloud implementation costs. Companies can adopt the standard early for any quarters they have yet to issue financial statements for.

Lining up accounting practices. Mr. Chiriatti noted that from a functional standpoint today there’s little difference between a company using software in the cloud or in its own data center, and that was a major factor prompting the accounting standard-setters to conclude that the deferral model should be the same for both situations.

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The Value of Treasury Finance to Growth Company

Founder’s Edition, by Joseph Neu

When venture capital isn’t enough, you need a treasurer.

Growth companies looking to disrupt industries outside software and pure internet plays (which are already mostly disrupted) can have significant capital needs. This is why traditional venture capital needs to be supplemented with new types of investors and innovative ways to access capital markets. Given the cost of equity, pre-IPO, non-investment grade, un-rated companies needing capital have to be creative about debt financing.

Founder’s Edition, by Joseph Neu

When venture capital isn’t enough, you need a treasurer.

Growth companies looking to disrupt industries outside software and pure internet plays (which are already mostly disrupted) can have significant capital needs. This is why traditional venture capital needs to be supplemented with new types of investors and innovative ways to access capital markets. Given the cost of equity, pre-IPO, non-investment grade, un-rated companies needing capital have to be creative about debt financing.

This puts a new spin on the need for a treasurer with solid capital markets experience to serve as head of corporate finance for a growth-company CFO wearing multiple strategic hats. Growth companies that can’t afford to bring one in-house should have access to one on an on-demand basis.

That capital markets experience should include:

  • Wide-spectrum asset-linked securitization. Disruptive companies often have unique assets and monetization strategies to spin off cash flows that require a visionary mind that can bundle them into financial securities. They need finance talent with experience working on such problems, identifying opportunities and packaging them properly. These asset-linked financings may start with AR factoring, but quickly move to contracted revenue securitization, for example, and even rights to cash-flow streams from future data monetizations.
  • Relationships with debt financing innovators. Treasury’s role as chief bank relationship officer can also be useful, to the extent it includes meaningful connections with incumbent banks and bankers who go against trend to be innovative. Yet it also must include relationships with creative finance minds who’ve left the incumbents to join fintechs, capital advisory firms and investor groups. These relationships often are critical to getting needed funding or funding with a sub-10% cost of capital versus a 40%+ dilutive equity round.
  •  A contingency/opportunistic financing mindset. While most treasury professionals understand that the best time to arrange for financing is when you don’t need it, growth companies need to take this thinking to the extreme. They continually need to look to expand the number of current and contingency funding sources for the capital plan to keep growing as well as funding and liquidity options to tap to survive in a stress scenario or crisis event. 

But the treasurer also needs to be capable of executing the basics:

  • Expand the funding toolkit. “From the earliest stages of a startup, the finance team needs to think about expanding their financing toolkit so that the number of funding sources keeps growing, from 2-3, to 5-6, 6-10, to 16 or more,” says Kurt Zumwalt, former treasurer of Amazon.com and NeuGroup member who’s more recently been advising growth companies.
  • Build a bank group. Start early to build what will become long-term relationships. “As soon as you can build a traditional bank group, so much the better, as bank credit opens avenues to more sources of funding,” notes Neil Schloss, former treasurer of The Ford Motor Company and CFO of Ford Mobility (and NeuGroup member). Plus, more banks are thinking creatively about lending opportunities; so why not target those banks for your facility?
  • Instill a cash culture. Finally, a professional with treasury experience, especially in a high-leverage environment will appreciate the importance of free cash flow and instilling a cash culture throughout the business and finance operations.

NeuGroup can help connect you with one if needed.

Perennial value of free cash flow. Any form of debt financing requires cash flow generation to service it—and it helps if it is cash available after capex and other critical outlays. Equally important, as mindsets shift from revenue and user growth to profitability as drivers of enterprise value, the ability to generate free cash flow does more than improve firm borrowing capacity, it creates a better overall valuation, too.

This renewed focus on cash flow for funding a firm to reach its private value potential with debt and realize its full initial public market value should put treasury finance expertise in demand earlier at growth companies.

