Treasury to the rescue While a degree of order has been restored to the financial world, many company treasurers remain cautious in managing cash and risk, reports Ng I-ching Illustrations by Emilio Rivera III Before the onset of the financial crisis in 2008, global markets were largely flush with liquidity and borrowing was relatively cheap and easy. Corporate treasurers, whose role is to manage cash and arrange company financing, did not have to worry too much about the availability of money or the risks of borrowing, recalls Francis Ho, group treasurer of Hong Kong s utility giant CLP Holdings Ltd. Prior to the crisis, some companies thought they could keep using short-term financing to fund longterm capital expenditure and assumed the cost of funding would stay more or less the same over the long run, he says. But the sudden collapse of the U.S. housing market followed swiftly by several high profile bank failures changed conditions almost overnight. Financial institutions were quick to cut off funding to clients, creating fear across markets and in effect bringing bank lending to a halt. During the crisis, many treasurers were asked by their board, Where is our cash and what is the real-time cash position? Some treasurers were caught out, realizing they didn t have the full picture as many processes remained local, manual and not as transparent as they should be. This was especially true in Asia Pacific, says Tim Fleming, head of Asia Pacific corporate treasury sales at Bank of America Merrill Lynch. The result was that corporate treasurers, who typically used to work in the back office reporting to their company s chief financial officer, are now at the forefront and have to make managing cash and risk a top priority lest another credit crisis or market volatility drains capital from their corporate operations. In the post-crisis world, management of companies have put more emphasis on the treasury function, says Allen Leung, director of treasury operations in Asia Pacific for PPG Industries International Inc., a multinational producer of fibreglass and industrial paints and resin. Treasurers have to spend more time and be more vigilant about cash management, and strengthening risk controls, he says. 32 November 2010
The shifting roles The corporate treasury role has gradually evolved over the past decade or so, becoming increasingly strategic as treasurers learned to adapt and operate in a more complex financial environment. Such changes accelerated during the financial crisis. Today, treasury departments are often required by management to ensure liquidity by employing a range of measures to diversify financing and counterparty risk. Such measures include bond issuance, share buybacks and the creative use of hedging, all of which help shield companies from commodity volatility and foreign exchange risk. This heightened focus on risk prevention has thrust company treasurers into the limelight, says Eymon Tsang, director of corporate finance at Hong Kong-listed real estate conglomerate K. Wah International Holdings Ltd. Nowadays, I have to regularly inform the top management about the company s cash flow position, says Tsang, who oversees the company s treasury function. November 2010 33
Tsang issues regular updates on the company s liquidity position and monthly cash flow forecasts for his board and senior management. Though he declines to give an exact headcount, he says he had to substantially expand the treasury department partly to cope with the extra workload. Cash and carry Many lenders are recovering from financial distress and scrambling to comply with new regulations such as Basel III, announced in September, which recommends that banks hold more capital from 2013 onwards and have a capital conservation buffer of 2.5 percent to withstand periods of stress. These reforms will likely make lending more costly and banks stingier with loans. In this scenario, treasurers would be wise to increase their companies cash reserve to prepare for the unexpected, says Peter Wong, founding president and chairman of the International Association of CFOs and Corporate Treasurers (China). The board now requires the treasurer to keep more cash to reduce liquidity risks and in the expectation that banks will be more cautious in lending and their funds are now more expensive, he says. For instance, PPG has increased its cash reserve to a near record level of US$1.1 billion last year, up from US$500 million in 2007 before the crisis hit, says the company s treasurer Leung. K. Wah has boosted its cash reserve from HK$1.3 billion to HK$1.9 billion over the past 18 months, says Tsang. The larger cash buffer aims to prevent any liquidity shortage in the development cycle of future real estate projects in the mainland and Hong Kong, he explains. The situation is similar at Johnson Controls Hong Kong Ltd., the local subsidiary of the Fortune 500 company that makes building control systems and offers building management services. The 2008 crisis changed the company s focus on cash from the top down, says Wolfgang Ratheiser, the company s corporate treasurer overseeing Asia Pacific and the Middle East. Since the crisis, Johnson Controls Inc., the U.S.- based parent company, has reduced their net borrowing position substantially and has increased their liquidity cushion via commercial paper and bilateral lines credit lines pre-arranged with banks. By June, the company had a cash reserve of US$908 million, up from US$776 million in September last year, says Ratheiser. The bankruptcies of automobile giants General Motors Co. and Chrysler Group LLC, both clients of Johnson Controls, highlighted part of the company s exposure to counterparty risks and prompted Standard and Poor s to downgrade its credit rating from A- to BBB. To recover its credit rating, Ratheiser is pushing on several fronts to improve the company s risk profile. 34 November 2010
