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Justin Jones In Risk Management, Technology

Flying Into AI Use Cases, an Internal Auditor Turns to Copilot

Microsoft’s Copilot helps pave the way for more use of AI by auditors and others at corporates embracing change.

One NeuGroup member who is an early adopter of Copilot, Microsoft’s assistant for using generative AI within its Office suite of products, demonstrated the usefulness, efficiency and power of large language models (LLMs) like ChatGPT by presenting at a recent NeuGroup meeting with a slide deck generated in part by—you guessed it—AI.

The presentation, delivered at the fall peer group meeting of NeuGroup for Internal Audit Executives, sparked a conversation about AI use cases, best practices, risks and governance. It was one of dozens held across the NeuGroup Network this year about leveraging ChatGPT and other LLMs.

Microsoft’s Copilot helps pave the way for more use of AI by auditors and others at corporates embracing change.

The presentation, delivered at the fall peer group meeting of NeuGroup for Internal Audit Executives, sparked a conversation about AI use cases, best practices, risks and governance. It was one of dozens held across the NeuGroup Network this year about leveraging ChatGPT and other LLMs.
One of those sessions focused on the implications of AI for IT auditors. A few companies are setting up labs to give IT auditors a deeper understanding of LLMs and the risks they present.

Audit use cases. The presenter provided a hypothetical use case of a team member designing an audit program entering the prompt, “Pretend you are an auditor assessing X; what are the key risks? And what test steps would you suggest?” Members who have done similar prompts have been impressed with the tool’s ability to help teams get started in the early stages of a long process, freeing up users to spend more time on activities that add value.

Another relatively straightforward use case is employing AI to record interviews or meetings. The Copilot tool can produce a transcript from Teams, Microsoft’s communications platform, summarize the discussion in a work paper and produce a list of to-dos for meeting participants. One member said, “the summarization tools are amazing.”
With a Copilot license, a user can also access any referenced document or chat to produce a PowerPoint presentation. And they can search an entire database more efficiently depending on their access permissions.
Auditors using Copilot can ask Excel to write formulas, create pivot tables and identify outliers from any dataset. Suggested prompts include, “summarize this data and identify three key trends” and “create a model to show what if X happens.”

Tips for prompting. The presentation included a list of tips for interacting with ChatGPT or other AI interfaces. They include:

Define the tool’s role: “pretend you are an IT auditor assessing…”
Use “chained prompting” by breaking up a complex prompt into multiple, simpler tasks.
Define the output by supplying the format you want: “create a document” or “provide a list.”
Change the tone or format: “make this less formal” or “summarize this.”
Provide context and be as specific as possible. Example: “Pretend you are an IT auditor in a large tech company assessing access controls in SAP S/4HANA. Provide a list of three key risk areas I should focus on with suggested audit test steps in each, in a form that a non-expert would understand.”

Risks. Access control for companies using AI was a key risk identified in the discussion. As one member put it, “It seems if you’re going to put this into place, then your data governance needs to be really strong.” If it’s not, companies run the risk of users accessing confidential or privileged information.

A section of the member’s presentation on AI governance recommended establishing a clear and accountable structure; developing and implementing AI policies and procedures; conducting regular AI risk assessments and audits.
Several members discussed the risk of employees’ personal information being accessed in error, and fallout from that. When asked about whether a rogue user could ask the chat to pull the CEO’s Social Security number, one member said, “In theory, it could find it.” This is where a company’s IT and IT audit teams come into play.

IT auditors setting up AI labs. At the inaugural meeting of a NeuGroup pilot peer group for IT auditors, members discussed how they are handling the use of AI across organizations. To do their jobs, they need to understand AI technology. Or as one member put it, they need to be able to “use their own sticks to make fire.” His company is among a small number setting up labs where experts will instruct IT auditors.

The member wants IT auditors to get hands-on experience with what they’re auditing and told his team, “This is your opportunity to learn how AI and ML works in detail.” He said having the ability to audit AI tools without relying on a third party is imperative.
Another member, who is not setting up a lab, pointed out that AI advancements may mean that IT auditors will have to add advanced skillsets to their teams. “Now you’re talking about finding a qualified data scientist. How are you solving the people problem on this?” he asked.
That generated much discussion among participants. Most agreed that finding the perfect person—a data scientist with audit experience—was unlikely. But looking for a data scientist who likes challenges and is a leader is a good first step.

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Justin Jones In Risk Management, Talking Shop

Talking Shop: Defining the Scope of Fraud Risk Assessments

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

Context: Fraud risk assessments performed by internal auditors are designed to identify a company’s vulnerabilities to internal and external fraud, including embezzlement, asset misappropriation, misstatement of financial information, corruption and cybercrime. According to a position paper by The Institute of Internal Auditors, “organizations should have robust internal control procedures to limit the risk of fraud, and internal audit’s role is to assess these controls.”

- A fraud risk management guide produced by the Committee of Sponsoring Organizations (COSO) and the Association of Certified Fraud Examiners (ACFE) states that organizations perform “comprehensive fraud risk assessments to identify specific fraud schemes and risks, assess their likelihood and significance, evaluate existing fraud control activities, and implement actions to mitigate residual fraud risks.”

Member question: “Have you typically completed fraud risk assessments based on a company-wide perspective or have you started with a smaller group or portion of the business? IA has not executed one at my company since I have been here, so I’m looking for how this has been approached elsewhere to determine if we can narrow the scope.”

A fraud risk management guide produced by the Committee of Sponsoring Organizations (COSO) and the Association of Certified Fraud Examiners (ACFE) states that organizations perform “comprehensive fraud risk assessments to identify specific fraud schemes and risks, assess their likelihood and significance, evaluate existing fraud control activities, and implement actions to mitigate residual fraud risks.”

Peer answer 1: “We do a company-wide fraud risk assessment via survey and leverage the ACFE model, tailored for our business. While we include functions across the company, we only survey 55 to 60 cross-functional representatives to complete the survey.”

Peer answer 2: “We do a company-wide one for Sarbanes-Oxley (SOX) focused on financial reporting fraud risk. For operational fraud risk, it’s audit by audit (we require every team to assess fraud risk in the risk control matrix). We just completed a procurement fraud review which was basically a procurement fraud risk assessment plus walk-throughs of key controls.”

Peer answer 3: “Rather than focus on groups or portions of the business, we do ours based on a combination of 23 general fraud schemes that are applicable, e.g., channel partner fraud, government contract noncompliance, manipulation of estimates/reserves, off-balance sheet activity, expense reimbursements), results of relevant investigations that occurred during the year, and emerging trends.

“We then assign a risk level to each, identify risk mitigations (primarily by mapping them to existing SOX controls), and then flag the schemes with no or insufficient mitigating activities and controls. The flagged areas are either escalated to management for consideration of new risk mitigations or considered as auditable areas as we develop and update our audit plan.”

Peer answer 4: “Our fraud risk assessments are conducted annually with a company-wide perspective to satisfy our entity-level SOX control and to give EY info to modify their audit scope if needed. This approach involves:

“Considering enterprise risk management assessment results.
“Conducting surveys to gauge employees’ perspectives on the company’s fraud risk management as well as the company culture on fraud.
“Identifying processes with high inherent fraud risks for focused analytics. There were 11 this year, but we did analytics on higher inherent risks and where actual fraud happened, assessing the effectiveness of existing controls for these areas.”

NeuGroup Insights asked the member who posed the question for an update. She said, “We have decided to move forward with a company-wide fraud risk assessment in order to perform a more comprehensive assessment. We have not begun the project yet, so there is a possibility the scope will be narrowed slightly.

“The approach will be to conduct three to five brainstorming sessions with cross-functional groups to obtain input on possible fraud risks and scenarios. In future years, perhaps, I would hope we transition to a survey approach, but that is just a preliminary thought.”

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Justin Jones In Capital Markets, Regional, Risk Management

Recession and Rates Rank High on Treasurers’ 2024 Risk Lists

New NeuGroup Peer Research reveals the risk of an economic downturn and high interest expense loom large.

As treasurers look ahead to 2024, the results of the NeuGroup 2024 Finance and Treasury Agenda Survey reveal two intertwined risks—headwinds which may also appear at odds with each other—looming on the horizon: the continuing threat of recession, paired with interest rates that may remain higher for longer. Normally, of course, economic weakness brings about lower rates. But the last few years have been anything but normal.

New NeuGroup Peer Research reveals the risk of an economic downturn and high interest expense loom large.

Economic downturn ripple effect. So although more observers believe the Fed may be able to navigate a soft landing following the recent cycle of rate hikes in the US, members’ top risk headed into 2024 is the same as it was headed into 2023: economic downturn.

“I continue to see a great deal of uncertainty ahead that requires one to consider downside scenarios persistently in their thinking,” one member told NeuGroup Insights in an email. “The global economy is going through multiple major transitions and events are affecting economies in uneven ways and increasing overall fragility.”
NeuGroup senior executive advisor Paul Dalle Molle, who leads NeuGroup for Growth-Tech Treasurers, noted that fast-growing companies with credit ratings below investment grade are particularly vulnerable to the risks of tightening credit markets that would most likely accompany an economic downturn.

Perfect storm. A potential recession, or even persistent declines in consumer spending, could put higher pressure on working capital—an issue which could compound if interest rates remain high, keeping borrowing costs elevated as well (members’ No. 3 risk for next year).

Over half of survey respondents expected interest rates to stay high or continue rising (see chart)—an issue that could portend weaker earnings, margin pressure and intensified calls by stakeholders to cut costs. To be sure, volatile markets and the recent decline in rates have no doubt altered rate expectations for some members—for now.

Political fallout. NeuGroup members also expressed apprehension about political impacts, including geopolitical volatility and uncertainty around regulation.