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Pushing Responsibility for Risk Gets Results

Sometimes you have to assign risk to reluctant BU leaders to get their attention.

Complying with internal audit’s requests isn’t always front and center in terms of business leader priorities. But prompting them to accept responsibility for identified risks can change that.  

In a lengthy discussion at a recent meeting of NeuGroup’s Internal Auditors’ Peer Group, members discussed the inadequate funding internal audit (IA) often receives to perform its function as well as the sometimes-low priority business leaders can give to complying with IA’s requests. The discussion was kicked off by one member noting that his company’s risk-committee chairman had challenged management to inform the board about the risks they’ll be accepting in the business. 

Sometimes you have to assign risk to reluctant BU leaders to get their attention.

Complying with internal audit’s requests isn’t always front and center in terms of business leader priorities. But prompting them to accept responsibility for identified risks can change that.  

In a lengthy discussion at a recent meeting of NeuGroup’s Internal Auditors’ Peer Group, members discussed the inadequate funding internal audit (IA) often receives to perform its function as well as the sometimes-low priority business leaders can give to complying with IA’s requests. The discussion was kicked off by one member noting that his company’s risk-committee chairman had challenged management to inform the board about the risks they’ll be accepting in the business. 

A plan is hatched. Recognizing an effective approach, the chief information security officer (CISO) sent an email to the COO, who had provided less funding than requested, to tell him he would have to accept responsibility for the ensuing risk. “Within a week the CISO received the funding,” the IAPG member said. 

  • The tactic can be effective across risk functions. The member said the board’s risk-committee chairman took a similar approach, requesting the heads of business units to present the risks they see to the committee. “It’s changing the conversation,” the member said.

Multipurpose use. Another participant noted that the approach can be used for a variety of situations, including IA’s perpetual challenge of seeking final closure from managers on audits that were completed quarters ago. By letting that time pass, the business leader is essentially telling audit that he or she is accepting the risk. 

  • “It boils down to the question: Are you taking an inordinate amount of risk or not, and if you’re accepting that risk, then explain to the risk committee why you’re comfortable with it,” he said. 

Of course, the business leader may respond that the identified issue is no longer a risk or question audit’s expertise on the matter and argue that it doesn’t pose a significant risk. Those are common challenges faced by IA, to which the member said that it is incumbent upon IA to help management understand the priority of issues—whether it’s a “drop everything and fix it now,” or a “do this when you have some time.”

Making it transparent. The first member added that his company typically gives the business the option to say by what date, from a priority standpoint, it will “mitigate” the issue. “This transparency goes up to the audit committee, which can then say, ‘The business says it will take two years,'” and management then has to defend that time frame. 

He added that regulators are raising questions about companies’ vulnerabilities, but corporate culture often passes the buck on taking on who is responsible in correcting or mitigating those weaknesses. 

  • “There needs to be that type of discussion about who has responsibility for these risks, and the audit committee needs to be in the firing line for these types of things,” the member said.  
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Companies’ Buyback Addiction and Other Capital Allocation Insights

Why share repurchases become a drug for companies.

Responding to questions about their capital allocation priorities, assistant treasurers at a recent NeuGroup meeting acknowledged “regurgitating the standard [capital] deployment line,” as one participant put it, after organic growth captured nearly half the votes and M&A ranked second.

Stock buybacks ranked last, even though much of the discussion ended up focusing on that use of capital, which may be a clearer indication of capital priorities. Key insights included:

Why share repurchases become a drug for companies.

Responding to questions about their capital allocation priorities, assistant treasurers at a recent NeuGroup meeting acknowledged “regurgitating the standard [capital] deployment line,” as one participant put it, after organic growth captured nearly half the votes and M&A ranked second.

