Three topical questions were posed to delegates at the start of the second day of the Association of Corporate Treasurers (ACT) conference in Liverpool by the organisation’s president, Jono Slade, who is also global head of corporate finance at mining group Rio Tinto.
Firstly, did corporate treasurers place too much trust in the banks before the 2008 crisis? Six out of 10 in the audience replied ‘yes’. Secondly, are regulators in the eurozone getting it right with the slew of new rules and regulations? More than seven out of 10 (71%) in the audience thought not. Thirdly, despite the series of crisis’s that have hit the region, would the eurozone survive the turbulence? Seven out of 10 believed that it would and the single currency will continue.
RBS Treasurer Outlines Repair Work
The first ACT conference presentation of the second day [day one report here -Ed.] was given by John Cummins, group treasurer at Royal Bank of Scotland (RBS), who joined the group just after its ill-fated acquisition of Dutch group ABN Amro in 2007 after 10 years as treasurer at financial group Standard Life. Even today, the group continues to attract unfavourable headlines thanks to its UK government-backed bailout that followed soon after the overpriced ABN Amro deal, but Cummins stressed that today’s RBS is on the road to recovery, with a better funding structure, improved balance sheet and ‘sensible’ funding mix. “The liquidity pool is much improved, while our short-term reliance is reduced,” he added.
Things could hardly have been worse of course after such a low starting point but turnaround and recovery activity is sometimes some of the most interesting work that a treasurer can do. In the case of RBS’ treasurer there will certainly lots for him to get his teeth into.
The group’s slow recovery has reflected that of the UK banking sector generally since 2008, with total capital 650% higher from its pre-crisis level of £20bn, now standing at £150bn, smaller and more focused balance sheets, and a healthier wholesale funding profile, explained Cummins. This strength had an associated cost however, with liquidity buffers sharply higher and a restrictive post-Vickers Report regime imposed on the sector by its new UK watchdog, the Prudential Regulatory Authority (PRA), which requires UK banks to restrict their purchases to gilts, bonds and treasuries or to hold cash.
As a result, each pound of additional liquidity has a carry cost, which must be factored into product pricing for corporate end user clients, explained Cummins, and costs have increased as UK banks move away from short-term debt. The continuing push from both regulators and the markets for banks to have more capital requires better returns if they are to maintain their return on equity (RoE) and as capital ratios have nearly tripled at UK banks, so the cost of equity capital has risen. The international Basel III rules are also a key driver of this trend.
“Pre-crisis, the market pushed the banks to strive for an ever-increasing RoE without thinking about leverage,” said Cummins. “Today, bank management must attempt to balance a number of tight restraints while at the same time attempting to deliver acceptable returns.
“We have to rebuild trust with our customers, investors and the general public, politicians and the media, which means putting customers before profit.”
In 2013, RBS’s treasurer has six main risks at the top of his agenda to manage: market access; maintaining the confidence of investors; anticipating what might come next from regulators; keeping staff motivated (often in the face of sizeable job cuts); the weakness of economic recovery in Europe and increased competition.
For corporate treasurers, the impact of the ‘new normal’ operating environment for the banks would be an alteration to banks’ product sets, changes to specific products through increasing innovation and both keener competition and improved service levels being offered as reducing revenues force banks to revert to more traditional client-based business and to adopt a longer-term focus, claimed Cummins.
Financial Innovation: A Force For Good or Evil?
This question, about the worth or otherwise of financial engineering, was the subject of a debate at the ACT conference by a panel of ‘three wise men’: former investment banker and now best-selling author, Philip Augur; senior independent adviser to Deutsche Bank, Sir Richard Lambert, who has previously edited the ‘Financial Times’ and was also chief of the Confederation of British Industry (CBI); and Keith Starling, chief financial officer (CFO) of social investment pioneering group, Big Society Capital.
An audience vote on whether financial innovation had generally proved to be good for society showed only 31% convinced of its benefits. Lambert argued that ever since loan contracts were first devised in Babylonian society 4,000 years ago, innovation had steadily raised living standards and general wellbeing, with only overly complex financial products proving to be a source of trouble.
As his books testify, Augur is less convinced. While much financial innovation had been beneficial “the last 40 years had seen a world of turbo-charged financial innovation, producing leveraged and structured products that have had destructive results – wrecking economies and denting gross domestic product [GDP],” he argued. Recent innovation had merely developed a “gaming of the system” characterised by increasing tax avoidance and investment bankers creaming off disproportionately huge rewards.
CFO Starling countered that the past 50 years had been distinguished by many positive developments from financial innovation, with automated teller machines (ATMs), debit cards and online banking giving the ordinary consumer instant access to cash. In addition, three specific innovations had “unlocked the power of the entrepreneur”:
- Micro-Finance: Loans at fair terms had been made available to individuals who would otherwise be financially excluded and their numbers have risen from 20 million in 2002 to 200 million by the end of 2010.