Ongoing armed conflicts in the Middle East and Eastern Europe will continue to disrupt business in the new year. Other concerns mentioned by members include fallout from Argentina’s election of a president who promises to upend the status quo and another polarizing presidential election in the USA.
More restrictive regulation in the US on clean energy requirements may also follow in 2023, along with proposed tightening to Basel III and potential changes in Fed stress-test criteria in the wake of the banking crisis earlier this year.
“Fundamentally, I remain optimistic, but with a heightened sense of risk and urgency,” one member said. “For treasury, it’s a good moment to reflect on risk management. Take the time to review exposures, strategies and processes.”

The cyber element. We should note that members ranked cyber risk No. 2 in the survey. Earlier this year, a Deloitte poll showed that over one-third of corporates had faced a cyberattack over a 12-month period.

In recent meetings, a number of members have shared how they are stepping up cybersecurity procedures within treasury, because insurance for cyberattacks is often too expensive.
One member shared that his company has regular drills in which the entire office shuts down its computers and switches to using spare, encrypted laptops for the day.

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Justin Jones In Banking, Cash & Working Capital, ESG

Cashing In: Trade Finance Fuels Working Capital, Boosts Sales

How HSBC helped an energy company optimize working capital, boost sales and keep a key client happy about payment terms.

Earlier this year, the treasurer at a clean energy company found himself in a precarious position: he needed to get cash in the door faster to fund operating expenses, but the corporate’s annual revenue is heavily reliant on a few large clients who had negotiated long payment terms. At a recent session of NeuGroup for ESG, the treasurer dug into the details of a project that leveraged a strategic partnership with HSBC to offload the receivable to the bank and get paid sooner.

The NeuGroup member company’s business relies largely on selling a single product and has lopsided payment cycles, with the bulk of revenue coming in at the end of every quarter. The treasurer said this led to a “dry period in the middle” of each reporting period, which required a solution to maintain cash balances for regular expenses including payroll.

How HSBC helped an energy company optimize working capital, boost sales and keep a key client happy about payment terms.

The NeuGroup member company’s business relies largely on selling a single product and has lopsided payment cycles, with the bulk of revenue coming in at the end of every quarter. The treasurer said this led to a “dry period in the middle” of each reporting period, which required a solution to maintain cash balances for regular expenses including payroll.
HSBC, which offers a variety of global trade and receivables finance solutions, worked with the energy firm to purchase the receivable while the company continued to offer its customer attractive payment terms. So without jeopardizing the relationship, the business was able to get the cash it needs up front and minimize its counterparty risk—allowing it to expand sales to the buyer.
This structure takes into account the varying credit profiles of the energy company and its client, the balancing of seller and buyer risk, the corporate’s need to ensure sales are not jeopardized and its desire to improve working capital.
During the session, Vivek Ramachandran, HSBC’s head of global trade and receivables finance, said, “the upside is huge: they get early access to cash flow and can build up capacity a lot quicker, even with long-term contracts.”

Shorter cash conversion. The treasurer shared that the company has a “constant need to reduce pressure that comes from working capital requirements,” which he described as growing pains—a good problem to have. Because sales cycles often range from nine to 12 months, working capital forecasting isn’t easy.

Mr. Ramachandran said HSBC is well-positioned to enable solutions to address challenges like this. “We have a view not just of companies themselves, but also of their counterparties,” he said. “For this transaction, we had a relationship with the buyer, and worked with them to structure payment obligations that also reduce risk.”
The treasurer said that the deal had very specific boxes to check, which required a partner bank willing to create a bespoke solution. “The deal had very long terms, which you won’t always see, and the amount was very significant,” he said. “The pricing had to be reasonable as well, in sync with our working capital needs. HSBC had to basically make sure everybody is winning, and make a margin—but now we are all able to win.”

Treasury’s strategic opportunity. The member added that treasurers have an opportunity to enhance working capital at all companies by breaking down silos and collaborating with the business. “Step into the other world, whether it’s sales or procurement pricing, and you might see opportunities,” he said. Finding those opportunities is becoming a requirement for strategic treasury teams.

“Sometimes, I’m having discussions with vendors on payment terms, or working on a financing solution for customers,” the member said. “Normal, conventional cash and risk management is no longer enough for treasurers.”
He added that this is especially vital for growing companies in unconventional industries like clean energy, but “treasury is changing across the board.”
Mr. Ramachandran added that “the more visibility treasury has into buyer contracts, the easier it is for banks like us on both sides of the transaction to inject financing that releases working capital.”
- “I think the world of trade will change a lot,” he said. “The conversations we’re having do not sound like historical trade finance conversations, because working capital optimization is going so much further now: it’s not just financing a receivable, it’s part of a broader capital structure discussion and how companies can optimize their sources of capital, with trade finance now being one of them.”

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Justin Jones In Senior Executive, Talking Shop

Talking Shop: Spend Authorization Limits for CFOs and CEOs

Context: Delegation of authority policies are an important part of good corporate governance and critical for companies structuring and implementing financial controls and setting limits for spend authorization as well as payment approvals. Financial authority policies cover employees inside and outside of treasury and other finance teams, and at some companies they are wide-ranging.

“Our authority policy has more than a dozen sections covering all kinds of limits,” one member told NeuGroup Insights this week. “Treasury’s limits address things like authority to open bank accounts, move cash, authorize FX trades, issue debt, etc. Having all of these requirements is part of a healthy control environment and avoids issues that can arise like failure to segregate duties and also mitigates fraud risk.”

Member question: “At your company, what are the CEO and CFO spend authorization limits? I’m trying to help our chief accounting officer do some benchmarking on our financial authority policy to rightsize some limits.”

“Our authority policy has more than a dozen sections covering all kinds of limits,” one member told NeuGroup Insights this week. “Treasury’s limits address things like authority to open bank accounts, move cash, authorize FX trades, issue debt, etc. Having all of these requirements is part of a healthy control environment and avoids issues that can arise like failure to segregate duties and also mitigates fraud risk.”

“As a reference point, at my company, the CFO must approve spend—a commitment to an external party—over $2.5 million; and anything over $20 million must go to the CEO.”

Peer answer 1. “All payment processing with SAP via banks and also budgeted spend needs dual approval. VPs outside finance have up to $250,000 authority. Finance VPs, who are CFO delegates, can approve and release via our bank up to $10 million.

“From $10 million to $20 million requires approval from the chief accounting officer and the CFO. The CFO can approve up to $40 million and would need second approval from the CEO.”

Peer answer 2: “All VPs have authority up to $1 million and there is authority below that level up to $250,000. From $1 million to $2 million requires a division president or the general counsel or a corporate VP or SVP and the corporate controller. Above $2 million requires the approval of the CEO or CFO and they have discretion up to $25 million, at which point it has to go to the board.

“For a company of our size, with revenue below $5 billion, limits of $25 million make sense (and this is a per expense approval) because anything bigger than that is probably going to have awareness at the board level.
“We want to be sure that the divisional teams have financial discipline on spending and understand that we need to consider what is best for the entire company, not just specific divisions.”

Peer answer 3. “The CFO can approve anything up to $2 million; and the CEO approves anything over that amount. Let me caveat that we are founder-led, which I think makes a difference in terms of limits based on other companies where I have worked.

“With lower limits, you run the risk of a bottleneck at the top. You’ve got to have a good process and a good connection to the top to get past potential bottlenecks.”

Peer answer 4: “Purchase orders, invoices and contracts of $10 million and up require CEO approval; above $1 million needs CFO approval. FP&A managers approve anything below $25,000; FP&A directors approve up to $100,000.

“Once invoices are fully approved, automatic payments only require one treasury approval for liquidity purposes. If payments have to be made manually, an accounting or treasury manager enters them and a senior manager in treasury, the CFO or I can approve without any limits.”

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Justin Jones In Capital Markets, Risk Management

Natural, Synthetic, Go Now, Not Yet: Exposure to Floating Rates

Corporates weigh when to swap fixed-rate debt to floating as inflation cools and the rate outlook shifts.

Growing conviction that the Federal Reserve is at the end of its interest rate hike cycle and may cut rates next year has turned up the heat on the simmering issue of whether and when corporates with debt should swap some of their fixed-rate exposure to floating rates. Many companies in the NeuGroup Network say nearly all their debt is fixed—a byproduct of very low rates that prevailed for about 15 years following the global financial crisis of 2007-2009.

Corporates weigh when to swap fixed-rate debt to floating as inflation cools and the rate outlook shifts.

The issue is particularly compelling now because some treasury professionals and bankers are for the first time in their careers adjusting strategies and tactics to a market where rates are relatively high today but are expected to decline in the not-too-distant future. This, of course, follows the challenges created in 2022 by soaring inflation and skyrocketing rates.
Speaking at a recent meeting of NeuGroup for Mega-Cap Assistant Treasurers sponsored by Societe Generale, Subadra Rajappa, head of US rates strategy at the bank, said decisions about whether and when to swap to floating are best addressed on a case-by-case basis. Subsequent discussions by members underscored that point and made clear that companies approach the issue from various perspectives—informed by debt levels, average weighted cost of debt, future issuance plans, internal risk tolerance and business cyclicality.

Natural floating. “On fixed to float, I have very strong opinions—only for our portfolio,” said one member whose views stood out and include a reason not heard often in NeuGroup meetings for choosing not to swap to floating—arguing that what the company is doing and will continue to do is essentially “floating naturally.” (Swaps are considered synthetic.)

