AFP GUIDE TO Assessing Today s Regulatory Reality€¦ · implications for corporate treasury practitioners. A similar piece of legislation (EMIR) has been introduced in the EU. Its

AFP® Guide to

Assessing Today’s Regulatory RealityGlobal Liquidity Guide Series

Issue 6Underwritten by

AFP GUIDE: Assessing Today’s Regulatory Reality

AFP, Association for Financial Professionals and the AFP logo are registered trademarks of the Association for Financial Professionals. © 9/13

AFP® GUIDE to

Assessing Today’s Regulatory RealityGlobal Liquidity Guide SeriesWelcome to AFP’s Liquidity Guide to Assessing Today’s Regulatory Reality.Global treasury operations are consistently being challenged with understanding the nature and impact of the regulatory environment in which that they operate. Keeping tabs on current and anticipated regulations can be a daunting task as final rules, cross-border implications and implementation timelines seem to shift and collide. In this, the final in a series of AFP Guides, Reval experts have helped outline six examples of regulatory developments that are exerting key pressures on corporate treasury operations.

1. Dodd-Frank2. Basel III3. FATCA/FBAR4. SEPA5. EU Financial Transactions Tax6. Money Market Reform.

ContentsIntroduction: Sources of Regulatory Pressure 1

Dodd–Frank End User Exemption Protocol 2 3

Basel III 7

FATCA/FBAR 10

SEPA 14

EU Financial Transactions Tax 18

Money Market Reform 20

Conclusion 23

“Keeping tabs on current and anticipated regulations can

be a daunting task…this guides outlines six examples of regulatory developments

that are exerting key pressures on corporate treasury operations.”

Jason Torgler, Reval


Return to

Contents

www.AFPonline.org ©2013 Association for Financial Professionals, Inc. All Rights Reserved

This guide systematically reviews each of these six regulations, providing:Summary – highlights of the regulation including an outline of significant compliance requirements;Impact – key takeaways on the effects on corporate treasury;Compliance – assessments addressing impact mitigation;Future-proofing – new changes within these regulatory areas and preparing for future directional change;Opportunities – ways that many of these regulations afford financial professionals the opportunity to review policies and procedures, resulting in incremental approval.

World-class treasury operations are currently taking five fundamental actions that best address regulatory awareness and compliance:

1. Securing treasury talent adept at understanding and putting measures in place to mitigate regulatory risk.

2. Implementing technology that provides visibility into regulatory risk and advises on compliance measures.

3. Setting a clear hedging strategy that accounts for current and anticipated regulatory compliance requirements.

4. Implementing tools to enhance visibility and exercise control over global bank accounts.

5. Reviewing short-term liquidity (borrowing and investing) strategies and ensuring alignment with regulations.

Corporates have many partners to leverage in the run-up to regulatory compliance. Banking, consulting and technology partners can serve as strong allies in analysis and deployment. Companies would do well to lean on them for insight and assistance.

Jason Torgler, Vice President, Corporate Strategy, Reval

DISCLAIMER: The material contained in this publication is not intended to be advice on any particular matter. No subscriber or other reader should act on the basis of any matter contained in this publication without considering appropriate professional advice. The publishers, author, third-party information providers, editors, and sponsor expressly disclaim all and any liability to any person, whether a purchaser of this publication or not, in respect of anything and of the consequences of anything done or omitted to be done by any such person in reliance upon the contents of this publication.

ACKNoWLEDGEMENTS: The author would like to thank the following subject matter experts at Reval for their help in the preparation of this guide: Justin Brimfield, Krishnan Iyengar, Tracey Ferguson Knight, Günther Peer and Pat Trozzo. The author would also like to thank Michal Kawski, Gazprom, and Sean Grace, Securitas, for providing valuable practitioner insight to some of the issues covered in this paper.

http://www.AFPonline.org

DO YOU SEE TREASURY CHANGE ON THE HORIZON?

if so, you may be wondering how future-proof your treasury is.

Staying ahead of challenges known today and those yet to be uncovered requires transparency into all aspects of cash, liquidity and risk. It requires a long-term vision that will enable treasury to work seamlessly across the enterprise regardless of function, location, time zone, now and in the future.

Leverage Reval’s all-in-one SaaS solution for Treasury and Risk Management for sustainable success. For today, tomorrow, for evolving treasury needs, the answer is Reval.

Your Strategy. Our Mission. | Visit www.reval.com/future-proof-treasury.

© 2013. All rights reserved. Reval ® is a registered trademark of Reval.com, Inc.

Is my companyexpanding intonew markets?

Will I be able to support our M&A growth initiatives?

How will I hedgecommodities

amid extreme volatility?

What if I need torestate our financialearnings?

What happens ifwe are impacted bya natural disaster?

Future-Proof-Print-Final.indd 1 5/22/2013 1:25:03 PM

http://www.reval.com/future-proof-treasury

www.AFPonline.org ©2013 Association for Financial Professionals, Inc. All Rights Reserved 1


Return to

Contents

Introduction: Sources of Regulatory PressureInternational corporate treasury practitioners are accustomed to managing different regulatory environments around the world. Regulations regarding certain activities are more onerous in some jurisdictions than in others. Changes of government do sometimes make a tremendous difference, but often this is overestimated as many regulatory changes take a while to prepare and then implement.

However, since the international credit crisis, triggered by the collapse of Lehman Brothers, there have been two main, and interrelated, pressures on regulation affecting corporate treasury practitioners.

The first is the understandable desire on the part of many governments to try to prevent any recurrence of 2008’s banking crisis and associated financial sector troubles. Legislators and regulators have focused on a range of institutions and practices, all of which have been blamed to greater or lesser extents for the recent difficulties in the global economy. of these, there are different elements:

■ Work to try to strengthen banks. Should the financial system again be subjected to a similar set of problems to those experienced in 2008, most governments would be unable to provide the same level of financial support for their banks. Accordingly, much legislative and regulatory time has been spent identifying ways of strengthening banks. This has been directed in two ways: first to reduce the risk of failure, by making banks stronger, and second to make clearer distinctions between banks, such that if one fails, there is a reduced risk of contagion to other banks.

■ Gain control over the ‘shadow banking system’. Regulators have also sought to try to reduce the impact on wider financial stability of the so-called shadow banking system (this phrase means different things to different people). Again the emphasis is

on reducing the risk of contagion – in this case, it has been focused on two things: first to understand derivative positions, and second to reduce the risk of a heavy redemption from one money market fund resulting in a run on all money market funds.

The second pressure is coming from governments that are trying to identify ways in which to protect their tax revenue streams. Government balance sheets have been affected by both the cost of supporting their domestic banks, and the effects on public expenditure of domestic and global recessions. As a result, governments are keen to reduce the incidence of tax avoidance and evasion. Governments have already been cooperating to combat money-laundering, and they are extending this process to share information to try to prevent organizations evading tax by keeping balances offshore in tax havens. More realistically, companies choose to keep balances in different locations for a range of operational and tax reasons, especially when governments seek to impose new or higher taxes.

Although the financial system’s recent difficulties have provided the incentive for governments and regulators to take action, some measures had already been taken to achieve these objectives. The first Basel capital accord was introduced in 1988; the Financial Action Task Force was established in 1989 to combat money laundering; the Single European Market was launched in the European Union (EU) in 1992. That said, there are some new areas of legislation and regulation which will have a significant impact on corporate treasury practitioners seeking to manage liquidity.

In this guide, we evaluate six regulations: the Dodd-Frank End User Exemption (and its EU equivalent, EMIR), Basel III, FATCA and FBAR, SEPA, the proposed EU Financial Transactions Tax, and Money Market Reform in the USA and the EU. In each case, the regulation is introduced, its impact on corporate treasury practitioners is described, and actions to comply with or mitigate the effects of each regulation are identified.




