Trillions of US dollars need to start referencing SOFR, the Fed’s new overnight funding rate, very soon. Can the market handle it? Does it want to? Presentations at several NeuGroup meetings in the last few weeks have delved into those questions and the likely demise of Libor. 

In just a few short years – possibly by the end of 2021 – the London Interbank Offered Rate, otherwise known as Libor, may cease to exist. This means that almost $200 trillion linked to the tainted rate, things like derivatives, CDOs, student loans, structured products, adjusted-rate mortgages and the like, will need to be moved to the Fed’s Secured Overnight Financing Rate. 

It won’t be easy. At both recent NeuGroup FX Managers’ Peer Group meetings, members were told that the FCA might declare Libor as an unrepresentative benchmark, which means the FCA will no longer compel banks to submit Libor quotes. Then what? It’s all in the language of change, specifically, fallback language.

• Fallback language is a key transition element because it facilitates moving existing transactions priced over Libor to a new benchmark. The Fed and its ARRC, along with the International Swaps and Derivatives Association (ISDA), have both proposed such language, the latter in contracts for derivatives referencing Libor and other key interbank offering rates (IBOR). 
• By the way, ISDA’s proposal drew comments from 147 organizations, and according to association’s results published in December, only seven came from nonfinancial corporates. After that fallback language kicks in. 
• Good to know. About 95% of Libor contracts are for derivatives. 

Don’t let it get that far. Although fallback agreements are a good safety net, market players shouldn’t let it get to that point. The easiest solution is for all market participants to transition to the new rate before 2021. But it’s tough sell.

• Libor: breaking up is hard to do. “Here we are in September of 2019, and I would say that across our client base we really haven’t seen clients pulling away from Libor-based products in advance of the 2020-21 time frame with as much urgency as some have advocated for,” Andrew Little, managing director at Chatham Financial, said in a recent NeuGroup Bank Treasurers’ Peer Group webinar. “As a matter of fact, given the shape of the curve, we’ve seen some clients actually extend the duration of their Libor exposure well out to seven years, 10 years and beyond.“

Just what is SOFR? On one hand it’s a mouthful of Fed-speak. In reality, it’s an overnight, risk-free reference rate that correlates closely with other money market rates and is based on actual market transactions. So, it’s a repo rate, and thus backward looking (vs. the forward-looking Libor) and is calculated as a volume-weighted median of transaction-level tri-party repo data collected from the Bank of New York Mellon as well as GCF Repo transaction data and data on bilateral Treasury repo transactions cleared through FICC’s DVP service, which are obtained from DTCC. 

• The good news is that since SOFR is based on transactions that happened in the tri-party repo market, it’s not easily manipulated. The bad news is that it can be very volatile. During last week’s liquidity crunch, SOFR spiked to a record 5.25%, according to the Federal Reserve Bank of New York, yanked higher by borrowing rates for overnight repurchase agreements, or repos.

Still needs a spread component. Since SOFR is a collateralized or secured overnight rate and Libor is uncollateralized term rate reflective of bank credit, there needs to be some sort of credit spread to adjust for the basis between the two rates.

• At this point SOFR is too young to create a credit component. When it is more robust then a term rate can be developed, experts say. Regulators also don’t want SOFR to become the new Libor, i.e., a new tool for people to manipulate the market. This means it must be IOSCO compliant and have more of a track record. The International Organization of Securities Commissions published a set of standards for approved global benchmarks back in 2013.
• Chatham reports that there is a strong interest from the market to develop one soon, although the path forward is still unclear. “I think most of the [Libor-SOFR] conversation reduces in some way to the desire to replicate the time-varying credit spread that is inherent in Libor,” says Todd Cuppia, managing director at Chatham. That reality has increased the relevancy of what he calls the “alternative, alternative reference rates.” The two leading contenders are Ameribor and the ICE Bank Yield Index.
• Take comfort. For longer-dated Libor contracts, banks and the market may take some comfort from the fact that the historical spread method has already started to be priced into the forward curves. By that measure, “some may say that the transition is becoming priced in to the extent you believe that current basis markets and historical averages are going to be in range of what the different working groups have suggested, which was a multiyear average or median of those rates,” Mr. Cuppia said.
• “If you look at fed funds as a reasonable proxy for SOFR and you look at the basis between fed funds and Libor, you can see a pretty meaningful decline in those basis rates to what could be a fair representation of their historical average,” he said. “I believe that’s what could be guiding the thinking of those who are using those much longer-term Libor contracts relative to what their alternatives may be.”