This company is a frequent issuer, has significant debt outstanding—about 95% of it fixed—and bonds coming due every year that it refinances at prevailing rates. “We’re putting on new debt every year, so you could say our short-term fixed is somewhat floating naturally,” the member said. In other words, if the Fed cuts rates and the yield curve normalizes, the company may benefit from lower rates as it replaces old debt with new.
The core reason this member is not swapping to floating anytime soon is the company’s average weighted cost of debt is about 3.5%. “We have a very low fixed average cost of debt and I don’t see any reason to change that at this point in time,” the member said. “If I had 5% debt, 7% weighted average cost of debt, I would want to add some float.” They said a swap will make more sense as the portfolio’s average rate approaches 5%.
One obstacle to swapping to floating now is that the company’s management team has not historically supported swaps between seven and 10 years because of counterparty risk concerns. And shorter duration swaps would present more risk that the company is stuck paying more interest than it’s receiving—called negative carry—before floating rates decline sufficiently so that it is on the winning side of the swap.
The member said if it made sense to swap now based on the company’s average weighted cost of debt, they would not object to enduring negative carry provided they could enter a long-dated swap.

Synthetic ASAP. Negative carry is not a deterrent for a different member whose treasury team is pushing to do the company’s first fixed to floating-rate swap as soon as possible. “The negative carry is what it is,” this member said. Swapping to floating, they said “is a risk management tool and, yes, you can wait until the carry is less negative, but that will not be the optimal time to enter the market, as we all know.”

In a follow-up interview the member and a colleague explained that their motivation for asking management to approve the swap is to hedge the risk that interest income will decline as the rate cycle downshifts. “We have an exposure to rates declining that will hurt our net interest income/expense,” the colleague said.
“We have cash and investments that are short in duration and are therefore a floating-rate exposure. Our debt, however, is all fixed rate with a considerably longer duration. We want to mitigate the interest rate risk by swapping some debt to a floating rate exposure.”
The surge in interest income the company has earned on its investments will help make selling the swap to management easier, mitigating the pain of negative carry, the member explained. “We are as a team very much ready to go, realizing we have some room to take in the impact of negative carry from where we set the budget and where we are currently in the year from an EPS standpoint. We think getting started soon is the right move.”
The colleague added, “It’s a long elevator ride to sell people on this and the hardest part is to get everybody not to focus on the cash flows from one part of your net interest margin, this one particular swap, but to look at what this is going to do to our entire portfolio and our EPS and that this going to significantly reduce our interest rate risk.”

Middle ground. Another member at the meeting is grappling with the fixed-to-floating issue, taking a go-slow approach echoed by others in NeuGroup meetings over the last year. His company’s business is cyclical and has taken on significant long-term debt financing acquisitions, 90% of it fixed.

“From a tactical standpoint, higher debt levels make managing our exposure to floating rates in an ‘organic’ way, using commercial paper only, more challenging, as we are capping our overall CP balances,” he explained in a follow-up conversation. “Therefore, gradually adding synthetic exposure to floating rates using fixed-to-floating interest rate swaps would help achieve a more balanced mix of debt.”
The member envisions a multiyear process to achieve the company’s desired target for floating-rate debt, which is undisclosed. “It is impossible to time the market and the current negative carry on swapping to floating is high,” he said. “We plan to monitor a number of macro indicators including:
- Negative carry (monitor for declining negative initial carry).
- Fedspeak (monitor the Fed’s message suggesting the end of rate hikes that aligns with market expectations.)
- CPI (look for a slowing inflation rate closer to the Fed’s target).”
The member said the company’s banks cited backtesting showing swapping to floating within a three to six month range before or after the end of a hiking cycle generates the maximum savings. “As such, we are developing a programmatic and dynamic approach to gradually layer in swaps over time.”
He added, “I think that being a bit late to the party is better than being too early, especially in a ‘higher for longer’ environment. We’ll take another hard look at this in Q1 2024, markets depending. Gradually layering in small notional amounts would help average into rates and alleviate the fear of missing out.”

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Justin Jones In Senior Executive, The NeuGroup Insights Interview

Dealing with ‘Derailers’ in Board Presentations: Tips from a Pro

A former CFO of Merck offers tips for treasurers to stay on track if board directors lob off-topic questions.

When Peter Kellogg was CFO of Merck during the 2008 financial crisis, the greatest challenge he faced during board presentations came when directors peppered him with questions based on what they had read, seen or heard in the media or elsewhere. This is one example of what he calls “derailers”—questions about subjects that don’t affect the company directly, are not relevant to the topic of the presentation and can throw a presentation off-track.

These “understandable concerns” came largely from directors also on the boards of smaller, less stable companies. This required Mr. Kellogg to offer direct and clear responses to provide comfort and clarity about how the situation was different for a larger company like Merck.

Bad news, good news. The bad news is that periods of volatility, economic uncertainty and geopolitical risk—like now—often give rise to more derailers, requiring treasurers and CFOs to respond tactfully and steer the conversation back on track.

The good news is that he shared how to deal with derailers in a session of NeuGroup for Life Science Treasurers last month. His tips for successful presentations to boards and audit committees are based on a business career spanning more than 30 years during which he also served as CFO of Celgene, Biogen and Frito-Lay International. And he currently sits on the board of two life sciences companies.

Opportunity. In the meeting, one member called board presentations “just another chance to screw things up.” Mr. Kellogg, by contrast, sees them as opportunities for treasurers to send the right message and involve themselves in the company’s long-range plan (LRP).

“You’re representing the treasury function,” he said in the session. “You want to take the opportunity to lead with the idea that you’re a great operation, and that you’re a leader—you’re impacting the company, you’re involved in the LRP and you’re working with business development to enable key projects that could be important to the future of the company.”

Clean slides, direct language. During the session, Mr. Kellogg discussed the need to make board presentations easily understood by any audience, especially considering some directors may not have experience in treasury.

Keep slides clean. Decks cluttered with charts and statistics, which Mr. Kellogg calls “banker slides,” will only be a distraction, and could lead to further off-topic questions.
Avoid jargon. Terminology that a generalist audience wouldn’t understand is likely to make a board cringe, according to Mr. Kellogg. “It needs to be something that’s easily understood, you want to make sure they are able to stay on track.”

A former CFO of Merck offers tips for treasurers to stay on track if board directors lob off-topic questions.

These “understandable concerns” came largely from directors also on the boards of smaller, less stable companies. This required Mr. Kellogg to offer direct and clear responses to provide comfort and clarity about how the situation was different for a larger company like Merck.

The good news is that he shared how to deal with derailers in a session of NeuGroup for Life Science Treasurers last month. His tips for successful presentations to boards and audit committees are based on a business career spanning more than 30 years during which he also served as CFO of Celgene, Biogen and Frito-Lay International. And he currently sits on the board of two life sciences companies.

In a video interview you can watch below, Mr. Kellogg dives into three key ways treasurers can send the right message during a presentation to the board.

“You’re representing the treasury function,” he said in the session. “You want to take the opportunity to lead with the idea that you’re a great operation, and that you’re a leader—you’re impacting the company, you’re involved in the LRP and you’re working with business development to enable key projects that could be important to the future of the company.”

Keep slides clean. Decks cluttered with charts and statistics, which Mr. Kellogg calls “banker slides,” will only be a distraction, and could lead to further off-topic questions.
Avoid jargon. Terminology that a generalist audience wouldn’t understand is likely to make a board cringe, according to Mr. Kellogg. “It needs to be something that’s easily understood, you want to make sure they are able to stay on track.”

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Justin Jones In Capital Markets

PE Firms’ Hunt for IG Assets May Feed Corporates Seeking Capital

Deutsche Bank on what corporates need to know when Apollo and other PE firms that own life insurers come calling.

Private equity (PE) firms that control the balance sheets of insurance companies are actively seeking investment-grade (IG) assets, a trend that’s unlocking a flexible and customizable source of alternative capital for some corporates—including those that considered PE firms largely irrelevant to them except in cases of outright asset sales.

“This is a now a new option in the toolkit that you should definitely be aware of,” said Marc Fratepietro, managing director and co-head of global debt capital markets at Deutsche Bank. “It’s largely about the convergence of insurance companies and sophisticated alternative asset managers.” He spoke at the fall meeting of NeuGroup for Capital Markets sponsored by Deutsche Bank.

Deutsche Bank on what corporates need to know when Apollo and other PE firms that own life insurers come calling.

“This is a now a new option in the toolkit that you should definitely be aware of,” said Marc Fratepietro, managing director and co-head of global debt capital markets at Deutsche Bank. “It’s largely about the convergence of insurance companies and sophisticated alternative asset managers.” He spoke at the fall meeting of NeuGroup for Capital Markets sponsored by Deutsche Bank.
PE firms including Apollo, KKR and Blackstone that are moving into the life insurance industry and run multi-strategy asset management arms need longer-dated assets with strong credit ratings and stable cash flows to match against longer-term liabilities, he said. And they are more willing to take passive, minority stakes in a subsidiary or joint venture (JV), giving corporates new alternatives for raising hybrid or minority-stake capital while maintaining operational control and accounting consolidation of a business.
Prominent deals in this category include AB InBev’s sale of a $3 billion stake in a US can manufacturing business to Apollo in 2020, Brookfield’s deal to invest up to $15 billion in an Intel manufacturing plant last year and Apollo’s $2 billion investment in an AT&T subsidiary preferred instrument in June 2023.
Uses for the capital raised include delevering, acquisition finance or funding capital expenditures.

Sea change. “The profile of these PE companies and how they think about investing has fundamentally changed to include a long-duration IG model because their insurance liabilities are longer duration and/or they have increased access to permanent capital,” Mr. Fratepietro said. “And that’s a sea change that is much more interesting for investment-grade companies.”

Accessing this relatively new pool of capital requires active collaboration and coordination between corporate treasury and M&A teams. Corporates may benefit from working with a bank that is active in this space to structure transactions and negotiate with PE firms. “Aside from technical and market knowledge, a bank will bring experience working with both IG corporates and PE firms that can help both sides better understand and navigate respective objectives and constraints,” he added.

Public vs. private. While tapping this source of private funding is not cheaper than financing with publicly-issued capital, IG companies working with PE firms are able to structure unique transactions in ways not always possible in the public market. “The most valuable aspect of this capital sleeve is its flexibility to do off-the-run, customized transactions” that may include limited disclosure, larger sizes and potential ratings, tax and accounting advantages, Mr. Fratepietro said.