We have put in place several bilateral credit lines and are in the process of repaying a bond, he says. Cash management is vital Of course, amassing cash introduces other challenges. For example, how can treasurers make the surplus liquidity more efficient and use it to drive their companies strategic growth? Due to the difficulty of obtaining loans in China, more and more Hong Kong companies are depositing more cash in their mainland bank accounts so that they can fund their projects and developments there and benefit from the potential appreciation of the yuan at the same time. They tend to borrow from banks in Hong Kong to meet other operating cash needs because of the low interest rates here. K. Wah also uses this method to maximize the value of its capital, Tsang says. Another solution is to use short-term entrustment loans to reduce the need for bank borrowing. In China, where the group has many operations, a non-financial institution is not allowed to issue loans to another company but the parent company of a group can pay a mainland bank a small fee and entrust it to make a loan to the group s subsidiaries. In effect, the entrustment loans can reduce the subsidiaries need to take out the more costly loans from the banks while the liquidity of the company is maintained, Tsang explains. Diversification counts Meanwhile, some companies have taken a different approach to make their use of capital more efficient. Our strategy is to diversify funding and spread out the risks in terms of sources, tenor and instruments, says Ho of CLP. We seek an optimal mix of funding from bonds and bank lending, as well as a balance of short, medium or long dated debt for financing flexibility to match our business needs. To match the long payback period in the power industry, we also need to raise or convert to an appropriate level of fixed-rate debt, usually about two-thirds. Other companies have begun using a wider pool of banks in order to diversify and minimize their exposure to their banks counterparty risks, says Wong of IACCT. It s particularly true when U.S. or European banks are preserving bank lines for their home clients, he explains. The sovereign debt crises in Dubai and Greece showed that counterparty risk exposures could The board now requires the treasurer to keep more cash to reduce liquidity risks and in the expectation that banks will be more cautious in lending and their funds are now more expensive. jeopardize banks ratings and their abilities to lend. That reasoning has resonated with many companies in Hong Kong. Sam Kwok, treasurer of Airport Authority Hong Kong, says he preferred to use the relatively stable banks during the financial crisis, including Hong Kong and Japanese banks and China-backed lenders. And when it came to financing the airport operator s five-year, HK$5 billion syndicated corporate loans in June for refinancing and raising general funding, Kwok chose to close the deal with 14 banks. To get an even clearer picture of how its banks weathered the crisis, Ho of CLP maintained close communication with the lending banks to get market updates and a better understanding of the liquidity situation and their ability to lend. CLP has been using 54 banks since last year, up from 45 in 2008. In addition, the company has improved its line of communication to get backing and reassurance from the banks and investors for its ongoing investments in large-scale power projects in China, Australia and Southeast Asia. We maintain close dialogue with equity and debt investors, lending banks and credit rating agencies, he November 2010 35
Treasurers have to prepare for the unexpected. They ve got to pre-fund their strategic business and make sure they are safe. says. We continue to keep a high level of transparency about our business and strategy, and receive feedback from external parties. This allows us to communicate with stakeholders in time to clarify our situation and collect their comments if appropriate. In addition to assessing risks from its lenders, CLP has also turned to its supply chain. We use different approaches to ensure we will enter into contracts or business relationships with creditworthy counterparties so that they can deliver their obligations, Ho says. More bonds issuing Another tool that is growing in popularity among treasurers in diversifying their funding sources is a public bond issue or a private placement. Many corporate treasurers have reduced their reliance on the banks for long-term funding and raised the money they need from the public debt market, says Stuart Siddall, chief executive of the Association of Corporate Treasurers in the U.K. Treasurers have to prepare for the unexpected. They ve got to pre-fund their strategic business and make sure they are safe. That has forced them to seek funds in the debt market, he explains. Following global trends, Hong Kong has witnessed a surge of corporate bond issuance this year. In recent months, local blue chip companies such as Hongkong Land Co., Cheung Kong Infrastructure Holdings Ltd. and Hong Kong and China Gas Co. have sold new notes to help their companies refinance. CLP, for example, issued a 10-year, US$500 million corporate bond in March to capitalize on market opportunities. The main purposes were to further diversify our debt investor base, lock in long-term capital at attractive rates and extend maturity, says Ho. The notes were issued at 4.75 percent and swapped back into Hong Kong dollars to mitigate the currency risk. Philippe Jaccard, managing director and Asia head of liquidity and investment at Citi Global Transaction Services, says the growth of corporate bond issuance in Hong Kong should be heralded as a positive trend that the market is gaining sophistication, not an indication that companies have less faith in banks. Companies are turning to corporate bonds as a natural process of a more mature economy, in which the banking system cannot possibly carry all the debt outstanding on balance sheets, he says. The same will happen with bank deposits that will be moving into money market funds over time because banks can no longer satisfy all the short-term liquidity needs of a mature economy. It s about industry specialization coming from maturity. It s actually a very good sign. 36 November 2010