Return to

Contents

Timeline showing implemenTaTion of regulaTions

2013 2014 2015 2016 2017 2018 2019

fBar Live

faTCa Registration starts

Withholding starts Complete

Dodd-frank Starts end Sept

emir Implementation begins

eu fTT Implementation second half?

sepa Starts for eurozone countries

Starts for non-eurozone

countries

Basel iiiMinimum

total capital complete

Tier 1 capital completeLCR starts

NSFR starts Complete




Return to

Contents

Dodd-Frank End User Exemption Protocol 2overview of the regulation

While over-the-counter (oTC) derivatives were seen as a key feature in the instability of the banking system prior to 2008, regulators found taking action to rebuild the banking system difficult with the lack of transparency of derivative positions. In response, the Dodd-Frank Act requires all oTC derivatives to be cleared via an official central counterparty. This piece of legislation is designed to allow regulators to assess levels of systemic risk more effectively by virtue of greater transparency and visibility over financial institutions’ positions. However, some end users are exempt from the obligation to clear derivatives, provided they meet some specific requirements. This section explains these requirements and outlines the implications for corporate treasury practitioners. A similar piece of legislation (EMIR) has been introduced in the EU. Its implications are also outlined below.

implications for Corporate Treasury practitioners

The US regulator (the Commodity Futures Trading Commission – CFTC) has recognized that many companies enter into oTC derivatives for important economic reasons. For example, the use of a forward foreign exchange rate allows companies to fix input costs on imported goods, and interest rate swaps enable corporate treasury practitioners to limit the effects of any increase in interest rates. These examples show how derivatives can give companies greater certainty over costs, allowing them to price goods more competitively and to bid for future contracts with greater confidence.

The CFTC further recognized that any requirement for companies to clear oTC derivative transactions through a central clearing house would add cost to this risk management activity. This would result in a reduction in the availability of working capital for these companies, as they would be required to use cash for margin calls and collateral postings at the central clearing house.

As a result, the CFTC has allowed some end users to be excepted from the requirement to clear oTC transactions with a central clearing house. This exception applies as long as three requirements are met:

1. The end user cannot be a financial entity. This requirement includes almost all corporate treasury activity. However, some corporate treasury departments have to report transactions to the CFTC, although they remain exempt from the clearing requirement under Dodd-Frank. Entities which are not exempt from the reporting requirement include some in-house banks where the in-house bank centralizes market risk (i.e. interest rate and foreign exchange risk). In these cases, group subsidiaries deal with the in-house bank, which then nets and aggregates positions across the group before entering into one or more external derivatives transactions.

2. The derivatives transactions must only be used for strict hedging purposes or otherwise to mitigate financial risk. Under this requirement, corporate treasury practitioners using derivatives for other purposes would not be exempt from the requirement to both clear and report derivatives transactions (although the counterparty bank would probably be responsible for the reporting element). For example, companies investing short-term surplus cash in structured investments incorporating a derivative instrument would not be excepted from clearing and reporting the derivative. This would add cost to any structured investment instrument incorporating a derivative, making this potentially less attractive to the investor.

3. The end user must satisfy certain reporting requirements. To qualify for the exemption, a corporate treasury practitioner must complete the required documentation from the CFTC, and must maintain appropriate records and inform their bank(s) of their activities. Any changes must be advised to the CFTC in a similar manner.

Reporting requirements

If a derivative transaction does have to be reported (either to the CFTC or the Swaps Data




Return to

Contents

Repository – SDR), it will usually be submitted by the counterparty bank. only one party to each transaction is required to submit a report – usually the more financially complex organization. When reporting is required, a bank will report each transaction as it occurs. It will also provide regular updates of its outstanding aggregate positions.

Initially, all entities had to report internal derivatives transactions to the CFTC. However, on April 7, 2013, the CFTC released a statement which said that although such institutions still had to report transactions, it would not penalize any such corporation which decided not to report its internal derivative transactions. In practice, this has been taken by many corporate treasury practitioners as an instruction not to report them. However, corporate treasury practitioners should be aware that the CFTC could change its interpretation at any moment, and this could, in theory, include a requirement to report any unreported transactions since the clarification was issued in April 2013. In other words, all corporate treasury practitioners should continue to make provision to make future reporting.

Valuation requirements

Another feature of Dodd-Frank is that it places a greater responsibility on corporate treasury practitioners to arrange independent valuations on

all derivatives transactions. Under the regulation, banks and corporate counterparties have to establish a process to evaluate any variances between valuations of derivatives by the bank and by the corporation. Any variances need to be reported to the CFTC. If the variance exceeds any pre-agreed threshold, the two parties have to follow a pre-agreed process to review the variances. Variances are reviewed on a regular basis, which is determined by the number of transactions between the two parties, with the most heavily trading partners reviewing exceptional transactions daily, while the least frequently trading partners review transactions monthly.

The major implication for corporate treasury practitioners is that they can no longer rely on their counterparty banks to provide a valuation for compliance purposes. Instead, they will have to use another means to value derivatives. In many cases, functionality in existing treasury or risk management solutions will suffice. If not, third-party valuations will be required.

emir

A similar piece of regulation to Dodd-Frank is going through the EU legislative process. EMIR will also require the central clearing of oTC derivatives. However, as currently drafted, the regulation will require both parties to report the transaction to the regulator (rather than just the bank, as in the case of Dodd-Frank). This regulation is due to be finalized in october 2013, so there may be a number of further changes.

actions for Corporate Treasury practitioners

In terms of actions, corporate treasury practitioners should take the following steps.

1. Adopt a clear hedging strategy. Notwithstanding the requirements of either Dodd-Frank or EMIR, it remains good practice to have a clear hedging strategy in place. This approach allows the treasury department to demonstrate control over financial risk exposures. The hedging strategy should ideally be approved by the board, so that the board can also evidence formal control over the management of financial risk.

KRIShNaN IyeNgaR, VP, Reval, Ny

Not all corporate treasury departments will qualify for the End User Exemption under Dodd–Frank. As an illustration, one corporate treasury department aggregates risk across group subsidiaries. It operates an in-house bank which deals derivatives to the subsidiaries to hedge their exposures. Some of these have to be reported to the CFTC. In addition, the corporate treasury was deemed to be a finance entity and did not qualify as an end user, meaning that all its derivatives transactions have to be cleared. This underlines the importance for treasury practitioners to identify any group entities not exempt from Dodd–Frank.




Return to

Contents

There are many different ways in which a board-level hedging strategy can be drafted. In the case of foreign currency risk, the board can call for all exposures to be immediately translated into the group’s operating currency; in the case of interest rate risk, it can call for short-term borrowing costs to be fixed. Alternatively, the board may opt for a more nuanced approach such that currency exposures above a certain level (either in absolute terms or relative to, for example, turnover) are hedged, or that the group targets a fixed to floating ratio of 40/60, but within given parameters.

2. Establish set procedures. Whatever the agreed strategy, the treasury practitioner should establish a series of hedging procedures. These procedures should include processes to identify exposures, to measure the exposures, and to manage them (this may include a decision to use a derivative, or to do nothing).

The identification process should include an assessment of the type of risk faced. The measurement should include an assessment of the length of the exposure and how the measurement is to be made. The management decision should include the objective of any hedge, the type of hedge used, the length of the hedge and tools to assess both prospectively and retrospectively the quality of the hedge.

3. Follow set procedures. Corporate treasury practitioners should always follow established procedures. However, these should include a mechanism to alter a process if necessary, especially if the retrospective assessment of any hedge or hedges indicates ineffectiveness. The process should indicate circumstances in which these procedures should not be followed (for example, if the corporate treasury practitioner needs to hedge the proceeds of a corporate divestment, or the funds to pay for an acquisition).

The procedure will need to include an independent valuation of any derivative used to hedge an exposure. A tool will need to be in place to meet the obligation to discuss situations with the counterparty where there is too great a variance between this valuation and the counterparty’s valuation of the same instrument.

4. Document fully. All stages of each hedge should be clearly documented. This should include all details so that appropriate identification and assessment can be made. This information should be stored appropriately, should any retrospective hedge reporting be necessary.

Where derivatives are used for other purposes, the corporate treasury practitioner will need to follow the requirements of the new regulation. This will include establishing a mechanism to access clearing services, either via a bank or directly if volumes justify. This will add cost, both in terms of fees for clearing services and for initial and daily margin calls.