He continued, “These investors can give corporates a size, a certainty and ability to customize structural features and terms that might be more optimal than the public market alternative. And because of a convergence of public and private valuations, you can probably do it at a price that’s reasonable versus the public alternative.”

Bespoke structures, common elements. Mr. Fratepietro said the deals tapping into this source of capital exist on a continuum between M&A-style minority-stake sales and private, hybrid capital placements. “But there is no perfect blueprint for what works; each deal is different and designed to accomplish its own set of objectives; what can be done is not limited to what has been done,” he noted.

The common feature of these deals is the PE firm is looking to invest in an instrument that is backed by IG-cash flows, he explained. For deals structured as minority stake sales, the investment is usually in the form of common or preferred shares in a JV that has “high-quality cash generative assets and/or or a long-term offtake or supply contract with a well-rated counterparty.”
That said, “A key thing I tell people is that it’s not just limited to the JV structure. If you have something unusual you want to do in the capital space, talk to a bank that has experience with these transactions because there may be a way to fit what you’re trying to do into the growing pool of capital these multi-strategy asset managers have. There are a number of structural levers on these transactions that a bank advisor can help you understand from a trade-off perspective.”

Understanding the benefits. While the investment may be in the form of equity, this group of investors has the ability to divide risk into tranches in a way that potentially allows a substantial part of the investment to be placed into insurance accounts as a fixed-income instrument, which means a lower cost of capital for the corporate.

Depending on the structure, these transactions “can get you as much as 50% to 100% equity credit at prices that are competitive to what you could get the public market for similarly sized hybrids; but you can also do these things in a much more tailored way that could be more efficient from an after-tax cost of capital and execution perspective,” Mr. Fratepietro said.
- He added, “High-equity content gives a company the unique opportunity to de-capitalize a business and redeploy that capital in more efficient ways. Which is particularly useful in a higher cost of capital environment.”
He noted that companies that sell a business outright or issue common stock to raise capital sacrifice upside and incur a cost of capital exceeding 10%. “So assuming you don’t want to give up upside and you want something with a more fixed income-like cost, the challenge is that the depth and flexibility in public markets can be somewhat limited. It’s hard to get two, three, four, five billion out of the public market and do anything with unusual features, so this may provide a superior path.”

Best practices, banks and boundaries. Mr. Fratepietro underscored the importance of treasury playing an active role in any deals trying to access this pool of capital, noting that M&A or corporate development teams may assume they’re in charge because large PE players like Apollo are involved.

“These deals have a real capital markets nexus when you really boil them down to the nuts and bolts,” he said. “The execution tactics and structuring may be M&A-like in the case of a JV transaction, but other aspects like ratings treatment, pricing and comparison to alternatives require treasury input. I have seen deals where treasury got involved later and that doesn’t help.”
He recommends defining objectives and exploring solutions before engaging with a PE firm. Also, bring in tax, accounting and legal experts early in the process. He stressed the need to set ground rules with the firms and establish boundaries for engagement. Because PE firms are used to dealing with smaller companies, they may end up calling the CFO or CEO, creating inefficiency and headaches for treasury.
Finally, one reason to engage a bank to advise on the process is the benefit of considering different PE firms, Mr. Fratepietro said. “If you’re going to do something like this, it’s important to engage multiple firms and actually try to run a bit of an auction for the instrument you want to sell.”

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Justin Jones In Crypto, Technology

Closing the Gap: Corporates Step Toward Digital Assets

NeuGroup Peer Research digs into how all treasuries can catch up to digital assets leaders.

NeuGroup’s newest survey, Digital Assets: Current and Future Use Cases, reveals that while many treasury teams have yet to launch blockchain projects and adopt the use of cryptocurrencies and digital assets, there’s a growing core of early adopters who can provide peers with ideas and methodologies for stepping up their engagement.

Members of NeuGroup for Digital Assets are blazing a path for corporates, creating real-world use cases for blockchain technology and the products it supports, with nearly half of respondents already executing a blockchain project.

NeuGroup Peer Research digs into how all treasuries can catch up to digital assets leaders.

Members of NeuGroup for Digital Assets are blazing a path for corporates, creating real-world use cases for blockchain technology and the products it supports, with nearly half of respondents already executing a blockchain project.

Preparing for the mainstreaming of corporate engagement in the digital asset space is a must for many companies that seek to remain competitive in an increasingly tech-driven world. Getting started can be overwhelming; however, our data and follow up-conversations with survey respondents reveal seven critical steps treasuries can take to narrow or close the gap and become more digital asset-enabled:

Review peers’ projects to identify potential use cases and build better legal understandings around active digital assets projects.
Work with trailblazers to identify how to allocate organizational resources efficiently.
Engage with digitally savvy NeuGroup members for insights on which third parties to consider and how to evaluate their capabilities.
Benchmark against successful product launches to evaluate available tools for processing on-chain transactions.
Collaborate with other parts of the organization to determine how to create support channels for the product lines, build robust compliance for wallet support and work with tax and legal to understand and develop use-case-based tax and accounting strategies.
Start small by opening a wallet and developing a token/digital currency policy, and work through specific operating hurdles before the project goes live.
Take advantage of crypto market downturns to acquire talent, evaluate and upskill existing talent, or even buy an entire digital asset marketplace.

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Justin Jones In Risk Management, Talking Shop

Talking Shop: Bloomberg Usage Fees for IBOR Fallback Rates

Context: For some corporates, the transition from the London interbank offered rate (Libor) to risk-free reference rates—such as the Secured Overnight Financing Rate (SOFR)—included the decision to adopt so-called fallback language in existing derivative contracts covered by the International Swaps and Derivatives Association (ISDA).

- During the yearslong process, ISDA created the IBOR Fallbacks Supplement to define how legacy Libor derivative contracts would transition to SOFR.
- ISDA in 2019 announced the selection of Bloomberg Index Services Limited (BISL) to calculate and publish adjustments related to fallbacks. Bloomberg today provides the term and spread adjustments for the fallbacks.
- While publication of Libor ceased in June 2023, the move away from it remains relevant for many corporates, including the member who asked the question below.

Member question: “Has anyone else been approached by Bloomberg about a $5,000 fee for using the Libor fallback rates?”

During the yearslong process, ISDA created the IBOR Fallbacks Supplement to define how legacy Libor derivative contracts would transition to SOFR.
ISDA in 2019 announced the selection of Bloomberg Index Services Limited (BISL) to calculate and publish adjustments related to fallbacks. Bloomberg today provides the term and spread adjustments for the fallbacks.
While publication of Libor ceased in June 2023, the move away from it remains relevant for many corporates, including the member who asked the question below.

Member question: “Has anyone else been approached by Bloomberg about a $5,000 fee for using the Libor fallback rates? We let our interest rate swaps fall back using the ISDA IBOR Protocol and now Bloomberg says we owe $5,000 a year, even though we never signed an agreement with them. They say they have the right to charge us because they signed an exclusive agreement with ISDA to calculate the Libor fallback rates.”

Peer answer 1: “Yes. We begrudgingly went through this with Bloomberg. Painful, but no way around it if you want access to the fallback rate.”

Peer answer 2: “That is my understanding. When they carved up the post-Libor index revenue, Bloomberg got ISDA fallback, Refinitiv got the SOFR adjusted and ICE got the SOFR swap. We did sign an agreement to access/use the rate from Bloomberg and pricing is consistent with what you note.”

Peer answer 3: “No. We fell back to one-month term SOFR, which is published by CME Group.”

Sources tell NeuGroup Insights that some corporate clients have asked Bloomberg if they owe fees for the use of the fallback rates. In other cases, the sources say, Bloomberg has raised the issue during conversations with clients about other subjects.

Asked to comment on the issue of fees, a Bloomberg spokesperson said, “Bloomberg serves as the fallback adjustment vendor for ISDA, which means we build, distribute and commercialize the IBOR fallback in conjunction with ISDA. The publicly available fee schedule is a standard way that the industry charges for the use of reference rates such as the ISDA IBOR fallback rates.”

Here are the fees listed on Bloomberg’s usage terms sheet for IBOR fallbacks. Users with financial assets of less than $5 billion are not subject to the fee.

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Justin Jones In FX, Regional

Currency Headache in Argentina: Chilling Effects of FX Controls

A new regulation makes some blue-chip swaps, used to move trapped cash out of the country, less attractive.

In the run-up to Argentina’s Oct. 22 general elections, the government body that regulates markets issued an official bulletin that has effectively limited outflows of Argentine pesos (ARS). In recent NeuGroup meetings, corporates and regional experts said the regulation increased the perceived legal risk of blue-chip swaps, a type of international asset trade where a multinational in Argentina typically uses local currency to buy sovereign bonds or shares of local companies with US listings and sells the securities offshore for dollars, often through a brokerage.

Blue-chip swaps offer corporates an option in FX markets in countries with tight controls on cash outflows—albeit at a much less favorable rate: Today, $1 translates to about 350 Argentine pesos (ARS) in official channels; the volatile, unofficial blue-chip rate hovers around 1,000 ARS. Some corporates are willing to accept the rate because these transactions are one of few ways to get trapped cash out of Argentina.
The new regulation requires five days of notice for any transaction above 200 million ARS—roughly $200,000 at the blue-chip rate. In a recent session of NeuGroup for Latin America Treasury, Alejandro Haro, CEO of Comafi Bursátil, the brokerage arm of Banco Comafi, said “this is a major change.”

A new regulation makes some blue-chip swaps, used to move trapped cash out of the country, less attractive.

