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Spotlight Features

Reverse Repo: A Safe Haven for Cash Amid Financial Turbulence

What the FASB’s Supply Chain Finance Disclosure Rules Mean for Corporates

The Science of FX Exposure Management

Ted Howard
In Risk Management, Technology

Tales from the Cyber Crypt

Assistant treasurers exchange recent scary cyber tales of success and failure.

In a breakout session at NeuGroup’s Assistant Treasurers’ Leadership Group focusing on securing companies from cyberattacks, members recounted recent experiences and the conundrums they face combating them.

Digital protection, à la carte. NeuGroup’s own Scott Flieger, director of peer groups, said a fellow member of a college board who runs a cybersecurity advisory firm recommends companies make a menu of their digital assets, from bank accounts onward, and seek to value them. Then ask how much the company is willing to pay to protect that asset. He added that few understand a company’s digital assets better than assistant treasurers. “Being the person in treasury who has an inventory of the digital assets and can value their importance—that’s an important position,” Mr. Flieger said.

Assistant treasurers exchange recent scary cyber tales of success and failure.

In a breakout session at NeuGroup’s Assistant Treasurers’ Leadership Group focusing on securing companies from cyberattacks, members recounted recent experiences and the conundrums they face combating them.

Digital protection, à la carte. NeuGroup’s own Scott Flieger, director of peer groups, said a fellow member of a college board who runs a cybersecurity advisory firm recommends companies make a menu of their digital assets, from bank accounts onward, and seek to value them. Then ask how much the company is willing to pay to protect that asset. He added that few understand a company’s digital assets better than assistant treasurers. “Being the person in treasury who has an inventory of the digital assets and can value their importance—that’s an important position,” Mr. Flieger said.

Bad timing. The email system of a NeuGroup member firm’s collections team was compromised, revealing all its customer contacts. The fraudsters then sent realistically scripted emails to customers requesting payments be sent to a different bank and providing the necessary details.

The member’s security team wanted to alert customers, but it was two weeks from quarter end, “and you don’t want to spook customers so they don’t pay you—a real treasury issue,” the member said.

Cyber reticence. Companies develop their cybersecurity plans internally, but then what? “One of our biggest challenges was that people don’t want to talk about cybersecurity,” one participant said, noting wariness about discussing the plan with third parties.

  • “We had a hard time finding peers to benchmark against, and we were paranoid as well, creating a special NDA that we made all of our banking partners sign before talking about our cybersecurity,” he said. Even his team’s discussion about how to store the plan was challenging, “because we effectively created a playbook for how to hack us.”

Cryptocurrency conundrum. A ransomware attacker may demand the transfer of $50,000 in Bitcoin to a cryptocurrency account to unfreeze a company’s system. If news breaks on CNBC about the attack, pressure will mount to meet that demand, but opening cryptocurrency accounts takes time. Companies may open cryptocurrency accounts in preparation for an attack, but would this information becoming public in an earnings call invite such attacks? And should any payment be made at all, given that the attacker could be a terrorist organization?

  • One solution: “We back up all our data, even on the desktops, so if we get locked out of our primary system, we can just reload everything,” one member said.
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Ted Howard
In Risk Management, Treasury Management

Crisis Management Brings Executives Together

Having a crisis response plan can help make the company more resilient now and later.

Following a framework for crisis response planning that engages management as well as the board can create significant political capital for internal audit, not to mention better prepare the company for crises that may arise.

Having a crisis response plan can help make the company more resilient now and later.

Following a framework for crisis response planning that engages management as well as the board can create significant political capital for internal audit, not to mention better prepare the company for crises that may arise.

Multipurpose framework. The head of internal audit at a major government contractor said in a recent NeuGroup meeting that his company uses the National Fire Protection Association 1600 Standard on Continuity, Emergency and Crisis Management. He described it as a “fairly transferable” framework that can be used across a variety of scenarios, from fire drills to much more complex and resource-intensive corporate initiatives. Most members participating in the meeting were unfamiliar with the NFPA document and listened raptly as the IA chief describe the benefits.

The member noted that the company’s risk committee chairman had required adopting the framework and given the nature of the company’s business, most of its provisions were already in place.

What not to do. The member said a fascinating outcome of crisis response planning is understanding better what executives are not supposed to do or say, “particularly for the C-suite, where it’s not uncommon to have lots of type A personalities.” The exercise clarifies what each executive’s role is and emphasizes letting the crisis manager inform them about developments so they can better determine their next steps.

By promoting understanding of the various scenarios and analyzing what to report versus what to disclose, the requirements and the cadence of reporting, “We really challenged management to think about that, and it was very helpful,” he said.

Muscle memory. “Every time we went through the exercise, whether [for a major initiative], or for cyber, or an inside threat, we’d learn something new, or ask questions we hadn’t thought to ask before,” the member said. The future will always bring situations that can’t be anticipated, and he recounted a few humorous ones. “There’s always something you don’t think about, but the more you do it, it builds muscle memory,” he said.

Political capital. The member noted that facilitating these conversations in his capacity as IA was highly rewarding. “It engaged management at different levels and created political capital that has paid dividends in so many different areas for IA,” he said.

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Antony Michels
In Senior Executive, Treasury Management

Appealing to Millennials and Gen Zers: The Academic Perspective

Insights from the Foster School of Business on what today’s MBAs want—and what treasurers have to say.

Corporates who want to hire MBA finance graduates face a highly competitive market and are well served by knowing what the current crop of millennials and Gen Zers value most when weighing job offers. That was among the key takeaways from a presentation by faculty and administrators at the University of Washington’s Foster School of Business to the members of a group of treasurers at mega-cap companies. Here’s what matters most:

Insights from the Foster School of Business on what today’s MBAs want—and what treasurers have to say.