Conclusion

In most cases, the requirements under Dodd-Frank or EMIR will not impose unnecessary additional work for the corporate treasury practitioner. However, there are three areas to be wary of:

1. The treasury practitioner must ensure that appropriate documentation is in place to meet the conditions for an end-user exemption. This places an additional burden on the treasury practitioner both in initial preparation and in the event that any material changes to the hedging strategy need to be reported. From the positive perspective, though, any documentation such as this does provide the treasury practitioner with the opportunity to review existing strategy and processes.

2. The treasury practitioner will need to implement an independent valuation of any derivatives. Many companies have relied on the counterparty bank for these valuations (for inclusion on the corporate balance sheet), and may well consider an independent valuation to be an unnecessary additional cost for essentially plain-vanilla derivatives. However, it does provide an additional check on treasury activities, placing greater control with the corporate treasury practitioner.

3. Finally, if the treasury practitioner uses derivatives for any purpose other than risk mitigation or hedging, then the new requirement for clearing will impact the company. This will impose additional cost on any use of derivatives, and may alter the economic rationale of any decision. For example, it




Return to

Contents

may make structured investments more expensive to use and may therefore result in the corporate assuming additional risk when investing corporate cash. Structured investments use a combination of traditional investment instruments and derivatives to provide investors with a targeted investment instrument. For example, a structured investment might be based on an MXN-denominated certificate of deposit but incorporate a USD-MXN swap, to give the investor exposure to the USD. By effectively incorporating two transactions into one instrument, structured investments can offer cost savings to the investor, but which may be eliminated by the costs of clearing. However, there have been examples of companies using structured investments inappropriately. Any change will require the treasury practitioner to demonstrate full understanding of any structured instrument, reducing the risk of error when placing funds.

future-proofing

Finally, there are three main areas to watch:

1. The final EMIR rules. Corporate treasury practitioners with responsibility for activities within the European Economic Area will need to comply with the final EMIR rules. At present, these will require corporate treasury practitioners to do the following:

a. Report oTC derivatives to the ESMA and the relevant local regulator.

b. Clear any transactions with an approved central counterparty (a value threshold will apply).

c. Put in place timely confirmations with financial counterparties (the requirements are currently due to be implemented throughout 2014).

d. Mark to market any required outstanding transactions.

one problem for corporate treasury practitioners in global organizations is that there are some differences between the requirements under Dodd-Frank and those under EMIR, especially over reporting requirements. over time, these are likely to become consistent as regulators cooperate. In the short term, corporate treasury practitioners will need legal advice to ensure compliance once the requirements of both sets of rules become clearer.

2. Keep a watch on statements from the CFTC. All regulations are subject to review to ensure they are working as the regulator intends. There may be changes to the way this regulation is applied which may place additional burdens on corporate treasury practitioners to benefit from any exemptions under the rules. The CFTC may also retain the same exemptions but change reporting requirements.

3. Understand the implications of other regulation and legislation on derivatives transactions. Dodd-Frank and EMIR are not the only pieces of regulation which will affect derivatives transactions. For example, Basel III has the potential to change the oTC market too, so that some corporate treasury practitioners may choose to clear transactions centrally to avoid additional costs being imposed on banks on non-cleared transactions (see below).




Return to

Contents

Basel IIIoverview of the regulation

Basel III is the latest in a series of capital accords introduced by the Bank for International Settlements (BIS), which is based in Basel, Switzerland. Basel III complements two earlier accords (Basel II and Basel 2.5). The accords are implemented by local regulators according to detailed timeframes within the framework established in the accord.

Basel III concerns four main areas:

1. Minimum capital standards. Chief of these is the requirement for banks to hold 7% of their risk-weighted assets in common equity or core tier one capital. (Some systemically important banks will be required to hold an additional 1% to 2.5%.) These standards must be in place by 2019, although many banks are already working to adjust their balance sheets.

2. Liquidity coverage ratio. Also to be introduced by 2019, the liquidity coverage ratio will require banks to hold sufficient unencumbered, high-quality liquid assets, such that they can compensate for any net cash outflows over a stress-modeled 30-day period.

3. Net stable funding ratio. The net stable funding ratio is being introduced from 2018 and will require banks to hold assets with a residual maturity of over one year to fund illiquid assets on their book.

4. Leverage ratio. Finally, a bank’s leverage will be limited to a maximum 33 times its core tier one capital. The leverage will include all of a bank’s exposures, including off-balanc-sheet items, without any risk weightings being applied.

impact on Corporate Treasury practitioners

Although there are differences in approach between local regulators (Canadian banks must comply with the 7% RWA ratio now), banks around the world already incorporate Basel III requirements into their strategic planning. This means that Basel III is already beginning to affect corporate treasury practitioners in a number of key areas, notably the availability

of credit and bank appetite for corporate deposits. over time, as banks are required to meet the various standards and ratios, the availability of a range of products, and their pricing, will change, forcing the corporate treasury practitioner to reevaluate the use and delivery of these services. We examine the most significant effects from the perspective of liquidity.

Increased cost of borrowing

In general terms, Basel III will increase the cost of borrowing from banks. First, as banks will be subject to more detailed minimum capital standards and to the new leverage ratio, many will have to shrink significantly the volume of loans on their asset book. Second, banks will work to align the interest rates and fees with the cost of capital they have to set against each loan. As a consequence, many banks will continue to move away from assessing revenue from companies on a relationship basis, towards a service-by-service basis.

Changes to investments in bank deposits

Another feature of Basel III is the liquidity coverage ratio. Banks will have to characterize bank deposits with a maturity of less than 30 days as either operational or non-operational. Under this distinction, operational deposits include general working capital and cash held by depositors for transactional purposes. Non-operational deposits are other cash balances not immediately required by the depositor’s business. Basel III considers operational cash to be ‘stickier’ than non-operational cash, in the sense that companies are likely to maintain operational deposits with their prime transactional banks. Non-operational deposits are more likely to be used to chase yield and to manage counterparty risk via the diversification of investment.

From a bank’s perspective, it will have to hold liquid assets against 25% of operational deposits, rising to 40% of non-operational deposits. Banks will also have to demonstrate how they distinguish between the two types of deposit, which may place an additional reporting requirement on corporate treasury practitioners.

As interest rates rise, banks are likely to respond by offering better returns on surplus cash balances




Return to

Contents

held on checking accounts and other demand deposit accounts by companies using transactional services, when compared to deposits classified as non-operational deposits. Banks may also refuse to accept non-operational deposits for terms of less than 30 days. For longer-term deposits (over a year), banks will factor in the impact of the net stable funding ratio.

Changes to investments in other instruments

As well as affecting banks’ appetite for corporate deposits, Basel III will also affect banks’ demand for unencumbered, highly liquid assets to meet the liquidity coverage ratio. Highly liquid assets will include government securities as well as short-term instruments issued by highly rated companies. Banks will need to hold these assets, increasing the relative price of these instruments still further.

Changes in availability of pooling structures

one possible effect of Basel III will be to change the availability of notional pooling structures, if banks are required to set aside more assets to cover any debit positions in a notional cash pool. This would have

the effect of making notional cash pools uneconomic, forcing treasury practitioners to review any liquidity management structures that include a notional cash pool, especially any operating on a cross-border basis.

Impact on corporate hedging activity

Finally, Basel III will have an indirect effect on corporate hedging activity. This is because banks will have to hold additional capital against oTC derivatives which are not cleared with an approved central counterparty. This is a cost which banks will inevitably pass on to companies seeking to hedge. Corporate treasury practitioners will respond in different ways:

■ Choose to clear trades via a central counterparty. Although corporate treasury practitioners may not be required under Dodd-Frank or EMIR to clear trades via a central counterparty, they may still choose to do so. This decision will be determined by evaluating the relative costs of clearing transactions (including margining, etc.) against the wider spreads offered by a bank for a non-cleared transaction.