Blue-chip swaps offer corporates an option in FX markets in countries with tight controls on cash outflows—albeit at a much less favorable rate: Today, $1 translates to about 350 Argentine pesos (ARS) in official channels; the volatile, unofficial blue-chip rate hovers around 1,000 ARS. Some corporates are willing to accept the rate because these transactions are one of the few ways to get trapped cash out of Argentina.
The new regulation requires five days of notice for any transaction above 200 million ARS—roughly $200,000 at the blue-chip rate. In a recent session of NeuGroup for Latin America Treasury, Alejandro Haro, CEO of Comafi Bursátil, the brokerage arm of Banco Comafi, said “this is a major change.”

Chilling effects. Mr. Haro, as well as a NeuGroup member who has executed a blue-chip swap in the last week, said a knock-on effect of the regulation is that demand has steeply declined in the blue-chip market. That has essentially imposed a soft cap of about $3 million per swap transaction, down from around $15 million before the regulation.

He added that earlier this year the blue-chip swap market could see up to $80 million total per day, compared to $30 million now.
At a recent NeuGroup meeting, one treasury manager said he had plans to execute a blue-chip swap worth multiple millions in USD the week before the election, with an eye on another, larger transaction later. The new requirement to submit notice, in addition to increased regulatory attention, caused the treasury team to put an indefinite hold on the plan.
This is not the first step Argentina has taken to limit the use of the blue-chip mechanism. Earlier this year, the central bank issued a new regulation on blue-chip swaps: Before a party can execute the transaction, it must prove it has not tapped the country’s official FX market for 180 days; after the swap, it can’t access that market for another 180 days.

Tangled legal knot. Gabriel Gomez-Giglio, the chair of Baker McKenzie’s Latin American banking and finance practice, noted in a recent interview that the new regulations, in concert with a number of other factors, including uncertainty around the Nov. 19 election run-off and ongoing price volatility in the country have “basically been a deterrent to conduct transactions.”

“Our clients are holding onto many more pesos,” he said, despite noticing rising demand from corporates to get cash out of the country. “It’s a vicious cycle.”
Mr. Gomez-Giglio, as well as Mr. Haro, noted that the regulation is unclear on how the five-day notice will be implemented, with no clarity on whether the day that notice is issued counts as one of the five days.

Moving forward. There are many parties simply executing daily trades up to the legal limit that don’t require five days of notice, about $200,000 USD—but it’s not ideal, as the blue-chip rate fluctuates often, according to Mr. Haro.

The member who canceled plans for blue-chip swap transactions is looking for alternate avenues for trapped pesos. “We have been in a holding pattern, investing our excess cash in a money market fund that holds deposit balances,” he said. “This provides some protection.”
He’s also looking into dollar-linked bonds, as are some of Mr. Haro’s clients. Others are looking into hard-dollar bonds, which are dollar-denominated and issued in Argentina. Parties purchasing these must use the blue-chip rate—but because this does not qualify as a blue-chip swap, it does not require five days of notice or the 180-day waiting period.
Because of the perceived legal risk of transacting amid increased scrutiny from regulators, Mr. Haro and Mr. Gomez-Giglio each said they have noticed many corporates adopting a wait-and-see approach until after the presidential run-off election later this month. Sergio Massa, the nation’s current minister of economy, who received the most votes in the general election, will face off with libertarian economist Javier Milei, who seeks an overhaul of the economic system, leading to a “dollarization” of Argentina’s troubled economy.

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Justin Jones In Technology, The NeuGroup Insights Interview

A Chatham Financial Star Says Clients Are the Stars of the Show

Chatham managing partner Amol Dhargalkar describes his personal journey and his vision of the future of finance.

This episode of NeuGroup’s Strategic Finance Lab podcast stars Amol Dhargalkar, the managing partner, board chairman and global head of the corporates sector at Chatham Financial—the risk advisory firm where he has spent more than two decades, his entire working career. You can hear his interview with NeuGroup founder and CEO Joseph Neu now on Apple and Spotify.

Chatham helps corporations develop strategies to hedge their exposures to foreign exchange, interest rates and commodities—often using derivatives. It offers a cloud-based technology platform called ChathamDirect used for risk-analysis calculations, asset valuations, and to streamline accounting and reporting.

Chatham managing partner Amol Dhargalkar describes his personal journey and his vision of the future of finance.

Chatham helps corporations develop strategies to hedge their exposures to foreign exchange, interest rates and commodities—often using derivatives. It offers a cloud-based technology platform called ChathamDirect used for risk-analysis calculations, asset valuations, and to streamline accounting and reporting.

Amol sat down with Joseph in mid-October at Chatham’s campus in Kennett Square, Pennsylvania during a busy week: Chatham sponsored and hosted a NeuGroup meeting of assistant treasurers, and announced the acquisition of EA Markets, a capital markets investment banking firm.

That deal is just the latest of Amol’s achievements at Chatham; he was named chairman in May of 2022, another sign of his drive and determination. He tells Joseph he only has two speeds—not doing something, or going all the way—both at work and in personal pursuits like running.
But as you’ll hear, he firmly believes that work and running are team sports. For him, working with colleagues to serve clients paves the road to individual growth and achievement. “We’re not the star of the show, the client’s the star of show,” he said. “We’re there to just come alongside them as a partner and help them achieve whatever their capital markets goals are.”

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Justin Jones In FX, Talking Shop

Talking Shop: The Pros and Cons for FX of More Frequent Netting

Context: The gross magnitude of inter- and intracompany payables and receivables at multinational companies has made intercompany netting processes essential for efficient global cash operations. With proper setup, an effective netting program will reduce foreign exchange and payment costs, simplify transaction and reconciliation processes and optimize cash concentration.

Similarly, the practice of centralizing the buying and selling of currency amounts, set to a specific calendar, increases operational efficiencies and may consolidate FX exposure reporting onto a single platform.
Matching intercompany netting dates to hedge maturity dates further streamlines settlements and accounting treatment at the business unit level. One member company recently questioned if benefits would be amplified by creating more netting cycles.

Member question. “Does anyone make frequent netting payments? We are doing monthly netting and associated monthly FX trading and wondering about the pros and cons of doing more frequent netting.”

Similarly, the practice of centralizing the buying and selling of currency amounts, set to a specific calendar, increases operational efficiencies and may consolidate FX exposure reporting onto a single platform.
Matching intercompany netting dates to hedge maturity dates further streamlines settlements and accounting treatment at the business unit level. One member company recently questioned if benefits would be amplified by creating more netting cycles.

“Monthly netting is a process where we make intercompany payments in one payment per month to avoid multiple payments. As we are accumulating AR and AP until the netting day, we naturally have a higher FX balance sheet that we need to hedge. Increasing netting frequency seems to be a lot of extra work.
“The background for my question is that one of our finance risk committee members is concerned about the growing size of the FX balance sheet hedge amount. They said, ‘What if we do daily netting? Then we will have close to zero FX balance sheets and save hedging costs. Do we have any new tech or service?’”

Peer answer: “We have two trading cycles a month for our balance sheet program. For years, we had one trading cycle; however, due to the development of analytical tools in our cash management area, we have more visibility and have introduced the second trading cycle. During both cycles, we net our payments to deliver operational efficiencies while minimizing settlement risk.

“We are performing two as there are many countries that receive excess cash (after our main cycle), from client receipts, and the second cycle allows us to manage our cash balances more effectively and efficiently.
“With regards to netting, to avoid additional costs you always want to be in a position where you minimize the number of wires or ACHs your cash management team has to perform—while effectively minimizing your settlement risk as well. From a hedging cost perspective, I am of the mindset that the more frequently you are hedging (and in the market), the more costs you incur externally and operationally.”

NeuGroup Insights reached out to the member who posed the question to learn whether his company has decided to do more frequent netting. He said, “We are sticking to a monthly netting schedule as I expected. The reasons for not doing more frequent netting:

“No technology allows us to avoid daily netting wire fees that can multiply by daily vs. monthly.
“Hedging cost for FX balance is about one to two basis points. For our size, savings are around $200K annually if we do daily netting; the additional costs for wires and a potential head count increase are not worth saving $200K.
“The FX balance will never be close to zero. To move to daily netting, we will have to pay down AP when the local team is still waiting for the customers to pay them. We will have to issue the intercompany loans in FX, and still must hedge them. Not a big saving on hedging costs and FX volume.”

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Justin Jones In Technology, The NeuGroup Insights Interview

Making Strategic Finance Decisions Built on Data and Integration

Chatham Financial’s Amol Dhargalkar sees forward-looking treasury teams driving a future of data analysis woven into strategic decisions.

In a NeuGroup Insights video you can watch by hitting the play button below, Chatham Financial managing partner and board chairman Amol Dhargalkar shares with NeuGroup founder and CEO Joseph Neu a vision of the future for treasury and financial risk management built on data and integration. He gives two real-life examples that make his points concrete, clear and compelling.

Mr. Dhargalkar foresees advanced technology allowing finance teams to improve the collection and analysis of data from disparate sources and using the insights gleaned to make better risk management decisions. The key, though, is also integrating and coordinating those decisions with a company’s broader capital markets strategy—as well as the corporate’s overall strategic goals.

Last week, Mr. Neu and Mr. Dhargalkar sat down to record a forthcoming episode of NeuGroup’s Strategic Finance Lab podcast after the conclusion of the fall meeting of NeuGroup for Large-Cap Assistant Treasurers sponsored by Chatham and held at its headquarters in Kennett Square, Pennsylvania. The video is an excerpt from their conversation.
That same week, Chatham—a financial risk advisor and technology company focused on hedging strategies and solutions for FX, interest rate and commodity exposures—announced the acquisition of EA Markets, a capital markets investment banking firm. As part of the deal, Chatham appointed EA Markets co-founder and CEO Reuben Daniels as a managing director and global head of investment banking at Chatham.
In the podcast—slated to drop next week—Mr. Dhargalkar elaborates on why it made sense to add Mr. Daniels and EA to the Chatham team. And he discusses the importance of working as a team. “Everything we do in treasury and capital markets is a team sport,” he said. “The idea that we can the best version of ourselves by ourselves is one of the biggest myths out there.”