Stock buybacks ranked last, even though much of the discussion ended up focusing on that use of capital, which may be a clearer indication of capital priorities. Key insights included:

  • Like a drug. Returning capital to shareholders through stock repurchase programs often starts out as a way to dispose of leftover cash in a meaningful way. But soon the programs become a key element to achieve a targeted earnings-per-share (EPS), and then whatever remains becomes the leftover. “It’s like a drug that you can’t get off,” said a participant. “I’ve seen that in company after company.”
  • Analysis of buybacks’ value varies greatly. One member said her team performs extensive analysis on whether share repurchases are providing adequate returns. Another member said that if repurchases are the last choice in capital deployment, then there’s not a lot of value from examining their returns, although some may want to maximize even the returns of leftovers. 
     
  • A signal to investors. For fast-growing companies, noted the assistant treasurer of a major technology firm, announcing that cash will go to repurchases instead of capex tells investors the company no longer has opportunities in which to invest, and its business model is changing.
     
  • Downplaying repurchases. A company whose acquisition opportunities come in “chunks” may see repurchasing shares as a good way to return money to shareholders and even out cash levels. To downplay the importance of buybacks in managing their EPS, they may report earnings before share repurchases. 

    They have that line item because that’s what they want investors to focus on, a member said.

S&P 500 as a benchmark. Several participants acknowledged their companies assume the money they return to shareholders will earn S&P 500-type returns, so if a company’s stock is outperforming the index, it should slow repurchases, and vice versa. One member prompted peals of laughter by asking whether anybody had ever heard their CFO say the company’s current share price made repurchases too expensive to continue.

Accountability for allocation decisions? Sort of. Responses to a survey question asking whether there is accountability for ensuring that capital allocations generate anticipated returns were 53% affirmative and 35% saying no.

But further discussion revealed that for most members, the answer rests somewhere in between. Their companies may have rigorous accountability policies, but given the long-term nature of significant investments, the relevant decision-makers often have left the company or are in very different positions. Monitoring too closely for accountability can stifle innovation.

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Shining a Light on Proxy Advisors as Activist Allies

Founder’s Edition, by Joseph Neu

Investors and corporates need to know about conflicts of interest when proxy advisory firms team up with activist investors against management. 

The former CFO of a company that successfully defended against an attack by an activist investor shared some key lessons learned from the experience at a NeuGroup meeting last week. Here’s a big one:

  • Management at even the most shareholder-friendly corporations must court passive investors to counter the inherent power of proxy advisors that support the activists. 

Founder’s Edition, by Joseph Neu

Investors and corporates need to know about conflicts of interest when proxy advisory firms team up with activist investors against management. 

The former CFO of a company that successfully defended against an attack by an activist investor shared some key lessons learned from the experience at a NeuGroup meeting last week. Here’s a big one:

  • Management at even the most shareholder-friendly corporations must court passive investors to counter the inherent power of proxy advisors that support the activists. 

A powerful duopoly. An editorial in the Wall Street Journal on Monday highlighted the power of the proxy/corporate governance duopoly. It reveals:

  • In­sti­tu­tional Share­holder Ser­vices and Glass Lewis con­trol 97% of the proxy ad­vi­sory mar­ket.
  • ISS pro­vides rec­om­men­da­tions to 2,239 clients, in­clud­ing 189 pen­sion plans, and ex­e­cutes 10.2 mil­lion bal­lots an­nu­ally on their be­half.
  • Glass Lewis, which is owned by the On­tario Teach­ers’ Pen­sion Plan and Al­berta In­vest­ment Man­age­ment Corp., has more than 1,300 clients that man­age more than $35 tril­lion in as­sets.

More: “Stud­ies have found that the two firms can swing 20% of votes in proxy elec­tions. An Amer­i­can Coun­cil for Cap­i­tal For­ma­tion re­view last year found that 175 as­set man­agers with $5 tril­lion of as­sets voted with ISS rec­ommen­da­tions 95% of the time. Ac­tivist hedge-fund in­vestors of­ten en­list the proxy firms to shake up man­age­ment, for bet­ter or worse.”

SEC scrutiny. This power has invited scrutiny from regulators. On November 5, the SEC voted to propose amendments to its rules governing proxy solicitations “to enhance the quality of the disclosure about material conflicts of interest that proxy voting advice businesses provide their clients. The proposal would also provide an opportunity for a period of review and feedback through which companies and other soliciting parties would be able to identify errors in the proxy voting advice.”