■ Reduce amount of hedging. Treasury practitioners will have a greater incentive to identify natural and internal hedges to minimize the number of external derivative transactions required. This will provide additional weight to any decision to centralize treasury activities. Treasury practitioners will also compress their portfolios such that they hedge more efficiently. (Banks have been doing this for a number of years.) Treasurers are, though, not likely to keep many more positions unhedged, as any increased cost of hedging will be outweighed by the risk of increased cost in the event of not hedging at all.

■ Become more like banks. In many instances, corporate treasury practitioners may become even more like banks in terms of their approach to risk management. They may seek to use exchange traded markets (historically, these have been avoided because of the requirement to trade standardized amounts and because of margining requirements) as the increased costs of oTC derivatives may make exchange traded instruments relatively more attractive.

PaT TRozzo, VP Product Management, Reval, Ny

Basel III’s requirement for financial institutions to meet higher capital requirements will make corporate hedging activities more costly. Because Basel III goes to the heart of banks’ business, banks will have to pass on the costs of meeting higher capital requirements to their corporate clients. Banks will charge wider spreads on derivative transactions and/or require their clients to post margin more frequently and/or in larger quantity, placing greater demands on the treasury practitioner’s ability to manage liquidity.

Corporate treasury practitioners will have to adopt a whole new skill set to manage hedging activities, especially if they choose to clear derivatives transactions. Corporations will need to invest more resources into the treasury department to acquire collateral management systems and to implement new operating procedures to replace manual activities.




Return to

Contents

If so, corporate treasury departments will start to need to use more sophisticated techniques to manage positions, transactions and collateral.

The potential impact of Basel III on derivatives transactions will take time to work through, and the effect of changes in other regulation may make any impact minimal.

what to watch

It is important to remember that it is banks which will have to comply with Basel III. Basel III is being implemented via national legislation. Implementation in the EU is via the Capital Requirements Directive (CRD IV), which entered into force in July 2013. A number of other countries (including Australia, Canada, China, India, Japan, Mexico, Singapore and Switzerland) have also finalized their legislation. Some (including the USA, which is working to achieve

consistency between Basel III and Dodd-Frank) have still to adopt final regulations. The BIS publishes details here: www.bis.org/bcbs/basel3.htm.

Many of the potential changes outlined above are already happening, and banks are certainly beginning to alter their behavior. The challenge for corporate treasury practitioners is to take a wider view. For example, bank borrowing costs will, in most cases, increase over time. This is partly a result of Basel III, but will also be a result of rising interest rates at some point in the future.

Fundamentally, it would be a mistake to try to identify the effect of Basel III in isolation. Instead, corporate treasury practitioners should work with their banks (as well as with other banks and other providers) to understand their responses not just to Basel III, but also to market developments in general.


http://www.bis.org/bcbs/basel3.htm



Return to

Contents

FATCA/FBARoverview of the regulations

The Foreign Account Tax Compliance Act (FATCA) and the Report of Foreign Bank and Financial Accounts (Foreign Bank Account Report – FBAR) are both targeted at reducing the opportunities for US individuals and entities to avoid and evade US tax by holding cash in offshore bank accounts and investment instruments, or through the ownership of non-US entities. It is likely that other governments will seek to adopt similar legislation, a process viewed as a natural extension to anti-money laundering regulations. The details of the two regulations are outlined below.

FATCA

The Foreign Account Tax Compliance Act (FATCA) forms part of the 2010 Hiring Incentives to Restore Employment Act, designed to combat the relatively high levels of US unemployment in the aftermath of the credit crisis following the collapse of Lehman Brothers and other banks in the USA and around the world.Its primary focus is to try to prevent tax evasion and avoidance by US individuals and entities that hold cash in offshore bank accounts and investment instruments, or via ownership of non-US entities. The US government wants to encourage the repatriation of cash, in the expectation that this will boost the US economy, reducing unemployment.

Foreign financial institutionsThe burden of the legislation falls primarily on foreign financial institutions (FFIs), which are required to provide information on bank accounts and investments held by US individuals and entities. An FFI is broadly an institution which, as a significant part of its activities, accepts deposits, holds financial assets on behalf of others, or invests in financial instruments on behalf of others. Most corporate treasury departments will not be included in this definition, but multinational organizations should check the status of any in-house bank or treasury center to confirm that this is so.If a foreign financial institution has not provided (or cannot provide) information, then the US Internal

Revenue Service (IRS) can require US institutions to withhold 30% of payments made to certain non-compliant foreign financial institutions. A number of countries have negotiated inter-government agreements (IGAs) with the US Treasury. These effectively make it easier for financial institutions in those countries meet their obligations under FATCA. The US Treasury publishes a list of countries deemed to have an IGA. This list is available here: www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA-Archive.aspx. At the time of writing, nine countries (Denmark, Germany, Ireland, Japan, Mexico, Norway, Spain, Sweden and Switzerland) have agreed IGAs with the US government. The IRS launched its FFI FATCA Registration Portal in August 2013, and FFIs must finalize their registration by August 25, 2014 to avoid being subject to withheld payments. Withholding of payments under FATCA is due to start at the beginning of July 2014, with reporting due to start at the end of March 2015. Further reporting requirements are to be phased in over the following two years.

Non-financial foreign entitiesUnder the terms of the Act, payments can also be withheld from non-financial foreign entities (NFFEs) which cannot demonstrate they have no significant US owners. A number of NFFEs, including publicly traded corporations and actively trading businesses, are exempt from FATCA. Non-exempt NFFEs must be able to certify that they have no beneficial US owners, or provide details of any US owners to their withholding agent, to avoid any withholding. Most centralized treasury operations and holding companies will be exempt from any withholding requirement under FATCA; however, it is vital that they examine their status with the regulations to determine this and provide any required FATCA certification to withholding agents (to prevent withholding), if necessary. They should also establish processes to capture and report relevant information on any US-source cross-border withholdable payments (interest and dividend payments, bank fees and insurance premiums are all


http://www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA-Archive.aspx

http://www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA-Archive.aspx



Return to

Contents

likely to be considered withholdable) made by the group to non-US payees.

FBAR

The Report of Foreign Bank and Financial Accounts (Foreign Bank Account Report – FBAR) requires US persons (a definition which includes both individuals and corporations) to report details of bank accounts held outside the USA. The legislation, and therefore the obligation to report, applies to individuals with authority over, but not necessarily having a financial interest in, the bank accounts, even if a company has already submitted a report. However, the rules are expected to be extended to require companies to report electronically in 2014. (Companies already have to report, either as a summary of bank accounts or in a detailed listing, depending on the number of accounts they hold.)

Unlike FATCA, where the onus is on banks and financial institutions to comply, FBAR places the obligation on individuals (and companies) to comply. A report needs to be filed once an individual has signing authority on any bank accounts with aggregate balances of USD 10,000 at any time within the year. This is a point of contention for many, as the rules are unclear as to the level of signing authority. At this stage, some companies only include the signers when considering aggregate balances. However, others include anyone that has access to move funds. This assessment reaches far beyond the treasury department, into the business as a whole, and makes collating information much more complex.

implications for Treasury practitioners

FATCA

Treasury practitioners should establish whether the company or any group subsidiary, including any in-house banks or treasury center, is considered to be an FFI or non-excepted NFFE. If considered as an FFI, the entity should register with the IRS. Any non-excepted NFFE should arrange the required certification to prevent withholding.

Treasury practitioners should also establish procedures to determine whether any US-source payments to FFIs or NFFEs are withholdable. For those that are, a process to report these to the IRS must be established.

In many ways, the FATCA implications for corporate treasury practitioners remain to be seen. Possible effects include:

1. Difficulties opening or maintaining bank accounts with non-US financial institutions. one of the greatest unknown factors is the response of foreign financial institutions to FATCA rules. The increased regulatory requirement has led some non-US financial institutions to choose to close bank accounts, especially investment-style accounts, held by US citizens, or to make it more difficult for US individuals to open accounts. Until the regulations apply to companies and the response of the foreign financial institutions becomes clearer, there remains a risk for US entities operating internationally that opening and maintaining bank accounts in some jurisdictions may become more difficult.

