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Treasury & Capital Markets
In search of a new equilibrium: insights and strategies for treasury
Changes in the global economy and unprecedented market volatility over the past few months have had a profound impact on companies and created significant challenges for treasurers.
Sponsored Section 29 Apr 2016

Changes in the global economy and unprecedented market volatility over the past few months have had a profound impact on companies and created significant challenges for treasurers. The U.S. dollar (USD) surging against 90%1 of currencies globally and oil prices dropping to below USD30 a barrel2—the lowest in 12 years—highlight the fragility of markets and their intricate linkages. Economic fundamentals are shifting, and the responses by corporates and investors to those changes continue to create volatility in areas ranging from commodity prices and currencies to interest rates.

While market developments will affect organizations differently, based on their sector, location, and maturity, treasurers need to have a deep understanding of the key market themes shaping the external environment in which they operate, and use those insights to drive improvements in performance.
 
Key Market Themes
China’s Growth Slowdown
China is now close to being a USD11 trillion economy, fuelled by the strong growth of its domestic sector. Its average nominal GDP growth was 14.3% from 2010 to 20143. Similar to how growth in the U.S. in the 1990s drove expansion of the global economy, growth in China similarly helped its neighbors and trading partners in the 2000s. In more recent years, however, slowing growth in China and decreasing fixed investments have had a significant impact on the global economy, which is the fundamental reason for market volatility around the world.
Despite the slowdown, China’s push for greater global integration continues. China’s One Belt One Road initiative has created opportunities for Chinese corporates and state-owned enterprises to expand overseas, and opportunities have also grown as the number of Free Trade Zones increased4. The Renminbi (RMB) has also marked itself as a key trade currency and will be included in the IMF’s global reserve currencies basket effective October 2016.
 
The New Normal in Commodity Prices
The slowdown in development of China’s infrastructure has in turn led to decreasing demand for commodities. Commodity prices started to fall in 2011 and reached new lows in early 2016. Oil prices plunged from a peak of USD145 in 2008 to less than USD30 a barrel in January this year, and the price now lingers in the USD30—USD40 range. Prices of other commodities have also declined, as slowing economic growth around the world translated into less demand for raw materials. The S&P commodity price index, which tracks commodity prices for everything from oil to cotton and cattle, is now about 50% lower than it was five years ago.
 
Diverging Interest Rates
The global economy has also been affected by interest rate changes, especially in developed markets. The U.S. began a first-in-a-decade rate tightening in December 2015, signaling the relative strength of the U.S. economy, though headwinds from China and commodities markets have complicated plans for further rises. On the other hand, Europe and Japan are still pushing towards easier money and expanding balance sheets, with the Bank of Japan introducing the zero interest rate on required reserves in February 2016, as well as charging negative rates for excess reserves over the 2015 average balances. 
 
Depreciating Currencies and Lower Growth in Emerging Markets
The comparative strength of the U.S. economy has pushed emerging market (EM) currencies down as much as 20—30% against the USD, to near their lowest levels since 2002. This drop has weighed heavily on emerging market returns, especially for investors who borrowed in USD-based instruments. However, while many forecasters expect EM currencies to continue to depreciate, a number of those markets have shown signs of stabilization and lower volatility in recent months.
EM GDP growth rates have also continued to trend down, squeezing funding and constraining resources for corporates in emerging markets. EM GDP growth slowed from 5.0% in 2013 to 4.2% in 20155 and the impact has been significant, considering that emerging markets now contribute a greater share of the global GDP. Foreign Direct Investment (FDI) into EMs has also slowed.
Limited growth at home has compelled companies in emerging markets to turn elsewhere for expansion. FDI outflow from emerging markets doubled from USD235 billion in 2009 to USD470 billion in 20146, in contrast to the slowing FDI outflow from developed markets.
 
E-Commerce and Technologies Disrupt Entire Industries
Amidst low growth and volatility, the technology and e-Com-merce sectors have continued to expand. Globally, the growth rate of e-Commerce businesses is expected to be 10 times that of brick-and-mortar stores. New channels and innovations also provide opportunities for corporates and the financial sector to reshape existing practices for doing business. Industries are being disrupted by new players with new business models, and existing players are leveraging technology to reengineer and reinvent traditional business processes.
One of the leading forces in this innovation is the “fintech” sector, which received about USD12 billion in investments in 20147. While the majority of this amount was spent on retail banking applications, more and more innovations are positioned to cover working capital optimization, data and risk management, and payment services for corporates. Global banks are making significant investments in these areas as well, collaborating with both fintechs and clients to drive innovative and sustainable improvements.
 