Chatham Financial’s Amol Dhargalkar sees forward-looking treasury teams driving a future of data analysis woven into strategic decisions.

Last week, Mr. Neu and Mr. Dhargalkar sat down to record a forthcoming episode of NeuGroup’s Strategic Finance Lab podcast after the conclusion of the fall meeting of NeuGroup for Large-Cap Assistant Treasurers sponsored by Chatham and held at its headquarters in Kennett Square, Pennsylvania. The video is an excerpt from their conversation.
That same week, Chatham—a financial risk advisor and technology company focused on hedging strategies and solutions for FX, interest rate and commodity exposures—announced the acquisition of EA Markets, a capital markets investment banking firm. As part of the deal, Chatham appointed EA Markets co-founder and CEO Reuben Daniels as a managing director and global head of investment banking at Chatham.
In the podcast—slated to drop next week—Mr. Dhargalkar elaborates on why it made sense to add Mr. Daniels and EA to the Chatham team. And he discusses the importance of working as a team. “Everything we do in treasury and capital markets is a team sport,” he said. “The idea that we can the best version of ourselves by ourselves is one of the biggest myths out there.”

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Justin Jones In Cash & Working Capital, Technology

Liquidity and Capital Structure Top Treasury’s 2024 Priorities

NeuGroup’s Treasury and Finance Agenda Survey also shows more emphasis and urgency on digital transformation.

The biggest risk facing companies next year is an economic downturn, according to preliminary results of NeuGroup’s 2024 Treasury and Finance Agenda Survey. At the same time, 53% of respondents predict interest rates will remain high or even go higher. The result is that treasury teams placed liquidity and capital structure optimization at the top of their objectives for the coming year (see ranking below). Amid ongoing uncertainty, that makes a lot of sense. By eking out as much cash as possible internally, treasuries can reduce the need for external financing, a significant component of a company’s capital structure.

NeuGroup’s Treasury and Finance Agenda Survey also shows more emphasis and urgency on digital transformation.

The biggest risk facing companies next year is an economic downturn, according to preliminary results of NeuGroup’s 2024 Treasury and Finance Agenda Survey. At the same time, 57% of respondents predict interest rates will remain high or even go higher. The result is that treasury teams placed liquidity and capital structure optimization at the top of their objectives for the coming year (see ranking below). Amid ongoing uncertainty, that makes a lot of sense. By eking out as much cash as possible internally, treasuries can reduce the need for external financing, a significant component of a company’s capital structure.

Liquidity and capital structure also dominated treasurers’ 2023 list of objectives. One significant change from a year ago is where digitization of the treasury function landed in the ranking. Last year, it was at No. 6; this year it shot up to No. 3. That’s a welcome development. The desire to modernize treasury’s technology stack aligns with rising concerns about costs as well as the push to improve analytics and decision support. Absent automation, staff are occupied with manual tasks instead of looking at the bigger picture and extracting valuable insights from data.

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Justin Jones In Capital Markets

Mixed Signals: Do Recent Unicorn IPOs Mean the Window Is Open?

Recent IPOs of unicorns ended a nearly two-year drought, but CFOs and market participants don’t expect a flood—yet.

The September IPOs of Arm Holdings, Klaviyo and Instacart ended a long drought of debut stock offerings from so-called unicorns—privately held startup companies that have reached a valuation of $1 billion or more. The first session of NeuGroup for Growth Company CFOs brought together chief financial officers of other fast-growing firms, including some unicorns, to discuss whether the recent crop of IPOs means corporates that have been standing by for the last two years can start looking ahead.

Nasdaq managing director Dan Angius, who presented at the late-September session, said the recent, modest wave of high-profile IPOs is encouraging, as is the strength of the US economy. But while the time may be right for corporates in some favored sectors or that have unique characteristics, don’t expect a tidal wave.

Recent IPOs of unicorns ended a nearly two-year drought, but CFOs and market participants don’t expect a flood—yet.

The September IPOs of Arm Holdings, Klaviyo and Instacart ended a long drought of debut stock offerings from so-called unicorns—privately held startup companies that have reached a valuation of $1 billion or more. NeuGroup for Growth Company CFOs brought together chief financial officers of other fast-growing firms, including some unicorns, to discuss whether the recent crop of IPOs means corporates that have been standing by for the last two years can start looking ahead.

Nasdaq managing director Dan Angius, who presented at the late-September session, said the recent, modest wave of high-profile IPOs is encouraging, as is the strength of the US economy. But while the time may be right for corporates in some favored sectors or that have unique characteristics, don’t expect a tidal wave.
“What does the recent IPO boom say about the market? It’s too early for this to be a fully formed reopening, and I’d set the expectation for 2023 not to see any radically higher volume of IPOs,” he said. But for reasons including that the Fed will likely pause interest rate hikes this fall and may pivot to rate cuts in the first half of next year, he said market conditions could change dramatically by mid-2024.

Notes of caution. A guest speaker from an equity advisory firm, who has over 30 years of experience in equity capital markets, sounded a similar note of caution. He said that corporates examining the recent batch of IPOs should not use them as tea leaves to gauge the health of the overall IPO market. “An IPO is not one-size-fits-all,” he said, underscoring the risks of broad conclusions.

Nasdaq’s Mr. Angius concurs, noting that Instacart and Arm Holdings had unique motivations for going public that diminish the value of looking at their deals as a larger indicator of market receptiveness. He said Arm Holdings’ IPO was driven by the opinion of Softbank that Arm was ready to exist as a standalone company.
In addition, a majority of the capital raised in Instacart’s IPO was reportedly used to pay off taxes related to employee equity compensation.

A narrow window. Following last month’s IPOs, one highly anticipated debut, VNG, delayed its launch until the first half of 2024. Birkenstock, another scheduled IPO that members in the session said they were going to keep an eye on, may have mistimed the market. “I think it’s going to be a really tough window this year,” the guest speaker said.

He also cautioned that investors are growing more demanding. Recent IPO performances, which have often seen stocks hovering around their debut prices, could signal a challenging landscape.
Traditionally, IPOs that do not price aggressively by pushing to the high end of their valuations secure a higher “pop” on their debut. These amounts can vary, but there is typically a higher spike for more conservative pricing. Recently, the guest speaker from the advisory firm said he’s observed investors seeking a higher pop, potentially doubling what was expected before the IPO drought.
In addition, the recent IPOs “had a lower-than-average hit rate, seeing less pickup on net new investors, really relying on existing investors to buy in,” Mr. Angius said.

Hope for the spring. But Mr. Angius sees reason for optimism, referencing a Goldman Sachs note that the previous longest IPO drought lasted about 30 months. So if the current slump began in October 2021, the ETA for a proper reopening will fall around April 2024.

He cited numerous companies confidentially starting the process of filing for IPOs aimed at the first half of 2024 “in a significant way,” which includes seeking out auditors, technical accountants and financial printers.

Politics and M&A: red herrings? Some members in the session expressed concern about political influences on IPO favorability, and whether the tone set by one party in power could mar investors’ confidence in the market. Mr. Angius referenced Nasdaq’s research showing that historical IPO trends haven’t been significantly affected by election cycles. However, he noted that government shutdowns could introduce uncertainty, as could political unrest—impacting some sectors more than others.

One member, who said he “wears a very dark hat” on IPOs in the near-term, wondered if a perceived rise in M&A activity, particularly Cisco’s acquisition of AI firm Splunk, is having an impact on the IPO market as a competing option to raise capital.
Mr. Angius responded that he thinks that was an idiosyncratic acquisition due to increased interest in AI, and “not endemic of a macro shift.” That said, M&A activity has been seen as a leading indicator for the IPO market.

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Justin Jones In Capital Markets, Investment Management, Sponsored Content

Reverse Repo: A Safe Haven for Cash Amid Financial Turbulence

Attractive yields and safety are two reasons some corporates are investing directly in reverse repos.

Turmoil in the banking sector earlier this year sent shockwaves through corporate treasuries, triggering widespread reviews of credit risk policies and changes in how cash investment managers think about counterparty limits for unsecured exposure to banks. As these managers continue to seek both safety and healthy yields, reverse repurchase agreements, also known as reverse repos, are drawing increased attention globally. And no wonder: they offer corporates an additional layer of safety—securities held as collateral—with the current, added bonus of higher yields than some other low-risk investments due to recent favorable regulation in the US and Europe.

Deutsche Bank data shows that yields in the range of SOFR flat (about 5.3%) to SOFR+40 basis points (or about 5.7%) can be achieved through reverse repo—with an overnight US Treasury tri-party repo (we’ll explain below) at the low end of the yield spectrum, and using equities as collateral out to three months on the high end.
Brendan McCarthy, Deutsche Bank’s director of client management for agency securities lending in the US, said reverse repos are an ideal tool for treasuries at large, cash-rich corporates that manage cash conservatively, as well as those that are looking at additional asset classes.
“As cash reserves have grown larger, a lot of investment managers are buying commercial paper, or doing different types of investments that have different tenors,” he said. That includes reverse repos, whose collateralization significantly reduces risk. In addition, accounting standards allow them to be treated as cash or cash equivalents, another reason “reverse repos are a natural fit: a very simple, highly liquid investment.”

Attractive yields and safety are two reasons some corporates are investing directly in reverse repos.