No magical thinking, please. Don’t assume that there is a possibility that Libor is staying. Along with the FCA, both the SEC and Fed say that it is going away. Still even the Fed sees resistance (or futility of forcing the issue).

• “Tellingly, contracts referencing US dollar Libor, without robust fallback language, continue to be written,” the New York Fed’s John Williams said in a speech this summer. He acknowledged the shortcomings of SOFR and replacement benchmarks, but said, “don’t wait for term rates to get your house in order. Engage with this issue now and understand what it means for your operations.”

Perhaps the FCA, Fed and SEC take a lesson from Abraham Lincoln’s observation on a man and his pear tree. “A man watches his pear tree day after day, impatient for the ripening of the fruit. Let him attempt to force the process, and he may spoil both fruit and tree. But let him patiently wait, and the ripe pear at length falls into his lap.”

“Never put off till tomorrow what may be done day after tomorrow just as well.” 

That cheeky line from Mark Twain turns on its head conventional wisdom on taking action. It also might apply to how some treasury teams are approaching preparation for Libor’s demise. And there are other variations on the “what, me worry?” theme.

• One participant at a recent NeuGroup meeting of cash investment managers said, with a smile on her face, “We’re not worried about Libor; someone will figure it out. We haven’t taken any action.” She expects the company’s banks will clear the path to a smooth transition. 

A slightly different view of preparedness surfaced at a meeting last week of assistant treasurers:

• ATs appeared to be well-versed, if stuck in place, regarding regulators’ push to move away from Libor to the secured overnight funding rate (SOFR). Yes, treasury must understand the company’s Libor exposures and make sure there’s fallback language in those contracts. But otherwise, right now it’s a big waiting game with a shortage of to-dos. 
• Coincidentally, on the same day as the discussion, the Alternative Reference Rates Committee, charged with guiding the transition to SOFR for cash products, released a “practical implementation checklist” to implement the risk-free rate. Any takers?

Reasons to tell asset managers where they rank in the race against peers.

A discussion of asset manager scorecards at last week’s NeuGroup meeting on corporate cash investment management prompted the question of whether, during review meetings, you should tell external managers where they rank among peers on the performance metrics you track. In other words, should you reveal the results of the horse race to the horses?

• Share results and compare to peers. The consensus was that yes, treasury should provide the information on win, place, show and below—although no one reveals the names of other asset managers in the horse race. Most tell the asset manager across the table which line was theirs so they can see how they stack up against peers.

Why share the information? According to members, the reason to reveal the results is to show the asset manager where they are doing well, e.g., return performance, and perhaps not so well, e.g., customer service. 

• If the manager is a top performer, acknowledging that in the results table can motivate them to remain one, especially if they see where exactly others behind them stand (hopefully close). 
   
• But it really helps if you need to fire a manager. Where the ranking reveal is most helpful is when it comes time to dismiss a manager, which members noted can be a hard thing to do.
  • “If you’ve shown that the manager is underperforming over multiple performance review meetings, they kind of know it’s coming, and it makes it much easier to relay the news,” as one member noted. Plus, you have given them the opportunity to improve.

Track the information to share. While portfolio performance on total return and other hard data can be obtained via Bloomberg or Clearwater, members suggested using a customer relationship management (CRM) tool to track various, soft scorecard criteria, such as the number of visits with the asset manager. Sharing the information in the review meeting also forces treasury to justify and add context to the results. 

• A potential point of contention is if the manager was told not to invest in a certain name or names and that ends up affecting its result. Is it really fair to assess a manager’s performance if they are not given free rein within the mandate?

Beyond this stable. While this discussion applies to scorecards for external asset managers, the advice also serves for scoring any treasury relationship. So why not create scorecards for all those relationships—and then share the horse race results with everyone involved?