Five Strategic Focus Areas for the Treasurer
Market volatility will eventually subside as the new equilibrium in the global economy sets in. Corporates or investors who navigate through the short-term changes well while planting the seeds for long-term growth can reap the rewards. Treasurers should rethink the status quo and strategize outside of their comfort zones so that they can build in flexibility, increase     efficiency and mitigate risk successfully. Five focus areas are especially important.
 
1. Revamp Internal Policies to Prepare for Unconventional Events
Revisit and refine internal policies to ensure that they are relevant and suitable in light of unconventional events, such as negative interest rates in Japan. Clear treasury policies and effective monitoring mechanisms will help provide direction and control in managing balance sheet risk and capital funding. Treasurers should manage the short-term volatility within treasury’s risk management framework, while helping the business achieve long term plans. Reviewing policies with external advisors who have extensive experience with corporates can help treasurers identify areas for improvement and avoid inflexibilities that can introduce complexities in the future.
 
2. Optimize Operating Liquidity and Working Capital
With investment opportunities and funding sources becoming more scarce, treasurers face a delicate balance between holding the “right” amount of cash and optimizing risk and returns. For strategic cash, treasurers need to focus on protecting principle while enhancing yield. For operating cash, treasurers need to achieve efficient utilization, helped by liquidity solutions that allow for optimal usage of cash when and where needed. Some treasurers may also want to consider paring back investment plans and focus instead on bolstering liquidity. Banking partners can help conduct deep dive reviews of cash flow patterns to determine optimal levels of cash and devise strategies to    deploy them effectively.
3. Manage FX Volatility Proactively and Comprehensively
Consider all options available across the financial and operational spectrum when it comes to managing FX risk. On the operational side, treasurers can work on local currency invoicing and revision of pricing, for example, while on the financial side, they can raise local market financing and utilize derivative instruments. It is important that treasurers fully understand the currency risks inherent in the business flow, taking into account direct and indirect FX exposures as well as the full menu of strategic options.
 
4. Improve Operational Efficiency
Develop a detailed picture of the end-to-end value chains of the business and the impact of external market volatilities that percolate through that chain, so that optimal strategies can be devised based on whether the changes have a positive or negative impact. At the same time, treasurers should also consider long-term projects that will improve process efficiency, such as supply chain financing or re-invoicing or central trading centers, to enable more productive use of working capital. Expert advisors can help pinpoint inefficiencies and identify fundamental structural improvements, especially for large-scale initiatives such as setting up a shared services center or regional treasury center.
 
5. Utilize New Technologies for Treasury Transformation
Treasurers need to be ready to support changing business    dynamics, as well as to utilize new technologies to meet the continuously increasing demand for valuable real-time information. Treasurers should take a proactive look at business plans and treasury technology platforms, with a view towards identifying sustainable technology investments. They should work in close collaboration with the CIO on a long-term plan aligned with the treasury transformation roadmap that allows for cost-effective processing of standardized tasks, provides value-adding information and addresses new cyber-security risks.
 
Succeeding in 2016
Until the market rebalances to a new equilibrium, the role of the treasurer is to navigate through this period of uncertainties and low visibility with caution and concentration. By focusing on these five key areas, treasurers can help achieve the ultimate goal of creating value for the firm by optimizing capital use and mitigating risks to the business flows from external market factors, and continue to thrive despite the challenges in the markets. 
 
 
 
 
Sources:
1. J.P. Morgan: Global FX Strategy 2016 Outlook November 25, 2015; Factset as of January 08, 2016
2. Bloomberg
3. IHS Global Insight
4. ECNS: “Third batch of free trade zones to be finalized shortly” 
5. IMF: Slowing Growth in Emerging Markets, a Gradual Pickup in Advanced Economies 
6. World Investment Report 2015, UNCTAD
7. The Economist: "The Fintech Revolution"
 

 

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