Deutsche Bank data shows that yields in the range of SOFR flat (about 5.3%) to SOFR+40 basis points (or about 5.7%) can be achieved through reverse repo—with an overnight US Treasury tri-party repo (we’ll explain below) at the low end of the yield spectrum, and using equities as collateral out to three months on the high end.
Brendan McCarthy, Deutsche Bank’s director of client management for agency securities lending in the US, said reverse repos are an ideal tool for treasuries at large, cash-rich corporates that manage cash conservatively, as well as those that are looking at additional asset classes.
“As cash reserves have grown larger, a lot of investment managers are buying commercial paper, or doing different types of investments that have different tenors,” he said. That includes reverse repos, whose collateralization significantly reduces risk. In addition, accounting standards allow them to be treated as cash or cash equivalents, another reason “reverse repos are a natural fit: a very simple, highly liquid investment.”

Yield-boosting regulation. Those attractive yields are not only thanks to the jump in rates over the last 18 months as central banks waged war against inflation—it’s also bank regulators. Deutsche Bank VP of risk management solutions Leon Kurz said the European Banking Authority and the US Federal Reserve are incentivizing banks to trade with corporates in the repo market to boost liquidity as measured by their net stable funding ratios (NSFR).

“There’s real value, quantifiable for the banks, to trade against corporate clients,” Mr. Kurz said. “With banks that know they are in competition against other banks, there’s value to be had. The competition will force them to pay out this value back to the corporate clients, which has increased this year.”

Investing in reverse repos. In a reverse repo, in this context, the corporate purchases securities from a broker-dealer that is borrowing cash for a specified term, usually ranging from overnight to 90 days. The agreement requires the bank to buy back the securities at a higher price—the premium that produces yield for the corporate investor. The yield is based on the length of the term and the quality of the securities used as collateral.

While a broad array of assets may be financed in the repo market, the most commonly used instruments according to SIFMA are US Treasuries, federal agency securities, high quality mortgage-backed securities, corporate bonds and money market instruments.
Global financial institutions like Deutsche Bank that have access to repo markets in all regions of the world are ideal partners for reverse repo investments. Their broad market reach enables execution with whatever counterparty has most demand and therefore pays the highest rate at any point in time.
“For example, one of our dollar-based German clients does trades in Europe, but they also access USA domicile banks via our New York-based agency desk,” Mr. Kurz said.

Three-party system. There are two structures for reverse repurchase agreements: bilateral and tri-party. In a bilateral repo, investors and collateral providers directly exchange money and securities. Mr. McCarthy said the tri-party structure is more commonly used by corporates, with a custodial institution, or tri-party bank, acting as an intermediary.

Banks including BNY Mellon, JP Morgan and Euroclear often play the role of tri-party bank, holding the securities on behalf of the corporate for the duration of the agreement. If, for any reason, the bank counterparty defaults, the collateral is returned to the corporate client.
But a fourth party often comes into play, which is where Deutsche Bank fits into this picture. It can be contracted as an agent, providing clients access to trade with over 50 bank counterparties through one agreement, handling all trade execution, settlement, and other processes, including reporting.
One valued service the bank provides when working as an agent is so-called margin shortfall indemnity—another layer of security that Mr. McCarthy said sets the bank apart from many of its competitors.
That means if the bank counterparty in a reverse repo goes insolvent and Deutsche Bank is unable to liquidate the full value of the collateral, “DB steps in to make up the difference to the investor,” he said.

What about money market funds? Between the banking crisis and the debt ceiling showdown earlier this year, a wave of corporates sought security in money market funds that invested largely in reverse repos. And although corporates can access some benefits of the reverse repo market through money funds, Deutsche Bank says it’s not the same as investing in reverse repos directly.

“If a corporate wanted to go out to a three-month tenor and bought money funds backed by repos, that will only buy overnight repos backed by very secure short-term treasuries,” said William Sauer, an associate on the US corporate investment solutions team at DB.
“What money funds can invest in are only on the lowest end of the yield spectrum. Working with Deutsche Bank makes things much more customized—if you’re comfortable with a three-month tenor, you won’t miss out on yield.”

Repo in action. One of Deutsche Bank’s clients, a logistics company, was confronted with excess cash balances after business surged following Covid-induced lockdowns. It paid down debt but still had billions of deposits in accounts, exceeding the company’s target limits with its core banks. And where could it put the cash to work when banks across the globe were failing?

For answers, the company turned to Deutsche Bank, which advised tapping the reverse repo market. The bank served as an agent to manage the transactions through its cash investment service (CIS). As the chart below shows, the company now has more than $5 billion in reverse repo assets.
The treasury team said working with Deutsche Bank brought several benefits. Among them: no need to onboard each new counterparty, saving time on administrative and compliance efforts. It also got access to the bank’s broad spectrum of potential reverse repo counterparties and money market funds linked to the CIS platform.

High customization, low maintenance. The treasury team added that another key benefit of reverse repo is that the risk-return is fully tailored to the company’s needs, including the counterparty, collateral type, collateral quality and tenor.

Once the program was set up, the corporate had to do very little active management, with Deutsche Bank’s CIS service deputized to manage all day-to-day activities.
Mr. McCarthy said that most corporates using this service “might check in once a week just to touch base, but they have full access to all details daily.”
The treasury team members said the project was a clear success, significantly reducing counterparty exposure through collateralization, but with attractive yields compared to standard time deposits.

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Justin Jones In Cash & Working Capital, Talking Shop

Talking Shop: Cleaning Up a Messy Short-Term Cash Forecast

Context: Cash forecasting is a perennial challenge for both treasury and FP&A teams, but the two functions tend to approach the problem from different perspectives. Treasury, responsible for short-term liquidity and cash management, depends more on bottom-up, direct forecasts. FP&A, concerned with planning and budgeting for the longer term, typically uses a top-down, indirect method. But treasury at some companies employs both approaches.

“It’s important for us to keep both,” said one member who participated in NeuGroup’s Cash Forecasting Survey last year. “At the end of the quarter, we run both models, using the indirect forecast from the income statement and direct forecast from the cash flow. This is great because we can reconcile the models.”
The problem for many treasuries is access to data, often a manual process. While a TMS automates some of the work, participants in post-survey focus groups had not yet found a system offering comprehensive cash forecasting functionality. That’s why 93% of treasuries are still using Excel, often in combination with the TMS. Only 53% said they are using their TMS for cash forecasting. Just 18% are using ML/AI tools.

Member question: “I am trying to get to a nice 13-week cash forecast and currently have a messy one that is taking me far too much time. I’d like to know how others handle short-term forecasting.”

“It’s important for us to keep both,” said one member who participated in NeuGroup’s Cash Forecasting Survey last year. “At the end of the quarter, we run both models, using the indirect forecast from the income statement and direct forecast from the cash flow. This is great because we can reconcile the models.”
The problem for many treasuries is access to data, often a manual process. While a TMS automates some of the work, participants in post-survey focus groups had not yet found a system offering comprehensive cash forecasting functionality. That’s why 93% of treasuries are still using Excel, often in combination with the TMS. Only 53% said they are using their TMS for cash forecasting. Just 18% are using ML/AI tools.

Peer answer: “Our process is at a relatively early stage and not perfect; but that may make it more applicable if you’re starting from scratch. It’s not a rolling forecast; we only forecast the current quarter in our direct cash flow forecast. We have a longer, indirect cash flow forecast which is rolling, but that is mostly driven by FP&A inputs.

“Our one quarter direct cash flow forecast consists of the items below. Periodically, we update it using quarter-to-date actuals from our TMS system (previously we used bank portals).

“Collections. Based on AR and forecasted billings.
“Employee spend (salary and other). Forecasted by our payroll team but mostly driven by historical data and growth.
“Vendor and T&E spend. Forecasted by treasury using historical run rate and FP&A expense growth assumptions.
“Corporate taxes. Forecasted by the tax team.
“Interest income. Forecasted by treasury.
“Capex. Forecasted by FP&A
“Debt/equity cash flows. Forecasted by treasury.”

NeuGroup Insights reached out to the member who posed the question to find out what he learned from a follow-up conversation with the peer who provided the written answer. The questioner began by describing his forecasting journey so far:

“Previously we just had a budget that was done quarterly. I began doing a monthly cash forecast, as I oversee all cash items for AP release and collecting AR and oversight on employee expenses; I was able to get a more accurate month-end cash number.
“However, it was a messy Excel sheet where I was continuously moving actuals around; it was very inefficient and I was not displaying my forecast, actuals and variance numbers well.”

Here are the member’s key learnings from the conversation with his peer.

Clean presentation. “Using hypothetical figures, he showed me how they use their cash flow to show forecast, actual and variance sections on a weekly basis. This was probably a light bulb moment for me. Looking online for templates, I did not like what I saw; what he showed me was clean and straightforward.
- “It was an Excel workbook. It had several tabs of reports and data that were pulled from Kyriba. It had a summary tab, cash waterfall, forecast, actual and variance sheet and several others. I liked seeing a bit of a summary tab showing who is responsible for getting numbers.
Clean data. “Knowing the source of your data is critical. The quote we have all heard is ‘garbage in, garbage out.’ I was pondering if I could use our accounting system for some tools and data but knew that things were not being reconciled in a timely manner. The peer member syncs bank data to Kyriba; using bank feeds to a TMS is the go-to route to get actuals in a timely basis.
- “Then, however, they export from Kyriba to an Excel workbook. As many people know, the visualization ability is not there yet.
Clear metrics. “Know what metrics are you trying to measure, i.e., free cash flow, change in cash. I began the process for doing cash forecasting to get a more accurate number than what our budget was spitting out, but there are more metrics I can incorporate into my reporting that can give me value.
Rules rule. “Try to set up as many rules as possible for your bank feed. I do not have a Kyriba or a TMS but believe I can roll up my Excel sleeves to make some rules work.
- “I will try to enhance the efficiency of my reporting by using formulas in Excel to allocate the transactions better to the forecasted line items. It is currently a manual task of adding and subtracting line items—that can be streamlined.”

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Justin Jones In Technology, Treasury Management

Up the Learning Curve: How Coca-Cola Is Implementing ChatGPT

Coca-Cola’s internal model of ChatGPT has numerous use cases for treasury team members who learn to use the AI tool.