This may require companies to alter their liquidity management structures, especially if maintaining bank accounts with existing banks becomes more difficult.

2. Pressure on US companies to repatriate cash to the USA. The intention of the legislation is for US companies to repatriate cash balances held outside the USA, the trigger for payment of US taxes. As the US IRS becomes aware of organizations’ cash balances, institutional investors may place companies under more pressure to repatriate cash as a means to minimize risks to reputation.

In these circumstances, treasury practitioners may be able to review policies on the use of cash, particularly to pay down debt, to use cash within the USA to fund new projects (the ideal response, from the US government’s perspective) or to simply find new techniques to shelter the same funds from US tax.

3. Extra time and resources required to ensure compliance. For most companies, many international payments will continue to be exempt from FATCA requirements. Any payment explicitly linked to any US-based trading activities is exempt, as are intercompany transfers to or from holding companies, captive insurance companies and treasury centers.




Return to

Contents

Ultimately, corporate treasury practitioners will need to work to understand how their bank and other financial institution partners view FATCA compliance and whether this has the potential to create difficulties for their use of liquidity within their organizations.

FBAR

Because reporting is determined by aggregate balances on bank accounts over which a specific individual has signatory powers, corporate treasury practitioners need to ensure they know where all the group’s bank accounts are located, who has signatory powers over them and to collate balances on those accounts in as a timely fashion as possible.

To prepare for FBAR compliance, there are three steps a treasury practitioner can take:

1. Generate an accurate listing of corporate bank accounts around the world. This is an important element of any headquarters treasury function. Without this information, the treasury practitioner cannot have clear oversight of cash across the group.

It provides an opportunity to rationalize bank accounts around the world to ensure that there are no unnecessary bank accounts with idle balances outside the overview of headquarters treasury.

Many companies have moved to shift the responsibility for opening and closing bank accounts to the corporate headquarters. Where this is not possible, group subsidiaries will usually require approval from corporate headquarters so that they can demonstrate knowledge of the bank account.

2. Standardize the signatories on these bank accounts as far as possible. The second stage is to standardize the signatories as much as possible. With the advances in technology in recent years, especially the increased use of Software as a Service (SaaS) delivery, it is now possible for bank account signatories to sign electronically wherever they happen to be in the world.

In practical terms, the size of the organization will determine the number of signatories required. It may be possible to standardize signatories across the whole organization, by division or by country,

especially if bank accounts have been rationalized successfully.

As with other activities, the treasury practitioner will need to ensure that there is sufficient segregation of duties to prevent the risk of fraud.

3. Implement a structure which records account balances by signatory as efficiently as possible. Finally, because the reporting requirement applies when the aggregated balance on all bank accounts for which a signatory is responsible reaches the equivalent of USD 10,000, it is very important that the central treasury has the ability to record and aggregate bank account by balances by signatory, as well as in any other way necessary for liquidity management purposes.

In all likelihood, this will involve some additional work within the treasury department but should be achievable as part of the rationalization processes outlined above.

The main concerns will be for organizations operating in areas where technology does not permit the submission of balance reports back to headquarters in such a timely fashion.

TRaCey FeRguSoN KNIghT, Solutions Consultant, Reval, Dallas, TX

One of the main challenges for corporate treasury practitioners wanting eBAM as a means to facilitate FBAR compliance is the lack of standardization between banks. North American banks, in particular, have been promoting the use of their own electronic banking platforms, making the process of collating information across multiple banks unnecessarily cumbersome.

Treasury practitioners can do two things to achieve compliance. First, any work to minimize the number of bank accounts held by a group will make the collation of information simpler. Second, they can use their treasury and risk management system vendors help them to identify ways to streamline the flow of relevant information into the treasury headquarters.




Return to

Contents

In theory, electronic bank account management (eBAM) should help corporate treasury practitioners achieve these objectives. In practice, there remain some significant differences between banks, and a lack of standardization across banks, as they each seek to try to push their own proprietary systems.

Conclusion

With respect to both FATCA and FBAR, the regulations have been finalized so corporate treasury practitioners should continue to monitor developments and consult with legal and tax advisors to make sure they are compliant. Nonetheless, it is prudent for practitioners to prepare for the implementation of FBAR, in particular by working to rationalize corporate bank accounts and implement tighter control over signatories. For those companies with bank accounts in the European Economic Area, it is sensible to perform this task mindful of the SEPA initiative outlined below.




Return to

Contents

SEPAoverview of the regulation

The Single Euro Payments Area (SEPA) has been designed to create a harmonized set of EUR-denominated payment instruments across Europe. It is a logical extension of the earlier introduction of the Single European Market and the adoption of the euro as a common currency. The legal foundation is established by the European Commission through the Payment Services Directive (PSD), which is currently under review (see PSD2 in ‘What to Watch’ below).

SEPA covers 33 member countries including all 28 EU states, the four EFTA countries (Liechtenstein, Iceland, Norway and Switzerland) and Monaco. The SEPA payment instruments are:

■ SEPA credit transfers (SCT)

■ SEPA direct debits (SDD)

■ SDD Core

■ SDD B2B

■ SEPA cards framework (SCF).

European Union Regulation 260/2012 has established migration end-dates of February 1, 2014, for eurozone countries and october 31, 2016, for non-eurozone countries. By these deadlines, legacy national payment instruments for credit transfers and direct debits denominated in EUR will have been replaced. The changes also require the use of ISo 20022 XML payment formats for SEPA payment instruments.

Realistically, the February 2014 deadline means that most companies should be prepared for the transition in eurozone countries by the end of November 2013. Any efforts to comply after this date will be complicated by the requirements of end-of-year reporting.

implications for Treasury practitioners

As with many other regulations, SEPA represents a series of challenges for corporate treasury practitioners, together with a number of significant potential opportunities.

SEPA challenges

Because of the imminent deadline, most companies should already have a SEPA migration project plan in place. Although the SEPA migration times have been uncertain in the past, the underlying requirements have remained broadly the same. At this stage, it will mainly be organizations which either started preparations late or which have undergone some significant corporate event (such as a merger) that are most likely to experience difficulties meeting the February 2014 deadline. That said, a number of challenges remain for corporate treasury practitioners:1. Check integrity of static data. one of the

major changes was the migration from existing bank account numbers to the International Bank Account Number (IBAN). The use of an 11-character Bank Identifier Code (BIC) rather than the eight-character SWIFT address for European Economic Area (EEA) cross-border payments could, in some cases, represent another challenge. By now, organizations should have a clean database for appropriate counterparties including accurate IBAN and BIC data.

2. Check ability to initiate and process SEPA credit transfers. Treasury practitioners will need to ensure their treasury management systems or ERP systems will be able to initiate credit transfers in the correct format by the appropriate deadline. They will also need to ensure they can fit attached additional invoice information within the 140-character space provided in initiated SEPA payments, and to capture similar invoice information on any received credit transfer. This will require communication with banks and system vendors.

3. Check ability to process SEPA direct debits. The challenge surrounding direct debits is more complex, partly because of the wide difference in the use of national direct debits across the SEPA area. In some countries, for example Germany, direct debits have been an important tool for companies to collect payments, while in others, such as the Czech Republic, the use of direct debits has been less widespread.The main challenge, however, is the shift in responsibility for storing SEPA direct debit




Return to

Contents

mandates. From having been stored by the banks, SEPA now requires the mandates to be stored by the creditors instead. This means that companies will need to have robust data storage capabilities which can capture both the creditor identification number and the mandate reference number for each direct debit relationship. Any existing direct debit mandates need to be updated to ensure they can be used in the SEPA environment. As well as being a technical issue, client relationship management is also required. Timing of the transition is important. Delaying the transition of mandates to the last minute might risk friction with clients, who may receive similar requests from other suppliers. Companies will also have to ensure they can provide appropriate invoice advice for SEPA direct debits. For retail direct debits, advice to customers must be provided at least five days before an initial payment and then at least two days before subsequent payments. For business-to-business payments, advice must be provided by the day before payment is taken.