Corporates who want to hire MBA finance graduates face a highly competitive market and are well served by knowing what the current crop of millennials and Gen Zers value most when weighing job offers. That was among the key takeaways from a presentation by faculty and administrators at the University of Washington’s Foster School of Business to the members of a group of treasurers at mega-cap companies. Here’s what matters most:

  • Strategic thinking
  • Business decision-making
    • A Foster School assistant dean later elaborated: “New graduates are seeking jobs in strategic positions that impact a company’s present and future direction. They are savvy in technology, use of communication networks, and see both the present and the future in how they think, so where they can exercise these attributes and skills makes a difference to them.  They think with innovation in mind and have a global sense of their potential impact.”
  • Cross-functional teams
  • Salary
    • The average salary for Foster’s 2018 MBA finance graduates was about $115,000, plus a signing bonus of $25,000.
  • Flexibility/work balance.
  • Promotions.
    • In an earlier session, one treasurer asked his peers if they found that new hires expected a promotion every year. He said that’s unrealistic and his approach is to tell people the company is “going to get you where you ultimately want to go,” but don’t expect a promotion every year. Another treasurer said finance has a 70% retention rate and warned, “You’ll lose them if they’re not advancing.”
  • Frequent feedback. The Foster School professors added that MBAs want contact with senior leadership.

How to engage potential recruits. The Foster School presentation recommended members take these actions to appeal to MBA students:

  • Give a guest lecture or serve on a panel at the school.
  • Host a group of students for a tour or talk.
  • Sponsor a spring analytics project.
  • Mentor a student.
  • The obvious: Hold on-campus recruiting events.

The corporate perspective. Not all the treasurers present said they favored MBA graduates. In fact, one member said MBA grads who are on rotations in the company’s leadership program usually don’t return to finance roles because they “want to do exciting business stuff, sexy biz dev stuff.” It’s easier, he said, to retain undergraduates who start in finance. “I love the leadership program when we get undergrads,” he said.

  • Another treasurer asked, “How do we make finance sexier?” He noted that corporates are often competing against investment banks for top talent.
  • The first treasurer said that when he does hire MBAs, he takes graduates from “second tier” schools who did well and are intent on proving themselves, as opposed to trying to recruit Ivy League MBAs. “Let them go to McKinsey or Goldman Sachs,” he said.
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Antony Michels
In Cash & Working Capital, Compliance, Technology

Supply Chain Finance Faces Rising Regulatory Scrutiny

Founder’s Edition, by Joseph Neu

Making sense of calls to increase debt classification and disclosure requirements for reverse factoring.

I received an email recently from a consultant giving me a heads-up about a potential financial reporting change that could adversely impact the multibillion-dollar market for supply chain finance.

Founder’s Edition, by Joseph Neu

Making sense of calls to increase debt classification and disclosure requirements for reverse factoring.

I received an email recently from a consultant giving me a heads-up about a potential financial reporting change that could adversely impact the multibillion-dollar market for supply chain finance.

  • Extended payables vs. debt. At issue is the ability of companies to use a financial intermediary to pay suppliers at a discount while extending their payments terms to the suppliers (sometimes in conjunction with raising financing against their own receivables, too), or simply extend payables beyond the norm to preserve cash (aka reverse factoring, payables financing or supply chain finance). Many such transactions are not recorded as debt but rather as trade payables.

The collapse of the UK construction firm Carillion in early 2018, linked by critics to its misuse of supply chain finance, is seen as one tipping point. But the broader use of reverse financing to help firms fund themselves at lower cost that is being promoted by a growing number of financial intermediaries is also driving regulatory scrutiny. Here are some recent examples:

  • Big Four ask for guidance. The Big Four accounting firms in October took the rare step of sending the FASB a joint letter, asking it to weigh in on how companies should classify various supply chain financing transactions and what details they should disclose.
  • Rating agencies. Fitch has a formula it uses to adjust company debt ratios to reflect their use of supply-chain finance. Moody’s has issued a warning.
  • SEC calls for MD&A disclosures. At the American Institute of CPAs conference in December, SEC Corporation Finance Deputy Chief Accountant Lindsay McCord said businesses needed to use the Management Discussion and Analysis section of their financial statements to give investors insight on their use of supplier finance programs that might change their financial condition.

To get the views of our members, I reached out to a few who manage significant supply chain finance programs.

  • Transparency and standardization needed. “The significant variations among accounting professionals in how they treat SCF reporting, even within the same accounting firm, does create external reporting challenges,” one member said. He would support standardization of interpretation and transparency of reporting.
  • The ESG component. Standardization would support good governance “to remove financial engineering and creativity merely for the sake of metrics reporting (for MNCs and large corporates) that are not necessarily beneficial to the overall business environment,” the member said. SMEs can be especially victimized by extraordinary extended terms (240-360 days), he added, with settlement delays of another 30-60 days in some countries.
  • Are new rules really needed? In another member’s opinion, “Any hack analyst can tell what is going on. Yes, it is a bit of a trick with the ratings agency’s metrics, but they too know exactly what is happening.”

I think it is fair to say that audit firms should be able to come up with a more consistent application of the current principles-based approach—i.e., the extent to which an intermediary’s involvement changes the nature, amount, and timing of payables, plus the direct economic benefit the entity receives—even without the intervention of those who set accounting standards.

  • We should all support disclosures that are sufficient to determine adherence to this principal and make clear how financing techniques affect the statement of cash flows. Reputation risk and ESG ratings related to the treatment of suppliers will also help prevent abuse if capital providers are paying attention.

To see what such disclosures might look like, take a look at examples from Masco and Keurig Dr Pepper in their responses to SEC staff comment letters.

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Ted Howard
In Risk Management, Treasury Management

Managing FX in Currency Tiers to Control Cost, Workload

Why one company’s treasury spreads currency management among teams for large exposures, currency clusters and “tier two” currencies.