- Venture Capital: A vital provider of funding for entrepreneurs, the industry boomed in the 1970s and slowed in the two subsequent decades, but had proved to be a great success overall.
- Social Investment: Otherwise known as the provision of finance to generate social and financial returns, social investment is used to promote health and wellbeing for those in society who would otherwise get left behind, such as the long-term unemployed, the homeless and NEETS (aka young people not in employment, education or training).
A market valued in the UK at £165m in 2011, the NEET and social investment sector is projected by the Boston Consulting Group to grow to £750m by 2015, and to top £1bn in 2016. “Big Society Capital represents a significant pool of money ready to be invested,” declared Starling. “It represents a huge opportunity for social entrepreneurs.” Significantly, a repeat poll at the end of the session found that 47% of the audience now believed that financial innovation was a good thing, so some of the arguments obviously hit home.
The Strategic Treasurer
According to Yuri Polyakov, managing director and head of financial risk advisory at Lloyds Bank Commercial Banking, the “new economic environment” has become a well-used phrase in the past couple of years, and it was certainly heard a lot at the 2013 ACT conference. The strategic treasurer is one who manages the consequences: risk arising from more regulation, which requires awareness; more uncertainty, which requires a regularly updated risk management policy; and more scrutiny, which requires the treasurer to communicate upwards within the organisation.
“Treasurers now have to communicate fairly complicated financial concepts to their senior colleagues,” he noted. To take regulation as just one example of rapid change, no less than eight new major regulatory regimes affecting businesses worldwide are being introduced over the period 2012 to 2017.
Judging just when a business stands in the economic cycle is challenging, given the huge amount of information and the need to make sense of it all. Market indicators have recently been strong, but are countered by still-weak economic indicators, suggesting that “we’re not out of the woods yet.” Polyakov suggested that treasurers devise a risk score card, based on the potential impact on the business posed by a particular risk and whether or not any action had been taken in response. This would help to highlight those risks that require urgent action and frequent monitoring.
Bob Williams, regional finance director for UK house builder Barratt Developments and a former ACT president, offered a case study on how the group had navigated the challenge of the downturn, which came shortly after its major acquisition of rival Wilson Bowden in 2007. At that time, the construction group had been criticised for “not gearing up enough” as it had raised some equity towards financing the acquisition.
Williams said that Barratt’s previous experience of an earlier UK property downturn from 1989 to 1992 had served as a model for its funding and persuaded it to raise some equity. “Do what you feel is right, rather than what the market is telling you to do,” advised Williams. Barrett also sold off stock as the credit crunch hit in the first half of 2008, stopped buying land and sat down with its banks to discuss resetting its covenants just as critics changed their criticism and accused the group of being too highly geared.
Strategic Funding For Future Growth: BG Case Study
An afternoon panel session considered how corporates are now using the capital markets, with capital market funding now increasingly replacing traditional bank funding – a ‘new normal’ trend reflected in the number of asset managers evident at this year’s ACT conference, according to Russell Maybury, managing director of corporate and institutional coverage at RBS.
“The capital markets aren’t just for the big boys, but have been successfully-accessed by lower-rated companies,” he told his audience. “Investors are hungry for yield, which has allowed BBB-rated issuers to move in.
“Vanilla issuance is no longer dominant in the sterling market as there is a huge amount of both hybrid and structured issuance, while investor ticket sizes have grown.”
The session provided a case study of natural gas giant BG Group from its group treasurer and acting group head of tax, Pedro Zinner, who said that treasury policy in recent years had been to find the ‘sweet spot’ from optimising the trade-off between diversification of the group’s funding and cost. “The policy of diversifying BG’s sources of funding has involved building a sustainable long-term strategy to support growth,” he said.
“The aim has been to gain adequate long-term funding on a risk-adjusted basis for BG to support its growth plan.” In 2012, the gas group completed a number of deals that included a US$500m five-year facility with Export Development Canada (EDC) organisation; three tranches of hybrid bonds totalling US$2.1bn; a co-operation agreement with the Japan Bank for International Co-operation (JDIC) signed last October; and a new US$3bn committed multi-currency syndicated bank facility the following month.
“BG isn’t alone in its journey as many of our peers in the oil and gas sector have a similar funding profile, in which credit facilities and the debt capital market are significant,” said Zinner. “So reliance on short-term borrowings has been reduced. A large proportion of outstanding debt now has more than five years to maturity, reflecting the long-term nature of the assets.”
There has been an uptick of treasurers inquiring about interest rate risk management in recent months as interest rates in the US and UK have started to show a rise in momentum, said Chatham Financial at the annual Bellin treasury conference.
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