4. Understand liquidity management implications. one of the SEPA objectives is to ease the transmission of cross-border payments. This will mean that many SEPA credit transfers will reach their destination quicker than before, so treasury practitioners will want to factor changes into payment initiation processes and cash forecasts. At the same time, SEPA direct debits allow for the reversal of payments up to eight weeks after a payment has been made (or 13 months, in the case of unauthorized payments). This change will need to be modeled into any cash forecast as well.

5. Decide when to optimize processes. To comply with the regulation, most corporate treasury practitioners have a choice between adopting a workaround solution or implementing a new optimized set of processes. For example, in the case of credit transfers, there are solutions from banks and third-party specialist providers which allow companies to initiate payments using a legacy format and then translate them into SEPA format. Companies which anticipate difficulties

in introducing new processes may prefer to do the minimum necessary to ensure compliance, before embarking on a wider review of processes when the opportunity arises.

SEPA opportunities

As well as the macro-benefits designed to improve the competitiveness of the European economy, SEPA also provides a number of opportunities for corporate treasury practitioners to improve the efficiency and effectiveness of their own organizations.

■ opportunity to rationalize bank accounts. Before SEPA, despite the introduction of a single currency, existing cross-border restrictions in legacy payment instruments and payment clearing systems within the eurozone meant the countries had to be treated separately for liquidity management purposes. Although EU rules prevent the cost of cross-border EUR-denominated payments being any higher than domestic equivalents, the realities of different payment formats and the ease of domestic collections have meant that companies generally chose to maintain bank accounts in the countries in which they operated.

güNTheR PeeR, Regional Vice President, Solution Consulting, eMea

At this stage, most corporations have a SEPA migration project in place. These started with projects to change static data, such as IBANs: there typically was an 80-90% success rate for auto-conversion of existing data into IBANs, with errors in held static data also identified.

When we surveyed our clients, about a third of respondents agreed SEPA gave them the opportunity to standardize processes within their organizations. About 30% saw it as a way to improve their bank account structures and 20% took the opportunity to develop a shared services center or payment factory. On the other hand, 12% view SEPA simply as regulation requiring compliance with no opportunity for gains.




Return to

Contents

Standardizing payment instruments across SEPA should allow companies to rationalize the number of bank accounts they hold within the region. This will have the effect of reducing bank account operating costs, both in terms of bank charges and by obtaining better cash visibility. For US organizations having to comply with FBAR (see above), rationalization of the number of bank accounts will also help that process.

Treasury practitioners will now need to balance the opportunities provided by rationalizing bank accounts with the risk posed by consolidating bank accounts too much with each counterparty bank.

■ Take advantage of standardized payment formats. The use of IS0 20022 XML in all SEPA payment formats should provide greater opportunities for straight-through processing of payments and improved reconciliations. SEPA credit transfers permit a data submitter to attach information of up to 140 characters to any payment instruction which will be received by the recipient’s bank. This may cause problems for companies used to combining 50 to 100 invoices in a single payment. Treasury practitioners may need to work to update their accounts payable and accounts receivable processes as a result of this change, generally in cooperation with their system vendors. Treasury practitioners will also need to watch for the use of any bank- or country-specific alterations, such as AoS2, to the standard, as these will have the potential to disrupt straight-through processing and, therefore, reduce the efficiency benefits.

■ Greater opportunity for centralization. Treasury practitioners can take this one stage further by centralizing treasury activities in a shared services center or payment factory. The new XML standard can quote reference parties so that a payment factory can initiate ‘payments on behalf of ’ (PoBo) group entities in such a way that recipients can reconcile invoices more easily.

■ More efficient cross-border liquidity management. Finally, SEPA offers the opportunity for corporate treasurers to operate a much more efficient cross-border liquidity management structure. By taking advantage of the opportunities outlined above,

companies will be able to streamline their bank account structures and simplify any notional or physical cash pools. This will reduce bank account and transaction fees, improve visibility of cash and make short-term borrowing as well as investing easier to manage.

It should be borne in mind that SEPA only applies to EUR-denominated payments. Countries outside the eurozone will continue to use legacy payment instruments and payment clearing systems.

what to watch

In July 2013, the European Commission completed its initial review of the PSD, first adopted in 2007. It has proposed the introduction of a second Payment Services Directive (PSD2) as a means to extend the reach of existing legislation to provide further benefits to the wider European economy.

At present, the PSD2 is in draft form and will be subject to further market scrutiny, as well as government input across the EU. At the same time, the European Commission has proposed a new regulation on interchange fees applied to card-based transactions. Together, these measures are designed to have the following effects:

■ Facilitate the development of internet-based payment systems. With consumers increasingly using internet and mobile technology to make purchases, the European Commission is keen to see the development of a payment infrastructure which is not based on card payments.

■ Improve protection against fraud. Under the proposals, consumers will be better protected against the risk of fraud and unauthorized card payments. This is aimed at encouraging the use of card payments over less efficient instruments, such as checks.

■ Reduce charges on the use of payment cards. The proposals will cap the level of interchange fees on both debit and credit cards, which the European Commission uses to prevent companies from applying surcharges for the use of these instruments. Caps on the use of debit cards and credit cards on a cross-border basis have already




Return to

Contents

been accepted by MasterCard, Visa and Groupe Cartes Bancaires (at 0.2% and 0.3% respectively), and will apply for a transitional period. other card schemes, such as commercial cards and third-party cards, will not be subject to the cap and retailers will be free to levy a surcharge on the use of these cards (or refuse to accept them).

The European Commission expects the proposals to pass through the legislative process by early 2014. There may be some amendments during this process. However, unless radically changed, the proposals will reduce the cost of processing card payments across the European Economic Area.




Return to

Contents

EU Financial Transactions Taxoverview of the regulation

As it currently stands, the proposed European Union Financial Transactions Tax (FTT) will apply to share, bond and derivatives transactions. It will apply as long as one participant is a financial institution and if at least one leg of the transaction is based in one of the countries implementing the tax. At present, the tax will be applied at 0.1% of the value of share and bond transactions and at 0.01% of the value of derivatives transactions.

This tax is only to be implemented by the 11 countries supporting the FTT – currently Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain. (The FTT has been proposed under the ‘enhanced cooperation’ regime of the EU. This means that, unlike most EU legislation, it only applies to countries which choose to adopt it.) Because of the potential threat to its financial services industry, the UK has launched a formal legal challenge to the proposals. This challenge is supported by Luxembourg, which has reservations for similar reasons. Sweden opposes the tax because of its experiences when it implemented its own financial transactions tax. These legal challenges will not delay the implementation of the FTT, although growing opposition within the 11 countries may do so.

From a liquidity perspective, one of the more controversial elements of the FTT as it currently stands is that there are no exemptions for non-financial companies using derivatives to hedge exposures with a view to mitigating financial risk. This contradicts the effect of the implementation of the clearing obligations outlined above under EMIR.

implications for Corporate Treasury practitioners

The implications of the FTT are potentially serious and significant for corporate treasury practitioners operating in a country applying the tax.

■ Increase in borrowing costs. Although primary bond and share issuance will be exempt from the FTT, borrowing costs will increase as a result of a combination of factors:

■ First, as banks will face increased costs when managing their own books, they will pass these costs on to borrowers.

■ Second, any bond and share investors will want compensation for their loss when they seek to realize any profits via a sale of a held instrument in the secondary market.

■ Third, any increase in borrowing costs may apply disproportionately to companies based in any of the countries implementing the FTT, as banks may prefer to lend outside the FTT zone, and bond and share investors may be more reluctant to buy instruments, knowing that the FTT will apply when they seek to sell in the secondary market.

■ Increase in hedging costs. Because there is no exemption for derivatives used for hedging purposes, companies will have to pay the tax of 0.01% on all interest rate and exchange rate swaps, forwards and options. This will also add complexity to accounting for these instruments, although most treasury and risk management solutions are likely to be able to accommodate any requirements, especially where they are delivered as SaaS, or easily updateable if installed.