Allegations made by companies include:

  • Disparity in governance ratings given to firms that pay ISS or Glass Lewis for consulting vs. those that do not.
  • Conflicts of interest when proxy advisors are paid by activist investors or other institutional investors with an agenda.
  • Lack of adequate means to dispute proxy advisor recommendations and even to correct factual errors.
  • Poor transparency on shareholder vote counts, including point-in-time ownership and associated voting rights.

Of course, corporate managements only have themselves to blame if they don’t hold themselves accountable to governance standards—and increasingly to environmental and social standards for corporate behavior (E, S and G).

  • Still, companies that do all they can to be good corporate citizens and look out for shareholders (and all stakeholders) should expect a fair hearing.

Don’t wait. The best advice is not to wait for a proxy battle to tell your positive story. “We had heard that good investor relations was to be proactive to passive shareholders,” the former CFO speaking to our members said. Not only IR, but the C-suite needs to meet regularly with investors to share the company’s business strategy along with its ESG story. This is the best way to counter the proxy duopoly.

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Bank Account Rationalization: Taking a Page from Marie Kondo

One member’s approach to reviewing accounts, purging the inessential and optimizing.

A photo of a smiling Marie Kondo, author of The Life-Changing Magic of Tidying Up, helped set a positive tone for one member’s presentation on the thorny task of bank account rationalization. 

  • The treasury operations team’s embrace of purging clutter and keeping only what’s essential was fueled less by the desire to spark joy than the imminent, mundane chore of moving offices. That meant buckling down and weeding through each and every physical folder for every single bank account. 

One member’s approach to reviewing accounts, purging the inessential and optimizing.

A photo of a smiling Marie Kondo, author of The Life-Changing Magic of Tidying Up, helped set a positive tone for one member’s presentation on the thorny task of bank account rationalization. 

  • The treasury operations team’s embrace of purging clutter and keeping only what’s essential was fueled less by the desire to spark joy than the imminent, mundane chore of moving offices. That meant buckling down and weeding through each and every physical folder for every single bank account. 

Inventory overload. Taking inventory of bank accounts is an onerous task to say the least. In a quick poll of meeting attendees, about 95% of members have over 500 accounts, and only a handful have a formal bank account rationalization process. It is important to remember that a recently closed account can be just as important as an open one for audit and FBAR purposes.

  • Inventory checklists should evaluate the accounts’ ties to the overarching bank relationship, products and services, portal(s), and business/accounting purpose, usage and signers. 
     
  • To keep or not to keep, that is the question. With all the aforementioned information the question of “what do we do?” becomes easier to answer. The inventory process helps you discover accounts you may have overlooked and products and services you don’t use or aren’t using enough. And that drives decisions to help you achieve account optimization, improving efficiency.  

Leaner and nimbler. Starting with large amounts of bank account paperwork, the presenting company digitized bank account files for all open accounts and two years of previously closed accounts. Then it established an ongoing plan for maintenance as well as one designed for facing M&A integration projects. While recognizing that “no two integrations will be the same,” the focus is on keeping bank relationships but consolidating accounts wherever possible. 

  Pros:

  • Reduce administrative work, KYC, audit requests, online administration, account maintenance
  • Increase liquidity: concentrate cash balance, enhance and maximize yield on investable cash   

   Cons:

  • Time consuming up-front work
  •  Easy to accidentally overlook some bank products and services (example: letters of credit)

Cast a wide net and target end-goals. Involving all internal stakeholders such as tax, legal and payment operations allowed for transparency, educated account closures and keeping purpose-specific open accounts. The presenter advised other members that when tackling account rationalization in an M&A integration, the game plan should be established and clearly communicated, while being sensitive to human relations (i.e.: what is happening on the other side of the integration equation). 

Don’t forget where you came from. Unfortunately, bank account rationalization isn’t a one-and-done project. The presenter stressed that establishing timelines, setting milestone objectives and scheduling ongoing maintenance of the process is necessary for continued success. 

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