At a recent NeuGroup meeting of treasurers in Europe, one member shared how his company manages FX risk management-related costs and workload by considering currencies in tiers.

Why one company’s treasury spreads currency management among teams for large exposures, currency clusters and “tier two” currencies.

At a recent NeuGroup meeting of treasurers in Europe, one member shared how his company manages FX risk management-related costs and workload by considering currencies in tiers.

Global policy, local execution. Generally speaking, at this company, corporate treasury at HQ is responsible for the framework and policies and the global hedging approach, but local (in-country) treasury staff implement the hedging strategy with advice and approval from HQ.

Big countries have their own treasury organization. Some countries in the global group are so large relative to the size of the company and have their own currencies that they will have their own treasury. Other countries together form a “cluster” that also can be managed on its own.

But “tier two” countries don’t. Various tier two countries can be served directly by corporate treasury. Here, local treasury and in-country project controllers forecast and monitor FX risks resulting from purchase orders, sales orders and tender offers, but the exposure is hedged at the group level by corporate treasury.

Other tier two countries are served by local treasury, such as India, China, South America and Africa; here, risk identification is done as above but the exposure is hedged with local banks by local treasury. (However, the valuation of the local third-party hedges is performed by corporate treasury.)

Group guidance promotes the use of global currencies like USD or EUR for project tenders in emerging markets but when that is not possible, negotiators need to ensure that currency fluctuation clauses are in the contracts. Failing contracts in global currencies, local treasury consults closely with corporate treasury to monitor risk and manage the cost of hedging.

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Antony Michels
In Cash & Working Capital, Technology

Smoother Sailing: The Benefits of Dynamic Discounting

How C2FO’s solution helps one company’s treasury team smooth its cash flows.

Successfully adopting dynamic discounting (DD) to execute early payments requires internal alignment across multiple functions in a corporate’s organization—as well as finding the right vendor and solution. However, the technology’s many benefits, including smoothing out cash flow for both the company and its suppliers, provide a persuasive argument.

How C2FO’s solution helps one company’s treasury team smooth its cash flows.

Successfully adopting dynamic discounting (DD) to execute early payments requires internal alignment across multiple functions in a corporate’s organization—as well as finding the right vendor and solution. However, the technology’s many benefits, including smoothing out cash flow for both the company and its suppliers, provide a persuasive argument.

A treasury executive from a major technology company explained her firm’s challenges and the benefits of implementing C2FO’s DD platform at a recent NeuGroup meeting sponsored by the Kansas City-based fintech.

The biggest challenge. The member said that aligning top executives internally was probably the most time-consuming aspect of the adoption, noting that there were multiple areas and teams impacted whose cooperation was critical. Besides the initial IT investment, the implementation required changing the company’s procurement and accounts payable processes.

  • The assessment and ultimately the recommendation to adopt C2FO were made by an executive committee comprising representatives from finance, treasury, IT, supply chain, procurement, and credit and collection. Ultimately the company’s CFO signed off on the project.

Three choices. The company considered employing the traditional discounting model, in which vendors receiving early payment within a certain number of days would accept a specified discount. Also contemplated: a sliding-scale model that tied the discount percentage to how many days early the vendors were paid.

  • Those approaches typically require extensive negotiations with suppliers and allow limited flexibility. The company chose the dynamic-discounting model, which lets it define the amount and timing of cash it deploys into the program and enables vendors to bid on the discount percentage they are willing to provide.

Smoothing out cash flows. The flexibility of the C2FO platform allows the company to better manage its cash flows, making the model especially attractive given the transactional, potentially volatile nature of the company’s business.

Benefits across the company. Treasury’s DD benefits include a risk-free investment opportunity, optimizing working capital and payment-term extensions. In addition to being a tool highly leveraged by treasury, there were benefits in other areas too:

  • Procurement: Stronger supplier relationships; standardized processes and payments; no more negotiating one-off discount terms.
  • IT: Minimal support required; a secure SaaS platform; easy user experience with minimal training; operations on multiple ERP systems.
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Antony Michels
In Capital Allocation, Capital Markets

Share Repurchases: Don’t Wait for the Sell-off

The case for spending all (or almost all) the cash allocated to buybacks right away.

Monday’s stock market sell-off provides an opportunity to revist an insight on stock buybacks from a NeuGroup meeting last spring: A risk management expert at Deutsche Bank argued that waiting for dips is not the most effective way to repurchase shares. That’s worth considering given that many companies only buy back their stock when the price dips below what they consider its intrinsic value.

The case for spending all (or almost all) the cash allocated to buybacks right away.

Monday’s stock market sell-off provides an opportunity to revist an insight on stock buybacks from a NeuGroup meeting last spring: A risk management expert at Deutsche Bank argued that waiting for dips is not the most effective way to repurchase shares. That’s worth considering given that many companies only buy back their stock when the price dips below what they consider its intrinsic value.

Danger in waiting. Research by Deutsche Bank suggests that for almost all sectors, more shares are repurchased (at a lower price per share) if companies buy as soon as cash becomes available instead of waiting until the stock declines.

“Management is notoriously optimistic about its undervaluation,” the Deutsche Bank expert said. But given the commitment companies make to repurchase shares, they have to buy them back eventually, even the dip never comes, he said. “So the danger is waiting.”

Methodology. The back-testing research assumes that if the required dip does not occur after one year, the company starts spending incremental cash flow on share repurchases because “we assume that no more than one year of cash flow can be retained,” the banker said.

Dollar cost averaging. In simple terms, the problem with spreading out buybacks over a longer period of time is that stock prices have risen over the long term, the banker said. And while dollar cost averaging makes sense on an emotional level, “It’s best to spend the money as soon as it’s available.” The one caveat, he added, is that it’s smart for companies to have a liquidity reserve in case of severe downturns.