Coca-Cola is one of several NeuGroup member companies that have partnered with OpenAI to create an internal version (also known as an instance or model) of ChatGPT that runs entirely on servers owned by the corporate. Within Coca-Cola treasury, senior director of emerging capabilities Rui (Ree) Yang is spearheading the effort to put the artificial intelligence tool to work by guiding employees to find uses that cut down on hours spent on repetitive tasks.

Ms. Yang is leading by example through a variety of use cases for the chatbot, including a recent project in which she created a world map that features every country’s credit default swap spread. Using Excel’s internal mapping function, she worked with ChatGPT to write a code that pulls and cleans data from FactSet, a data software provider, and outputs a heat map of the globe which can be updated in seconds.

Coca-Cola’s internal model of ChatGPT has numerous use cases for treasury team members who learn to use the AI tool.

Ms. Yang is leading by example through a variety of use cases for the chatbot, including a recent project in which she created a world map that features every country’s credit default swap spread. Using Excel’s internal mapping function, she worked with ChatGPT to write a code that pulls and cleans data from FactSet, a data software provider, and outputs a heat map of the globe which can be updated in seconds.
At the first-half meeting of NeuGroup for Digital Assets, she briefly discussed her company’s partnership with OpenAI. She later walked NeuGroup Insights through her journey so far to embrace ChatGPT and help coworkers see the potential in the tool, rather than fear it.
“Technology can’t run a business, you need human beings to run a business,” she said. “But tools can help us become more efficient and productive—that’s the type of mentality we’re trying to embed into employees.”

Rui Yang, Director of Emerging Capabilities, Coca-Cola

Putting ChatGPT to work. ChatGPT has proven particularly valuable for streamlining tasks like Excel document creation and writing code for specific automations; in the case of the global CDS map, the hours required to make the chart manually would likely have exceeded the benefit.

Because the data is on a private server, employees can use ChatGPT for tasks that deal with sensitive information with no risk of the publicly available model being trained on what employees share—surely a balm for risk managers concerned about leaks. Employees can ask specific questions about topics including org charts, company history and acronyms used by coworkers, which Ms. Yang said is incredibly useful for onboarding.
“Another way ChatGPT helps is it’s a really good proofreader,” she said. “If I’m writing a white paper or something that’s very formal, I may write my initial draft and ask it to proofread for me. It does a great job.”

Improving coding knowledge. Ms. Yang has basic coding knowledge but isn’t an expert at writing scripts, even for small automations. In just a few months working with ChatGPT, though, she’s been able to implement successful code generated in part by the tool and become better at understanding software coding more broadly.

When asked to build a web page for an internal announcement, Ms. Yang said she didn’t quite know where to start. But by asking ChatGPT questions about web design and the functions required to build what she needed, she completed the project in half a day.

Asking the right questions. Generative AI tools like ChatGPT often introduce errors known as hallucinations, but Ms. Yang said issues like this are often prevented by knowing how to ask the right questions.

“Having a good answer is highly correlated to asking the right question,” she said. “There’s definitely a learning curve for how to be a competent ChatGPT user.”
But once a user starts to understand the potential applications and limitations of the tool, she said it can improve their critical thinking skills while teaching resourcefulness.

Upskilling employees. Coca-Cola’s forward-looking approach to technology is not just about efficiency; it’s also about empowering the workforce and improving an employee’s skill set. “People have a fear of technology taking over a job, but I think the best way to be in command of technology is to learn to master it,” she said.

“Different types of repetitive jobs may shrink because of technology, that’s almost inevitable—so why not put yourself in a position where you’re upskilling yourself and learning these new capabilities?”

Building the habit. In many cases, NeuGroup members have shared that younger employees pick up tech tools faster than long-tenured ones, but Ms. Yang said that hasn’t been the case for ChatGPT. For all employees, implementing the tool has required intentional time spent learning how to use it and building the habit.

Ms. Yang consistently checks in and makes sure her coworkers use ChatGPT, especially if they’re bogged down by a repetitive task.
“There is a high chance ChatGPT can write a code to automate that process, and that can save lots of time—and provide an opportunity to master a skill,” she said.

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Justin Jones In FX, Technology

Why FX Algos May Belong in a Risk Manager’s Trading Toolbox

Some NeuGroup members are using algos to reduce trading costs and take advantage of aggregated liquidity in the FX spot market.

FX algos offer corporate risk managers a well-established technology tool that can, ideally, lower trading costs while increasing speed and efficiency without moving the market when the need to trade falls outside the window of optimal liquidity in the forex market. Algos allow managers to define specific trading rules based on timing, price or quantity to determine trade execution parameters, such as waiting for the market to reach a level where they want to buy or sell instead of taking the current price—including the spread—that a bank is offering at spot.

But corporates need to weigh the benefits of algos against the execution risk of using an automated instrument that trades currency over time, meaning the market may move against it. That’s one of the considerations about the tool that arose at the fall meeting of NeuGroup for Foreign Exchange where peer group leader Julie Zawacki-Lucci moderated a discussion between the FX risk manager of a mega-cap corporate and Justin Mitrani, head of electronic fixed income and currency sales in the Americas at Societe Generale, which sponsored the meeting.

Some NeuGroup members are using algos to reduce trading costs and take advantage of aggregated liquidity in the FX spot market.

But corporates need to weigh the benefits of algos against the execution risk of using an automated instrument that trades currency over time, meaning the market may move against it. That’s one of the considerations about the tool that arose at the fall meeting of NeuGroup for Foreign Exchange where peer group leader Julie Zawacki-Lucci moderated a discussion between the FX risk manager of a mega-cap corporate and Justin Mitrani, head of electronic fixed income and currency sales in the Americas at Societe Generale, which sponsored the meeting.
Execution risk, opportunity cost and the work it takes to both understand algos and execute trades with them may help explain why fewer than one-third of NeuGroup members in attendance said they use algos. Also, some risk managers may need to convince finance leaders to approve the use of algos or change their treasury policy.

Types of algos. So-called passive algos are the most common type used by corporates looking for an alternative to locking in a price in what practitioners call a risk transfer trade with a bank that offers a bid-ask spread. The bank takes the risk and the corporate must “cross the spread” to secure a fixed price. By contrast, a company using a passive algo can set a limit price and may “capture the spread” if another FX market participant takes the other side of the trade. The potential cost savings over a large number of trades during the course of a year can total millions of dollars compared to using risk transfer trades, members said.

The execution risk that the market moves against the corporate while it waits, though, creates the possibility of opportunity cost, Mr. Mitrani said about using an algo instead of locking in a price. “Clients have to weigh, ‘what is my opportunity cost for not transacting immediately?’”
He described other algos, including those that are time- or volume-based that try to replicate the currency’s time weighted average price (TWAP) or volume weighted average price (VWAP) during the life of the trade.
Opportunistic algos, another kind, attempt to take available liquidity; the client ends up crossing the spread, but because the algo has aggregated liquidity from multiple sources, they may obtain a better overall price because of the spread compression achieved, Mr. Mitrani explained. Few corporates use these, he said.

Using the tool. The member who uses algos has employed them more often as technology improves, and noted that he is able to enter algo trades electronically in his trading platform, FXall. He does not use them daily and considers algos “part of the toolbox” that account for about 10% of his total trading volume.

The member’s company only hedges balance sheet exposures and uses algos, for example, when it needs to do a spot trade to make a large FX payment to fulfill a contract. The member also turns to algos to hedge changes in forecasts that are greater than $50 million.
He noted that most banks only offer algos for spot trades, which must be rolled forward to work as a balance sheet hedge. Mr. Mitrani said if a client is using an algo offered by Societe Generale, the bank will price the forward.

When to use the tool. Mr. Mitrani said he sees more use of algos on larger trades or for emerging market currencies. “If market conditions are challenging, an algo can help you tap into additional liquidity sources,” he said. In addition, “when markets are volatile, and generally spreads widen, you get the benefit of spread compression through aggregation and access to an increasingly fragmented FX market. And because markets are moving, there is potential to capture spread.”

Both the member and Mr. Mitrani said algos provide flexibility for risk managers who have a view on the market. “If you think the market is coming toward you in your trade, you have the ability to slow your trade down and let the market come to you so you can capture more spread,” Mr. Mitrani said.
The member said algos are also useful for executing trades in overseas markets overnight. Timing also comes into play when a large spot trade comes in during illiquid hours and the banks’ bid-ask spreads are extremely wide. In this case, he can avoid the cost of risk transfer to the bank and use a passive algo that allows him to “capture the mid”—the middle of the spread between a currency’s bid and ask rates.
These algos may take a couple of minutes or longer to execute the trade and are among the most successful when the market is hardly moving, he said. One reason is the aggregation of liquidity over time.
Another NeuGroup member, at an earlier session, said it’s especially important that an algo is stealthy in an illiquid market. “You cannot have a stealthy algo that does not know market liquidity,” he said. He gave the example of putting on a Chinese currency trade on a Friday afternoon that moved the market “like an elephant walking in.” To guard against elephants, he measures the average market mid five minutes before algo execution and five minutes after it.

Goals and benchmarks. Both the risk manager member and Mr. Mitrani agree that corporates considering or using algos need to know why. “The client should have a clearly defined benchmark going into the trade. What are they trying to accomplish?” Mr. Mitrani said.

Being clear on the goal and the benchmark will help determine what to do if the market moves against you. “How do you handle it if you’re starting to lose on the trade? When do you say I want to finish this trade and move on more quickly,” he added.
Mr. Mitrani echoed the member in underscoring the value of algos as an execution tool offering another option to trade foreign currency. Through this lens, he said, “it becomes more a matter of clients creating what their execution workflow is, when they want to do a certain trade a certain way, what are those parameters and finding the choice that works best for them.”

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