■ Increase in cost of centralized treasury operations. Depending on their activities, some treasury centers may be considered to be financial institutions, which will make them directly subject to the tax. In addition, some central treasury transactions with group entities may also be subject to the tax. Any increase in costs will result in such centralized activities becoming less economically advantageous. This may possibly result in the reduction of the centralization of such activities, although most companies are unlikely to want to give up any central control of group activities, because of the risk management implications. It may, though, result in companies moving any central treasury activities, such as shared services centers or in-house banks, out of any country supporting the FTT.

■ Reduced return on investment. This will apply both for short-term liquidity investment and for longer-term asset management, such as the investment of pension fund assets. From a liquidity perspective,




Return to

Contents

UCITS instruments are exempt, so a corporate investment in a money market fund will not attract the tax. However, because money market funds’ activities will be taxed, returns on these and other UCITS and mutual investments will be reduced.

■ Difficulties in managing counterparty risk. The FTT will affect liquidity in the credit default swap (CDS) market, reducing the effectiveness of CDSs as a tool to both measure and manage counterparty risk.

what to watch

The current position is that member states choosing to implement the FTT have until September 30, 2013, to implement national legislation adopting the FTT, with the expectation that the tax will be applied from January 1, 2014. However, it is by no means certain that the FTT will be implemented, even in the 11 countries currently supporting it.

There remain a number of quite significant issues to overcome. Chief of these is the potential for major disputes over the application of the tax where one entity is outside the 11 countries. If the UK legal challenge does not result in the FTT legislation being redrafted, then there will inevitably be a further legal challenge due to the extra-territorial nature of the tax once the FTT is operational.

The EU’s lawyers published an opinion on September 10, 2013, in which they argued the proposed tax, as it stands, would be illegal under EU law. It is a non-binding opinion, which means the 11 countries are free to continue to implement the tax, but it does suggest that any legal challenge to the FTT (as currently proposed) would have a good chance of success.

Even so, there remains significant potential for at least some revisions. Some governments have realized the tax will affect the attractiveness of their bonds to investors, because of the application of the FTT on bond sales in the secondary market.

Some commentators expect the FTT to be abandoned and replaced by a stamp duty on shares on a pan-European basis. While regulators (and politicians) support a tax on derivatives transactions as a tax on market speculation, the FTT (or any standalone derivatives transaction tax) may include a hedging exemption for non-financial companies, the importance of which is recognized in EMIR.

Finally, some treasury practitioners are already planning to structure investments and hedging transactions to avoid the application of the tax, primarily by seeking to locate trades outside the 11 countries.




Return to

Contents

Money Market Reformone of the major concerns for regulators in both the USA and the EU has been the threat posed by ‘shadow banking’ on the stability of the financial system. Earlier, we discussed the way that regulators want improved information on derivatives transactions to achieve a clearer understanding of financial institutions’ relative positions.

Regulators are also concerned about the central role played by money market funds in providing short-term liquidity for banks, especially in the USA, and the risk that heavy redemptions from these funds might result in another loss of liquidity for banks. Both the US SEC, via a set of revisions to rule 2a-7, and the European Commission, via UCITS Directive 2009/65/EC, imposed tighter regulation on money market funds after the Reserve Fund ‘broke the buck’ following Lehman Brothers’ failure in 2008.

Both the US SEC and the European Commission continue to assess ways in which regulation can be tightened to protect financial stability. The latest proposals are outlined and examined below.

us money market reform

In June 2013, the SEC published its latest proposals for further reform of money market funds in the USA. As before, it has indicated that the objectives of these proposals are to:

■ Retain market stability. The SEC remains concerned that money market funds are susceptible to excessive redemptions at certain periods, and any heavy redemptions from one fund might be contagious.

■ Increase transparency of money market fund activity. To help investors understand risk, the SEC wants money funds to provide more timely information about their activities. This improved transparency would reduce the risk of heavy redemptions.

■ Retain money market funds as an available source of short-term liquidity. The SEC recognizes that money market funds continue to play an important role in maintaining liquidity in the money market. In particular, they are both an important source of

short-term funding for financial institutions and a popular way to invest short-term corporate cash.

The June 2013 proposals contained a number of proposals to achieve these objectives. The measures to improve transparency are relatively uncontroversial. They would require funds to provide daily disclosure of daily and weekly liquid assets and the market-based net asset values of their funds. Funds would also have to disclose any material events (such as the fall in net asset value below USD 0.9975 and the imposition of any liquidity fees or redemption gates – see below – as well as the provision of any sponsor support). Funds would also have to release details of their portfolio holdings immediately, rather than after a 60-day delay (as is presently the case). There are some additional proposals designed to increase diversification of holdings and require greater stress testing.

From a corporate treasury practitioner’s perspective, there are two additional proposals which represent a more serious threat to the utility of money market funds as a location for short-term surplus cash in the USA. These are:

1. The requirement for floating net asset value (FNAV) for prime funds. The first proposal from the SEC is to permit most money market funds to transact at a floating net asset value. Funds would be required to value any held assets at market rates, with any fluctuations in value shown in the price of the fund. This pricing would be at basis point level (i.e. a fund might be priced at USD 1.0008). This proposal would apply to all prime institutional money market funds except for government funds (defined as those with holdings of at least 80% in cash, government securities or repos backed with government securities) and retail money market funds (defined as those where redemptions are limited to USD 1 million per day).

2. The introduction of liquidity fees and redemption gates for prime funds. The second proposal is for a combination of measures to reduce the risk of excessive redemptions. Two particular measures are under scrutiny:

a. Liquidity fees. Under this proposal, a fund would be required to impose a 2% fee on any redemptions if the weekly liquid asset ratio fell




Return to

Contents

below 15%, unless the board decided either not to impose the fee, or to impose a lower fee. (Money market funds are required to keep at least 30% of their assets in liquid instruments, including cash, securities which can be redeemed into cash within a week, US Treasury securities and some government securities with maturities below 60 days.)

b. Redemption gates. As well as the liquidity fee, a money market fund board could also impose a redemption gate (i.e. prevent redemptions) for up to 30 days. Redemption gates could only be imposed for a maximum of 30 days in any 90-day period.

In both cases, a fund would be required to disclose whether it breached the 15% weekly liquid asset ratio, when it imposed or withdrew a liquidity fee or redemption gate, and the detail of the associated board discussion.

Under current SEC proposals, government funds would be exempt from the requirement to impose liquidity fees or redemption gates, although they would be free to do so.

The SEC has also asked for comment on whether the two proposals should be combined into a single measure. If so, money market funds (except government and retail funds) would transact at FNAV and be permitted to use both liquidity fees and redemption gates.

european money market reform

The European Commission released its proposals on September 4, 2013, as a draft regulation. The proposals include:

■ A tightening of permitted investment instruments. The draft regulation lists the assets in which a money market fund is permitted to invest (money market instruments; deposits with eligible credit institutions; derivative instruments but only for specific purposes; and reverse repos) and it sets rules on the diversification of these instruments within a fund’s portfolio. This change will also reduce a fund’s ability to invest in asset-backed commercial paper.

■ A prohibition of the use of external credit ratings.

■ A change in liquid assets, such that funds will have to hold 10% of assets maturing overnight and a further 20% in assets maturing within a week. (This replicates changes introduced by the SEC in 2010.)

■ Restrictions on external support for money market funds. CNAV funds will be able to receive external support from a sponsor only through the capital

JuSTIN BRIMFIeLD, eVP Corporate Development & Strategy, Reval, Ny

An SEC decision to require floating NAV for money market funds would raise two key questions for treasury practitioners seeking to manage corporate cash.

Would a floating NAV impact the ability to redeem cash the same day?

Because CNAV funds are priced at USD 1.00, cash can be returned within one to four hours, depending on the fund or portal. With a floating value, transfer agents (TAs) and fund custodians will have to price the shares. The money market fund industry will need guidelines should the SEC rule for FNAV, which are not being obviously addressed at present. The problem is that any guidelines will require most TAs and custodians to invest in systems which will be able to provide intraday shareholder pricing. Many fund managers may simply exit the business if they consider the cost of changing or upgrading systems to be too high. Without improved systems, money market funds may only be able to offer end-of-day or next-day redemptions.