Buyback ups and downs. S&P Dow Jones Indices in December reported that share buybacks for S&P 500 companies reached $175.9 billion in the third quarter of 2019, 6.3% higher than Q2 2019, 13.7% lower than Q3 2018, and 21.1% lower than the $223 billion record set in Q4 2018. Numbers for Q4 2019 aren’t available but S&P says most estimates call for $189 billion.

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Antony Michels
In Capital Markets, ESG, Risk Management, Senior Executive, Uncategorized

Activist Investors Who Care About More Than One Kind of Green

Founder’s Edition, by Joseph Neu

Takeaways from a fireside chat with ValueAct founder Jeffrey Ubben.

Based on a head’s up from a top Wall Street activist defense adviser, I went to an event earlier this month hosted by Refinitiv and Reuters Breakingviews that featured a fireside chat with ValueAct co-founder Jeffrey Ubben. Mr. Ubben has stopped trying to increase his net worth and is now focused on making the world a better place (at least according to his worldview). One of the vehicles for him to do this is the ValueAct Spring Fund launched in 2018, which invests in companies aiming to address environmental and social problems.

Founder’s Edition, by Joseph Neu

Takeaways from a fireside chat with ValueAct founder Jeffrey Ubben.

Based on a head’s up from a top Wall Street activist defense adviser, I went to an event earlier this month hosted by Refinitiv and Reuters Breakingviews that featured a fireside chat with ValueAct co-founder Jeffrey Ubben. Mr. Ubben has stopped trying to increase his net worth and is now focused on making the world a better place (at least according to his worldview). One of the vehicles for him to do this is the ValueAct Spring Fund launched in 2018, which invests in companies aiming to address environmental and social problems.

  • Inspired by Silent Spring. According to Ubben, the Spring Fund name was inspired by the Rachel Carson environmental science book published in 1962.
  • What makes the fund unique. It’s run by one of the leading activist investors at a firm with $16 billion under management that’s famous for, among other thing, forcing its way onto the board of Microsoft, proving mega-caps were not off limits. “It takes a profit maximizer to know a profit maximizer,” Mr. Ubben said. Bringing an activist mindset to an environmental and social investment mandate has appeal, and Mr. Ubben has raised $1 billion in capital so far.

Here are some key insights from Mr. Ubben:

  • Larry Fink’s letter ups the ante substantially. BlackRock Chairman and CEO Larry Fink’s latest annual letter to CEOs ups the ante on sustainability, calling for “a fundamental reshaping of finance.”
  • Building on multi-stakeholder and corporate purpose mandates. Climate risk as investment risk and putting sustainability at the center of investment mandates may be the most powerful driver of the multi-stakeholder, corporate purpose mandate that Mr. Fink helped usher into modern thinking in his earlier letter.
  • Sustainability is a way to get the long term back. The constituency to support sustainability includes at least two-thirds of CEOs who see it as a way to win back a long-term view from shareholders—give me more than a quarter to reallocate capital to save the world before showing returns on that investment. There are probably one-third of those that are really driven to save the world.
  • Profit maximization over decades. To make the case for profit-driven investment in sustainability, investors need to understand that the time frames must extend 30 to 40 years. Decisions made based on current values, versus terminal values, will lead to investments that will destroy capital over the next generation. They are not conducive to long-term profits.
  • Change the investor base. Thus, companies that want to embrace sustainability and long-term profitability in their corporate purpose need to move toward investors who share that purpose.
  •  This is the window to move. Not only is more research convincing more people to believe in climate risk and the need for action, but the cost of capital in the current lower-for-longer interest rate environment is conducive to making new investments and reallocating capital. As Mr. Ubben notes, we have moved from the traditional situation of being short financing to being short human, social and environmental capital.
  • The effort is capital intensive. Ultimately, the transition to sustainability will be capital intensive. Such a capital-intensive effort will require the capital structures of existing large companies. For this reason, Mr. Ubben is not a fan of villanization.
  • Big Oil capital budgets needed.  One of his investments is in Nikola Motor, for example, which is developing hydrogen fuel cells for long-haul trucking.  To move to this future, there needs to be substantial capital invested in refueling platforms and distribution. “We will need the capital budgets of a Shell or a BP to do this over the next 30 to 40 years,” he said.
  • Shifting value propositions. While shifting to long-term value propositions is one necessity for the fundamental reshaping of capitalist economies, another is a change in perception of value and unit economics. As an example, Mr. Ubben said that if biodiesel becomes mainstream, it would make sense for McDonald’s to pay customers to order french fries to generate more used frying oil to convert into fuel.
  • Utilities need pristine governance.  The grid is the most important asset in the energy economy, including a clean energy one. So it’s imperative that utilities embrace a multi-stakeholder model and adopt the best possible governance. If customers have no choice but to be utility customers, then the economy must rely on regulators and government to sustain their ESG viability. This drives Mr. Ubben’s activist investment in Hawaiian Electric Industries and his calls for a management shake-up. He favors performance-based ratemaking for utilities, encouraging them to become asset light and deploy micro grids.

Ultimately, it’s impossible to know if green activist investors like Mr. Ubben are motivated mostly by a philanthropic desire to fix a system they helped create and make capitalism work for society, or are using the increasing embrace of ESG to profit from green activism. It’s probably a bit of each. Regardless, finance professionals at multinationals have no choice but to pay attention and take action.

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Ted Howard
In Technology, Treasury Management

Do You Need Outside Help for TMS Implementation? Maybe

Consultants can help TMS implementations, but practitioners retain some skepticism.

Implementing treasury management systems (TMS) is an arduous and complicated task that can benefit significantly from outside expertise but maintaining a skeptical eye can optimize the outcome.

Consultants can help TMS implementations, but practitioners retain some skepticism.