Efficient capital usage and building a cash culture to accurately forecast cash flow starts with building a model of how cash flows through your company.

With so much focus these days on transforming revenue models, finance teams also need to encourage their companies to build a model to better understand and improve visibility of how cash flows through the business—now and as it is transformed.

At a NeuGroup meeting last May, an AT member from a technology company shared her effort to model her firm’s cash flow. 

Why it matters. Here are three key reasons to build a master cash-flow model:

1. A company’s long-term cash-flow model forms the basis of its capital structure and supports the capital allocation and deployment planning process—i.e., efficient use of capital requires it. 
    
2. A model of firm cash flows can be a key educational tool to bolster the cash culture, shifting perspective from how earnings happen to free cash flow and how cash comes in and goes out. This perspective shift is exponentially enhanced if a firm discloses and provides guidance on cash flow to shareholders.
    
3. A master model can streamline and standardize existing cash forecasting methodologies to improve cash forecasting. 

What to ask for. When our member AT queried different departments about whether and what cash-flow models they used, she asked what each did (its objective), how they sourced data, and to whom and when their output was sent to the executive suite and board. For example:

• FP&A’s model was used to report the company’s P&L and cash position to the CFO; 
   
• Corporate strategy employed a long-range forecast to understand the impact of M&A and other strategic moves. 

A need to bring it all together. “So, the company had many forecast models, but they often disagreed with each other, frustrating management,” the AT said. “Now corporate treasury has ownership and can reconcile a lot of these models.”

What to deliver? The AT asked each of her firm’s cash-flow-model users about the level of granularity they expect from a central cash model, including the forecast’s range, whether they just need it at the parent-company level or stepping down to the regional or legal-entity level, and how often the cash-flow model should be updated.

• The result should not be a treasury model but a corporate model that can serve multiple constituencies and materially increase senior management’s confidence in its use to make important decisions.

Key Insight: There are too many pain points for treasury to establish a master cash-flow model for every part of a company on its own. Therefore, treasury, or whoever builds the master model, must share ownership of the inputs and outputs across corporate functions and levels—e.g., with FP&A—or incorporate these functions into a master cash operations function—expanding the scope of treasury in conjunction with FP&A, A/R and A/P. Shared responsibility for the model helps everyone share and learn about cash to build a cash culture.

How one treasurer gives banks in his revolver a share-of-wallet reality check. 

Banks that agree to commit capital to a multinational’s revolving credit facility expect treasury to reward them with other, more lucrative work, such as bond underwriting. So treasurers have to deal with complaints when some bankers, inevitably, are not satisfied with their share of the company’s wallet.

Ward off the whining. One large-cap treasurer told members at a recent NeuGroup meeting that his method for managing banker dissatisfaction around share-of-wallet issues is to clearly communicate to each bank what they can—and cannot—expect from his company in terms of banking services.

Five tiers, clear lines. The first two tiers of this member’s five-tier revolver consist of banks that have made the largest capital commitment to the credit facility.

The banks in these tiers can expect to be named active or passive book runners in any of the company’s bond deals and play leading roles in any M&A transactions. They also would conduct interest-rate hedging transactions.

Tiers three, four and five. Banks in the third tier may be named senior co-managers or passive book runners in a capital markets transaction. Banks in the fourth tier might play a role in a bond deal depending on the size of the transaction.

Tier five banks, which commit the least to the revolver, underwrite letters of credit and may be used for FX hedging and cash investments.

The bottom line. The treasurer says the benefit of being explicit about what each bank can expect is that it allows each bank to run its model and get an accurate picture of what it will likely make over the next five years.To help treasurers figure out what banks expect to earn, check out How Much Money Banks Expect to Make to Be in Your Credit Facility.

Founder’s Edition, by Joseph Neu

How finance leaders can keep their teams relevant as artificial intelligence transforms the world of work.

Jack Ma and Elon Musk created buzz last week debating at the World Artificial Intelligence Conference in Shanghai. And with Labor Day now behind us, this is a good time to think about how AI will change the work done by finance professionals.  

On the plus side, Mr. Ma, the Alibaba chairman and co-founder, claims AI will create more personal time:

• A 12-hour work week. With AI, people should work three days a week, four hours a day, according to Mr. Ma. “I think that because of artificial intelligence, people will have more time to enjoy being human beings,” he said. 

