Corporate treasurers may have been spoilt in the immediate aftermath of the global financial crisis, with low interest rates and rising asset prices ensuring that financing remained cheap and accessible for an extended period. As quantitative easing (QE) gives way to quantitative tightening (QT), treasury management is becoming increasingly challenging.
In contrast to previous cycles, however, this challenge has been complicated in the recent past by unprecedented geopolitical uncertainty. In Europe, Brexit and the political and economic turmoil in Italy has generated extreme uncertainty across financial markets. Globally, meanwhile, the menace of heightened protectionism and trade wars against the backdrop of rising interest rates in the US has also driven volatility in foreign exchange markets. It has also fuelled instability in the equity and fixed income space in developed as well as emerging markets.
This has already had a measurable impact on the treasury operations of companies across the world that have been inadequately prepared for heightened currency volatility. In a recent HSBC Risk Management Survey, 70 per cent of CFOs report that their company has been hit by unhedged FX exposures in the past two years that could have been avoided. Vulnerability to FX volatility has by no means been confined to UK corporates exposed to the turmoil occasioned by Brexit. “Because our footprint is so global, the 200 CFOs and 300 treasurers who we interviewed for our survey were distributed across the Americas, Asia and Europe,” explains Michael Anthony, Managing Director of Global Thought Leadership, Corporate Risk Solutions at HSBC. “This dispels the idea that this is a challenge driven solely by Brexit.”
This view is supported by a geographical breakdown of responses to the survey, which suggests that treasurers in Asia are more vulnerable to FX volatility than those in Europe. Perhaps surprisingly, more than three quarters (78 per cent) of respondents from the Asia-Pacific region reported that they had been negatively impacted by FX risk that could have been mitigated over the last two years, compared with 67 per cent in the Americas and 65 per cent in Europe, the Middle East and Africa (EMEA).
Anthony adds that another notable by-product of elevated turmoil is that financial risk fuelled by currency and interest rate volatility is becoming inescapably interwoven with commercial risk. In other words, the competitiveness of longstanding business models may be at risk of erosion from cost pressures driven by adverse geopolitical trends. As Anthony says, today’s is a fast-moving global environment in which performance is generally measured on a quarterly basis. This is a backdrop against which few CFOs have the luxury of waiting several years to assess how their business models may be affected by Brexit, for example, or trade frictions between the US and China.
Interconnections between Commercial and Financial Risk
Anthony points out that a number of banks have already responded to the Brexit uncertainty on a proactive basis by strengthening their presence in financial centres such as Luxembourg and Dublin. In the global corporate sector, meanwhile, Harley-Davidson is a notable example of a company which has accelerated the relocation of some of its production facilities in response to the threat of rising tariffs.
These decisions, none of which are likely to be taken lightly by CFOs, mean that it is essential that corporates adopt an integrated approach to risk management. This recognises the interconnectedness between key elements ranging from funding decisions to M&A, industrial production strategies and so-called financial plumbing, such as cash-pooling.
The fact that treasury management plays a pivotal role in this interconnectedness is one of the more striking conclusions of HSBC’s survey. This finds that 87 per cent of CFOs of larger companies with annual revenues in excess of USD5 billion say that their treasury plays a key role in strategic decision-making.
Equally striking, however, is the number of CFOs who have recognised that they need more support in ensuring that their treasuries are sufficiently equipped to play this role. A little over half (58 per cent) report that they have “complete confidence” that their treasury department has all the skills necessary to shoulder this responsibility. Well over a third of treasurers (38 per cent), meanwhile, indicate that risk management is the area in which they are most in need of developing further expertise.
Solid Foundations based on detailed Analytics
HSBC’s Thought Leadership practice is well-positioned to respond to this requirement, using its analytical expertise to help its corporate clients build the solid foundations required to safeguard against geopolitical and financial risk. Anthony explains that this process begins with risk discovery and risk quantification, aimed at giving CFOs and treasurers enhanced visibility on the efficiency of their capital structure and ensuring that their key performance indicators (KPIs) are consistent with their short and long-term goals.
As an example, Anthony points to the importance of analysing a company’s capital structure from a holistic perspective. “We measure the efficiency of a company’s capital structure as a whole by looking at volatility of earnings and debt from a currency and financing perspective, in order to identify where risk is being created and where it is being mitigated,” he says. This is not a simple one to one matching exercise. Analysis of volatility, correlation and accounting all has to be taken into account. It also has to be modelled for the current as well as the projected situation.
The Value of Benchmarking
Fundamental to risk discovery and quantification for corporates, says Anthony, is a process of benchmarking. This is a valuable way of helping CFOs to measure the efficiency of their treasury operations relative to their peers and competitors. Typically, this is based on an analysis of key variables such as volatility of cash flow, earnings and debt costs relative to those of companies in the same sector and with comparable credit ratings. “For example, a highly experienced corporate treasurer recently asked us to look into why his competitors appeared to have a lower ratio of interest expense to revenue than his company,” says Anthony. “So we undertook a historical decomposition of the company’s interest expenses based on a detailed analysis of factors such as the spread, timing and currency of each of its bond issues. This concluded that the reason its funding costs were higher than those of some similarly rated competitors was the result of differences in the way its balance sheet was managed.”
Filling a Need
Like many other teams, treasury is being asked to do more with less. Using the analysis that HSBC’s Thought Leadership provides fills a need that has not been resourced with the thinning of treasury teams. Anthony explains that HSBC’s Thought Leadership analytical output is often used as an objective way for CFOs and treasurers to validate or refine their risk management strategies and – if necessary – to align them with those of their competitors.
“We’re not a group that delivers execution strategies,” Anthony explains. “We identify risk parameters and provide guidance on risk quantification, but we don’t tell clients what products they should use. We are confident, however, that if we demonstrate a consistent track record of giving candid, unbiased and valuable analytics to clients, it will help strengthen their relationship with HSBC.”
Conclusion: ‘Set it and Forget’ it is no longer an Option
This advice, Anthony believes, is becoming increasingly valuable to CFOs, given the pressures that are being exerted on their time from a growing number of sources. “These days CFOs have many more responsibilities, such as M&A, cybersecurity and IT implementation,” he says. “Because they have less time to dedicate to treasury management, it is more important than ever that their treasury departments maximise their efficiency and work as a strategic partner.” It was in order to help treasuries to achieve this goal, says Anthony, that HSBC’s Thought Leadership group was set up two years ago. Setting the team up as a global unit gives greater input to its analysis and enables clients to access this advantage.
Geopolitical uncertainty is likely to compound volatility across financial markets for many years to come. As a result, Anthony believes that treasurers will need to adopt an increasingly dynamic approach to risk management in order to ensure that their capital structure has the robustness and flexibility it needs to respond to ever-changing external influences. “Because the world keeps changing, treasurers have to keep on measuring and adapting,” he says. “There is no longer any room for a ‘set it and forget it’ mentality.”