Implementing treasury management systems (TMS) is an arduous and complicated task that can benefit significantly from outside expertise but maintaining a skeptical eye can optimize the outcome.

ATLG members who had implemented TMSs expressed horror at the notion of returning to Excel spreadsheets. Nevertheless, TMS vendor consolidation and other factors have worsened already sketchy vendor support services, increasing the need for outside help and expertise. The peer group of assistant treasurers exchanged insights on how to best go about that:

Self-implementation is best. A member considering a new TMS said that while he’s comfortable using consultants on the front end to analyze current processes and potential treasury transformation opportunities as well as the RFP process, he and his team are debating whether to lean on outside resources to help with implementation. Another assistant treasurer (AT), whose experience included installing four TMSs, recommended treasury implement as much as possible to best understand how the system works. Be prepared for vendors’ poor after-sale service.

Some exceptions. NeuGroup members generally agreed with that advice, although one participant said her team did use a consultant to implement SAP’s treasury module, since the vendor’s “mindset” tends to be focused on enterprise resource planning (ERP) systems rather than treasury.

Consulting on infrastructure. Consultants can be especially helpful in early-on TMS implementation decisions, specifically when it comes to setting up the TMS infrastructure–such as static data, including entity and account structures, naming conventions and a variety of other items that can be difficult to change. “Things you have to live with forever,” said Tracey Ferguson Knight of HighRadius, whose prior experience spans sales, consulting and implementation services at Reval and Thomson Reuters’ TMS division.

RFP consulting concerns. A few members noted consultants’ familiarity with the range of TMS options and which may fit a company best. Ms. Knight cautioned about using consultants to guide the RFP process, however, given that many of their practices increasingly rely implementing systems. “Some are better than others, but they’re likely, even if subconsciously, to steer you toward solutions they know better, where they can earn more business on the implementation,” she said.

Make no promises. If a consultant’s systems selection help is necessary, don’t make any promises or even discuss the possibility of implementation work, to avoid potential bias throughout the implantation process, Ms. Knight said.

Just advice, please. Ms. Knight agreed that treasury should perform the bulk of the implementation itself, noting that consultants’ greatest value is advising treasury on how the TMS system works and applies to the specific business. The consultants at vendors, especially quickly growing ones, however, often have recently been hired and may not understand how to best tailor the TMS to the client company’s business. A third-party consulting firm may be a better bet, but make sure their staff is indeed experienced, since they, too—especially the biggest consulting firms—frequently bring on new hires.

One obvious solution. A participant noted her firm simply decided to hire one consultant for the RFP and a different firm for the implementation. “We selected a different one for implementation in part for price but also independence,” she said.

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Ted Howard
In Capital Allocation, Insights Newsletter, Investment Management

What Would an AI-Driven Capital Allocation Look Like?

Perennial discussions of capital allocation tend to end up in essentially the same place.

My friend Tom Joyce at Deutsche Bank circulated the chart below last week in his “Chart of the Day” email. This one caught my eye because it shows how corporate uses of capital, at least at the S&P 500-company level, are pretty consistent year to year.

Founder’s Edition, by Joseph Neu

Perennial discussions of capital allocation tend to end up in essentially the same place.

My friend Tom Joyce at Deutsche Bank circulated the chart below last week in his “Chart of the Day” email. This one caught my eye because it shows how corporate uses of capital, at least at the S&P 500-company level, are pretty consistent year to year.

  • M&A and Buybacks. Tom calls out the changes: “During the current M&A upcycle, which began in late 2014, M&A has risen as a percentage of total corporate capital allocation. Since the passage of US tax reform in December 2017, incremental earnings benefits have been disproportionately allocated toward stock buybacks.”
  • Marginal differences. Still, should we get that excited about sub-5% average increase in share buybacks? A one year 10% increase in M&A capital allocations?

It seems to me like there’s not much innovation going on with capital allocation decisions. Set your capex need based on where your products are in their life cycle, opportunistically look at liability management, set aside for anticipated M&A and then debate the merits of dividends vs. buybacks in line with your capital return guidance. Essentially a monkey could do it.

Yet, capital allocation is a perennial top project and topic for treasurers in our network. I hate to guess how many hours are spent deliberating and supporting capital allocation decisions with analysis.

  • Thought bubble. What would an AI come up with if it were tasked to optimize the allocation of corporate capital? Especially if it were not constrained with all the commonly held conventions and assumptions about how it is being done now?

If anyone has let an algo or AI loose on their capital allocation, real or hypothetical, I would love to know what that looked like. Or if you are aware of research or solutions in this area, please ping me to connect.

Capital allocation is already on the agenda for at least one of our upcoming treasurer meetings. I’d enjoy shaking up the discussion with something new and relish getting into the weeds on dividends vs. buybacks and the rest, but not if the discussions always lead people back to the same place. 

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Antony Michels
In Regional, Senior Executive, Treasury Management

A High Bar: Lowering Corporate Expectations and Under-delivering Successfully

Slower economic growth, tighter consumer credit put pressure on finance chiefs in Asia.

The subdued mood among participants at the recent NeuGroup meeting of CFOs in Asia reflected the difficulty many members say they are facing as China’s economic growth slows and business conditions worsen, while expectations for revenue growth at corporate headquarters remain unrealistically high.

Slower economic growth and tighter consumer credit put pressure on finance chiefs in Asia.

The subdued mood among participants at a recent NeuGroup meeting of CFOs in Asia reflected the difficulty many members say they are facing as China’s economic growth slows and business conditions worsen, while expectations for revenue growth at corporate headquarters remain unrealistically high.

Managing expectations. The key challenge, then, for some members is managing the expectations of those in the C-Suite who still want 10% revenue growth. In other words, CFOs and their teams need to figure out how to successfully under-deliver. This topic—and how to deal with failure—will be discussed at the group’s next meeting in April in Shanghai (email us about your eligibility to attend).