Would a floating NAV affect daily investment windows, resulting in earlier cut-off times and a consequent need for investment decisions earlier in the day?

Because a share price will need to be struck, it will impact more than the daily window. It will also change the vehicle from a daily instrument to more like a T+1 or T+2 investment vehicle. In these circumstances, corporate treasury practitioners will use money market funds less.




Return to

Contents

buffer (see below). External support for other funds will only be permitted in exceptional circumstances.

■ Greater restrictions on Constant NAV funds. The main proposal is the introduction of a capital buffer (of at least 3% of a fund’s assets) to be used to maintain the CNAV of a fund in circumstances when the actual value falls below the par value (typically USD 1, EUR 1 or GBP 1). The buffer will be introduced over a three year ramp-up period and will be evaluated for its effectiveness three years after the implementation of the draft regulation. The draft regulation also explains how a buffer should be replenished. Any CNAV fund which fails to comply with the capital buffer requirements will have to convert to FNAV.

■ A change in valuation. only CNAV funds will be permitted to use amortized cost accounting; all other funds will be required to mark-to-market their assets (or mark-to-model, where this is not possible).

These proposals still have to complete their passage through the EU legislation process, so some changes are still possible. once the regulation is approved, it will become effective 20 days after publication and will be applicable in all EU member states from that date.

The potential implications for Corporate

Treasury practitioners

In the USA, the proposals to require prime money market funds to transact at FNAV and the opportunity for funds to impose liquidity fees or redemption gates both have the potential to make money market funds much less attractive locations for surplus cash. In Europe, the proposal to require CNAV funds to hold a capital buffer is likely to have a similar effect.

The FNAV requirement for prime funds will cause some difficulties for corporate treasury practitioners, from a tax reporting and accounting perspective. However, for those companies which use treasury or risk management systems, any reporting changes should be supported by the vendor. This will be relatively straightforward via a vendor update, in the

case of solutions provided as SaaS, or as a standard local installation. It may be more difficult where a system has been modified at or after installation.

The possibility of liquidity fees and redemption gates represents a much greater potential issue for corporate treasury practitioners. All treasury practitioners assess short-term investment primarily from the perspective of maintaining both principal (security of the investment) and liquidity. Liquidity fees and redemption gates threaten both of these. Liquidity fees would result in a loss of principal; redemption gates would mean a loss of liquidity, for a period up to 30 days. on the positive side, treasury practitioners would have greater access to information about a fund’s portfolio, allowing them to monitor performance in a more timely fashion. However, the imposition of liquidity fees and redemption fees is likely to result in an investor redeeming funds at the first indication of a tightening of a fund’s liquidity.

More widely, these reforms pose a threat to money market funds as an asset class of interest to corporate treasury practitioners. Money market funds emerged as a location for short-term cash partly because US banks were prevented from paying interest on demand deposit accounts. (France, where a similar restriction was in place until 2005, also has a sophisticated domestic money market fund industry – SICAVs.) With US banks now permitted to pay interest on demand deposits (and a number investing in systems to attract short-term deposits when interest rates start to rise) and money market funds potentially less attractive, corporate treasury practitioners may start to alter their investing practices if these proposals are implemented.

More particularly, money market funds have been attractive to investors because they offer diversification of risk without the need for major investment in administration or in personnel to manage assets. If money market funds are seen to invest in a narrower range of instruments, corporate treasury practitioners may decide either to self-manage funds or to provide a mandate to a third-party manager on their behalf.




Return to

Contents

Conclusion In this guide, we have identified the expected impact of six items of regulation (some of which have been implemented, while others are merely proposed) on the work of corporate treasury practitioners. There is no doubt that some, notably the introduction of SEPA in the EEA, will have a significant and direct impact on liquidity management. We have also seen that some regulations can be contradictory, notably in the use of derivatives. As with all items of regulation, those discussed in this paper will continue to evolve.

The challenge for corporate treasury practitioners is to retain the appropriate degree of perspective when seeking to understand the implications of any regulation. Although there will be some development costs in complying, more often than not, coping with new regulation is a matter of reviewing and tightening existing policies, processes and procedures. In particular, the following will be important:

■ Exercising control over bank accounts. Having central control over opening and closing of bank accounts, at a minimum, and having good visibility over cash balances is critical to efficient

liquidity management. It will also help to achieve compliance with FBAR and to take full advantage of SEPA.

■ Setting a clear hedging strategy. Following a clear hedging strategy is an important part of managing risk. Establishing appropriate records will help to gain exemption from Dodd-Frank requirements to clear derivatives, but these records will also form part of Sarbanes-oxley compliance.

■ Reviewing short-term investment policy. Changing money market fund regulation and the impact of Basel III will change the relative benefits of different short-term investment instruments. However, it is important to review a short-term investment policy on a regular basis to ensure it remains relevant.

In some cases, compliance (or impact mitigation) will impose greater costs on corporate treasury departments. However, if planned correctly, compliance with new regulation can usually be incorporated into regular reviews of existing practices. At the very least, new regulation will provide the incentive for corporate treasury practitioners to perform such reviews.


Return to

Contents

About the Author

wwCp limited

WWCP’s team of financial researchers, journalists and authors provides its WorldWideCountryProfiles service to a number of banks and financial institutions and professional bodies. Purchasers use the individual country profiles, which are researched and written to their specification, for their customers and prospects, sales literature, their intranet and extranet sites and sales training. WWCP researches over 190 countries.

WWCP researches, authors and publishes authoritative Treasury Managers’ Handbooks for Scandinavia/Nordic/Baltic countries; Central & Eastern Europe; Europe (five editions); the Americas (four editions); Africa; Asia/Pacific & Australasia; Middle East & North Africa; and a Global Treasury CD covering 98 countries (three editions).

Publications also include a number of definitive treasury guides: Best Practice and Terminology; with The ACT, Investing Cash Globally (three editions), International Cash Management and Trade Finance; and, with AFP, Treasury Technology and this Global Liquidity Guide Series.www.treasurybestpractice.com www.worldwidecountryprofiles.com www.wwcp.net

http://www.treasurybestpractice.com

http://worldwidecountryprofiles.com

http://www.wwcp.net

Sharpen your treaSury and finance skills CTP CerTifiCaTion World-claSS education and Training Gain inSiGht into Trends complimentary Webinars fP&a CerTifiCaTion learn peer-teSted, practical soluTions manaGe bank relaTionshiPs time-SavinG Tools leveraGe experienceS from your Peers Benchmark With proprietary researCh confirm besT PraCTiCes exchanGe iSSueS and ideas

expand your global Professional neTWork enhanCe your Career

/ your community / your resource/ your afP.

Join today.www.afPonline.org/Join

AFP, Association for Financial Professionals and the AFP logo are registered trademarks of the Association for Financial Professionals. © 5/13.

MBSP-13_GLQ_FullPg_Ad_3.indd 1 4/3/13 2:44 PM

Return to

Contents

http://www.AFPonline.org/Join

Return to

Contents

aBouT The assoCiaTion for finanCial professionals®

The association for Financial Professionals® (aFP) serves a network of more than 16,000 treasury and finance professionals. headquartered just outside of Washington DC, aFP provides members with breaking news, economic research and data on the evolving world of treasury and finance, as well as world-class treasury certification programs, networking events, financial analytical tools, training, and public policy representation to legislators and regulators. aFP is the daily resource for treasury and finance professionals.

aFP’s global reach extends to over 150,000 treasury and financial professionals worldwide, including aFP of Canada; London-based gtnews, an online resource for the treasury and finance community; and the London-based bobsguide, a financial IT solutions network.

general Inquiries [email protected]

Website www.aFPonline.org

Phone +1 301.907.2862

mailto:AFP%40AFPonline.org?subject=


Documents

AFP GUIDE TO Assessing Today s Regulatory Reality€¦ · implications for corporate treasury practitioners. A similar piece of legislation (EMIR) has been introduced in the EU. Its