The danger, says Tesla and SpaceX CEO Elon Musk, is that AI may have no need for us:

• Smarter than humans. Mr. Musk said that the biggest problem with AI is that humans will not be able to keep up. “I think generally people underestimate the capability of AI – they sort of think it’s a smart human,” he said “But it’s going to be much more than that. It will be much smarter than the smartest human.”  

How quickly AI is taking over the finance function will be a topic for NeuGroup meetings this fall, as we examine   the future of finance talent and the role of AI in it. 

To help prepare, I turned to “Exponential Organizations,” a best-selling book by Salim Ismail, the founding executive director of Singularity University and co-founder and chairman of OpenExO, which connects professionals with organizations seeking exponential growth. He argues that companies that adopt certain key attributes will tap digitalization to grow their businesses exponentially, much like Moore’s Law drove microchips. 

• AI accounting and transaction management. Mr. Salim says AI will influence accounting and transaction activities to include automatic AP and AR, with software-enabling automatic reminders and payment, automatic tax management, and AI watching for errant behaviors in transaction flows.
   
• Everything is a transaction. But AI will not stay in the back office: “Note that pretty much everything in the modern world is a transaction, be it communications, social agreements, and, not least, commerce.”

So what will be left for humans to do? 

• Humans are needed for less logical, human pursuits.  As Jack Ma emphasized, AI is unsurpassable at things that have a logic to them, but humans may be needed for the things that don’t. Interacting with other people successfully (lovingly) is something that is often irrational and where we still work best. 

My thinking: If AI and other machine automation will give us more time to become more human, then we also will have more time to interact with one another and learn to do it better. As AI takes over more transactions, finance leaders should encourage their teams to engage in more human interactions and build skills based on what they learn in those exchanges—to ensure finance supports a broader human purpose. With that in mind, even as AI’s power grows, our work at NeuGroup—thankfully—has a future. 

Deutsche Bank explains what treasurers should know about APIs.

Even treasury professionals who know that API stands for application programming interface and that so-called open APIs have been touted as the future of payment technology may not really understand what an API is or why it matters for treasurers and their bankers. So a presentation by Deutsche Bank at NeuGroup’s Global Cash & Banking Group (GCBG) first-half meeting gave members both a refresher course and a deeper dive into APIs and why they should care about them.

Mega messengers. APIs enable one system to connect to another, acting like messengers, looping requests to one system and responses back to the originator. In many cases, APIs are being used to transmit information to and from bank portals. Deutsche Bank expects more than three-quarters of banks will have invested in API or open banking initiatives this year, pushing this technology further into the cash operations space.

Timing is ripe for treasury applications. Yes, APIs have been around for what seems like forever. But new regulations, better technology and a competitive landscape have all advanced the cause of using APIs to create faster, more efficient customer experiences. For treasury, this means more real-time payments and faster reconciliations. Additional benefits include payment tracking, push payments and “requests-to-pay,” various risk management features (i.e., counterparty verification and KYC data) and alternative payment methods (i.e., paying into a “wallet”).

Interoperability with SAP. The presenter said Deutsche Bank is working with SAP to create an app so services offered by the bank can be plugged into a corporate’s ERP/TMS. Apps are downloaded from a marketplace and installed on the ERP or made accessible from the ERP through the cloud. That lets clients work with Deutsche Bank directly within the ERP, allowing them to, for example, select invoices, pay automatically on the due date and track all payment flows for these invoices.

What’s next? One member indicated that SWIFT already uses APIs, so it feels as if she’s moving backwards if she sets up separate APIs with each of her banks. Deutsche Bank’s presenter was quick to point out that the flip side is that using bank APIs allows for faster, real-time communication across the board for better cash visibility. He stressed that BAI payment files will not change, just the communication surrounding the initiation and completion of payment.

Bye-bye bank portals? One member asked if Deutsche Bank saw the use of APIs eventually replacing direct use of banking portals and was, perhaps surprisingly, answered with a “yes!” The happy prospect of a possible future without bank portals ranked high on more than one member’s key takeaways from the meeting.