Tighter belts. Dealing with the fallout from lower production has meant implementing cost-cutting initiatives, and some members expect the challenging business climate and the need for belt-tightening to last three to five years.

Pressure to produce. As demand slows, members say Chinese authorities are exerting pressure on corporates to build inventory to reduce the impact on the economy and keep employment high. Much of this pressure is indirect, through so-called window guidance, which is a part of life in China and the way government agencies influence corporate behavior with unwritten rules.

Credit, not tariffs. Although trade tensions between the US and China have added to the region’s challenges, the tightening of consumer credit in China ranked as a more serious concern for many participants, based on comments during the projects and priorities session at the meeting.

  • Other concerns mentioned at the meeting include complying with China’s corporate social credit system and the wide-ranging reform of the country’s individual income tax that has implications for corporates.

Hope for the future. Members remain bullish on the long-term business prospects in China, thanks in part to the country’s population of 1.4 billion. But for now the pressure is on, and some members are searching for ways to reduce the stress. How else to explain why one finance team has created a “S— Happens Award?”

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Antony Michels
In Compliance, Regional, Senior Executive, Tax

What China’s Individual Income Tax Changes Mean for Corporates, Expats

CFOs with employees in the country need to plan for new residency rules and ensure compliance.

The most significant reform of China’s individual income tax (IIT) laws in 38 years has numerous implications for foreign workers and the multinational corporations that employ them. Michelle Zhou, a partner at KPMG, presented many of the critical elements of the changes to a group of CFOs at a recent NeuGroup meeting in Shanghai.

CFOs with employees in the country need to plan for new residency rules and ensure compliance.

The most significant reform of China’s individual income tax (IIT) laws in 38 years has numerous implications for foreign workers and the multinational corporations that employ them. Michelle Zhou, a partner at KPMG, presented many of the critical elements of the changes to a group of CFOs at a recent NeuGroup meeting in Shanghai.

Big picture. CFOs—who are responsible for income reporting—need to proactively dig into the details of the changes with tax advisors and coordinate closely with human resources departments to develop retention policies that address the potentially negative financial effects the new rules may have for some employees. These include changes in the treatment of annual bonuses and equity incentives—although not all details have been announced.

Defining residency. High on the list of takeaways is that an individual who lives in China for 183 days or more will now be considered a tax resident, instead of one year under the old rules. This has implications for whether the employee pays tax only on income sourced in China or on all of her worldwide income.
• A new “six-year rule” replaces the old five-year concession rule. Under the old policy, if a foreign worker stayed in China for five consecutive years, her worldwide income would be taxed in China. The new law extends the period to six years, allowing foreign workers in China more time to avoid paying taxes on income sourced overseas.
o Under the new rules, if the person leaves mainland China for more than 30 consecutive days at any point during the six years, the clock to count tax residency will be reset.

Tax-exempt benefits vs. itemized deductions. The new law allows foreign workers to take advantage of several new itemized deductions limited to specified amounts:
• Children’s education.
• Further education.
• Mortgage interest or housing rent
• Medical fees for serious illness.
• Elderly care.

Foreign workers who don’t take the deductions listed above can continue use tax-exempt benefits until the end of 2021 by claiming allowances of a “reasonable amount” for children’s education, language training fees, housing rental, home leave visits, relocation expenses, and meal and laundry expenses. Corporates need to make sure employees are aware of the choice and the pros and cons of their decision.

Greater Bay Area preferential tax policy. To attract highly skilled workers to a number of cities in Guangdong province, China is providing them with the incentive of an effective tax rate of 15% via a tax subsidy. The policy is effective until the end of 2023.

CFO checklist. KPMG identified several areas that fall within the CFO’s purview that require action:
• Review tax budgets and plans for the new IIT system, including interaction with payroll.
• Review compliance and implement robust policies and processes to mitigate risks; prepare for tax audit.
• Review the company’s obligation to employees, offer training on annual tax filing; work with HR on retention.
• Examine how the new rules affect business traveler risks.

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Antony Michels
In Compliance, Regional, Senior Executive, Tax, Uncategorized

China’s Corporate Social Credit System: What Corporates Need to Know and Do Now

The implications and challenges for corporates facing a new world of ratings.

Full implementation of China’s corporate social credit system (SCS) is slated for the end of 2020—a reality with huge implications for multinationals doing business in the country. And that means more work for many CFOs and finance teams. • CFOs are often in charge of coordinating the final reporting of data provided by multiple areas of the company and ensuring there is no conflicting information. They’re also responsible for updates, the remediation of incorrect or invalid reporting, and follow-up with various agencies. It’s a huge job. Members of the NeuGroup’s Asia CFOs’ Peer Group got a helpful reality check on what corporate social credit ratings mean for them during a recent presentation by Björn Conrad, CEO of the China consulting firm Sinolytics.

The implications and challenges for corporates facing a new world of ratings.

Full implementation of China’s corporate social credit system (SCS) is slated for the end of 2020—a reality with huge implications for multinationals doing business in the country. And that means more work for many CFOs and finance teams.

  • CFOs are often in charge of coordinating the final reporting of data provided by multiple areas of the company and ensuring there is no conflicting information. They’re also responsible for updates, the remediation of incorrect or invalid reporting, and follow-up with various agencies. It’s a huge job.

Members of the NeuGroup’s Asia CFOs’ Peer Group got a helpful reality check on what corporate social credit ratings mean for them during a recent presentation by Björn Conrad, CEO of the China consulting firm Sinolytics.

The presentation included information from a study published in 2019 by Sinolytics and commissioned by the European Chamber of Commerce. In it, Chamber president Jörg Wuttke writes, “For better or worse, China’s corporate SCS is here to stay and businesses in China need to prepare for the consequences, and they need to start now.”

The good news. It’s not too late to prepare. Sinolytics says “implementation gaps” will give companies time to make the necessary internal adjustments to manage their regulatory ratings and engage with government authorities on concerns, but notes that inquiries need to be detailed, concrete and technically precise. Corporate leaders need to:

  1. Understand exactly what the system requires from the business.
  2. Assess where their company stands regarding the requirements—and identify gaps.
  3. Design and implement effective internal adjustments.
  4. Continuously monitor further developments of the corporate SCS.

Hard facts. The corporate SCS assesses the behavior of companies through topic-specific regulatory ratings (e.g., tax, customs, environmental protection and product quality) and a parallel set of compliance records (e.g., anti-monopoly cases, data transfers, pricing and licenses). These ratings will be made public, meaning a company’s customers, suppliers and competitors will have access to information that may cause data privacy issues that are not yet resolved.

Sinolytics says:

  • The system covers virtually all aspects of a company’s business in China. A multinational is subject to approximately 30 different regulatory ratings—many industry-specific— and compliance records, most of which have already been implemented.
  • Each rating is computed based on a set of rating requirements. In total, an MNC can expect to be rated against approximately 300 such requirements.
  • Some requirements create strategic challenges for companies, including those relating to the behavior of business partners such as suppliers and service providers. This burdens companies with the responsibility of monitoring their partners’ trustworthiness.
  • The corporate SCS uses real-time monitoring and processing systems to collect and interpret big data, which allows immediate detection of compliance and determines a company’s social credit score.

Ratings reality. Sinolytics says algorithm-based ratings of companies will have direct consequences after the collected data is processed and rated against the defined requirements. A good rating leads to rewards and a negative performance is sanctioned.

  • Carrot: High corporate SCS scores can mean fewer audits (e.g., taxes, safety), better credit conditions, easier market access and more public procurement opportunities for corporates.
  • Stick: Low scores mean the opposite of the above, and for every negative rating, there’s already a set of sanctions in place, Sinolytics says.
    • Sanctions include penalty fees, court orders, higher inspection rates, targeted audits, restricted issuance of government approvals (e.g., land-use rights and investment permits), exclusion from preferential policies (e.g., subsidies and tax rebates), restrictions from public procurement, as well as public blaming and shaming. And don’t forget blacklisting. Sanctions can even personally affect the legal representative and key personnel of a company.

Will the system create a more level playing field?

Sinolytics says yes—in principle. “The requirements and consequences of the Corporate SCS apply to all companies registered in China, regardless of ownership structure. This might in fact translate into an advantage for international companies vis-à-vis their Chinese competitors, as many international companies feature more advanced internal compliance structures,” the study says. However, Sinolytics has these caveats:

  • The field may be more level but the game played on it will be more difficult and controlled than before.
  • The system has the potential for discriminatory use toward international companies as there is no guarantee that the ratings cannot be applied in a biased way, targeting specific companies with greater scrutiny.
  • Some of the rating requirements apply to all market participants but are more difficult for international companies to fulfill. “This appears to be the case for the State Administration for Market Regulation’s blacklisting mechanism for ‘heavily distrusted entities,’ which makes the SCS useable in trade conflicts.”
  • Chinese companies might have an advantage in navigating the intricacies of the system, and that’s potentially enhanced by better information flows from government authorities.
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Antony Michels
In Capital Markets, Treasury Management

Love It or Hate It, ESG Is a Key Theme for 2020

Reasons you can’t afford to leave ESG off your priority list.

ESG and related themes of sustainability and green finance are polarizing. Nearly everyone sits on a spectrum where one end thinks it’s all a bunch of hooey and the other argues it’s the key driver of finance for the next decade. Personally, I feel conflicted—one reason ESG didn’t make my initial list of key 2020 issues.

Founder’s Edition, by Joseph Neu

Reasons you can’t afford to leave ESG off your priority list.

ESG and related themes of sustainability and green finance are polarizing. Nearly everyone sits on a spectrum where one end thinks it’s all a bunch of hooey and the other argues it’s the key driver of finance for the next decade. Personally, I feel conflicted—one reason ESG didn’t make my initial list of key 2020 issues.

Mixed feelings aside, I’m convinced the decade ahead is a time to take ESG and all it brings with it seriously. As I noted in an earlier post on green finance, there’s a “tsunami” of sustainability-linked finance products coming, as a member treasurer at one company leading the way put it.

Skeptics coming around. A top M&A and activist advisor at a leading Wall Street firm confirms that even investment banking skeptics have come around to ESG and green finance being a key consideration. “We didn’t really take it that seriously until about six months ago,” he said. “Yet now it’s a strategic priority for the bank, with an executive level committee dedicated to ESG and related opportunities.”

M&A options. More specifically, ESG has opened up a lot of new thinking about what deals might win regulatory approval and political backing when presented through a sustainability lens. The advisor also said that the financing for an acquisition can be structured more favorably now if you look at sustainability finance options.

Activism. ESG was once viewed primarily as a tool for activists looking, for example, to pry open a seat on the board. Now it’s become a guiding strategy in and of itself. Look at Jeffrey Ubben’s ValueAct Spring Fund, which invests in companies aiming to address environmental and social problems. Mr. Ubben represents a new breed of ESG investors who, having made a fortune as activist investors, are now trying to make the world a better place by using their knowledge and experience—not to mention their activist aggressiveness.

Board focus. For these reasons and others, boards are also focused on ESG, so it makes sense for corporate leadership to focus on it, too. According to a recent Deloitte white paper on 2020 board agendas, “Perhaps the most dramatic development―or, rather, series of developments―that boards may need to consider in 2020 is the intense focus on the role of the corporation in society.” This includes “social purpose” but also “concerns about persistent economic inequality, climate change, and the availability and cost of healthcare, as well as concerns about the ability of governments to address these and other issues.”

Investors, workers. As a result, the paper says, ESG “has also garnered the attention of investors and others, who are increasingly asking whether and how companies are affecting and affected by environmental and social developments.” Employees are also asking. “The rise of employee activism during 2019, with actions such as work stoppages and shareholder proposals, has increased the stakes in these and other areas.”

Disclosures. Risks tend to be taken more seriously when they are disclosed prominently in public financial statements. As Deloitte notes, “Companies are being called upon by investors and others to provide disclosures concerning the ESG challenges they face and how they address those challenges.” One driver is “the rise of third parties―including so-called ‘rankers and raters’―who comment on companies’ efforts in this area, making it important for companies to tell their stories rather than let someone else do so.”

Storytelling. As more observers are noting, ESG-driven investing of corporate cash, 401(k) and pension plans, as well as corporate venture funds and M&A efforts by biz dev teams, are relatively cost effective ways to help companies tell this story. Sustainability-linked finance, given its embrace by key market participants, may be an even better way to do this. But whatever you do, put ESG on your 2020 priority list.

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Ted Howard
In Treasury Management

Making Better Use of Data to Manage Risk

Cognitive risk sensing identifying and mitigating risk into dynamic process.

Cognitive risk sensing (CRS) is said to be the next frontier in terms of analyzing risk and addressing it in a dynamic fashion. But the approach, which should be especially helpful for internal audit (IA) and other risk functions, is still in its infancy for most organizations.

Cognitive risk sensing identifying and mitigating risk into dynamic process.

Cognitive risk sensing (CRS) is said to be the next frontier in terms of analyzing risk and addressing it in a dynamic fashion. But the approach, which should be especially helpful for internal audit (IA) and other risk functions, is still in its infancy for most organizations.

Neil White, risk and financial advisory principal and global internal audit analytics leader at Deloitte, said organizations have used structured data from areas such as operations and human capital to judge risk, often very effectively. However, such analysis tends to be backward looking.

Outside in. More recently, companies have started to tap unstructured data from outside the organization, an approach that has been used for some time in areas such as marketing and sales. But now is being applied to risk. Essentially that means pulling vast quantities of that data together from social media and other media sources, often using third-party aggregators. Quickly evolving technology such as natural language processing, machine learning and other forms of artificial intelligence now enables the analysis of that data that wasn’t possible before.

Room for growth. CRS is being applied by a still relatively small percentage of companies, according to a recent survey of C-suite ad other executives conducted by Deloitte. Just over 25.4% said their organizations collect and analyze external, open-source data as part of an IA function, and only 5.3% said they’re using it across the organization, with 30.6% saying they’re lagging.

Many of those companies using CRS today are likely in the financial services industry, which Mr. White said has been ahead of the game, adding Deloitte is also working with organizations in the healthcare and consumer-products space. A financial services firm, for example, can collect open-source and unstructured data about regulatory, technology and other issues impacting competitors, and using that information to determine how it, too, may be impacted.

Intelligent ML. “Now we’re starting to see risk insight being drawn from external data sources, with more intelligent ML learning models, resulting in a more resilient organization that can respond more quickly to those risks,” Mr. White said.

Since ML and similar technologies are more readily available and understood, Mr. White said. “We’re starting to see those applications into other parts of the risk world.”

For example, in the supply chain, domain specialists will use CRS for forward-looking insights to identify the potential commodities shortages in key markets or supply chain disrupted due to labor. “A large food distribution company using this for a more forward looking view on whether there will be disruptions to the underlying ingredients that go into those food products,” he said, adding that Deloitte is working with a medical device company using this approach to monitor potential risks in 14 different domains.

“It’s the first time we’re moving into a more forward-looking risk world and not relying entirely on the human knowledge within the organization,” Mr. White said, “And to me that’s what’s really exciting about this.

Dynamic response. He added that especially exciting is CRS enabling IA to get closer to the concept of real-time assurance, which, helps IA move a little closer to the genesis of the risk and respond more dynamically and provide more timely assurance.

“So it’s not just about a tool to peek over the horizon. Those companies who are doing CRS well are changing their entire risk response process and how they align talent, increasing the regularity with which they refresh their risk register and updating audit plans,” Mr. White said.

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Antony Michels
In Insurance, Treasury Management, Uncategorized

Rising Insurance Premiums Inflict Pain, Require Pushback

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

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

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

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

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

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

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

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

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

  • Global commercial insurance prices rose by 7.8% in the third quarter of 2019, the eighth consecutive quarter of price increases. The third-quarter rise in pricing was the largest year-over-year increase in the index since its inception in 2012.
  • In the US, financial and professional (FinPro) liability pricing increased by 11%, driven by directors and officers (D&O) pricing. “Factors contributing to the market firming include increased litigation with event-driven lawsuits expanding to areas such as #MeToo, cyber breaches social media and safety,” Marsh said. Cyber insurance pricing increased by nearly 3%.
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Antony Michels
In Capital Allocation, Capital Markets, Cash & Working Capital

The Art—Not Science—of Matching Capital Allocation to the Situation

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

This cash flow-based model approach involves:

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

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Ted Howard
In NeuGroup News, Technology, Treasury Management

Reimagining the Finance Future in 2020

Founder’s Edition, by Joseph Neu

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

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

Founder’s Edition, by Joseph Neu

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

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

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

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

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

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Ted Howard
In Accounting & Disclosure, Compliance, Treasury Management

CECL Important for Nonfinancial Companies, Too

Nonfinancial corporates extending credit must also prepare for CECL.

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

 

Nonfinancial corporates extending credit must also prepare for CECL.

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

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

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

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

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

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

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

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

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

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Ted Howard
In Functional, Treasury Management

Corporate Finance Ranks Most Concerned About 2020 Risks

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

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

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

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

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

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

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

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

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

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

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

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

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