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Financial crisis: Eyes on Treasury

13 January 2009 Ernst & Young

As the financial crisis bites, the treasury function within corporations has a heightened role to play in mitigating and cushioning the impact of potential liquidity, cash flow and other risks. However, the function must also continue to deal with a host of other challenges which include regulatory issues and the introduction of new financial standards.

That’s according to the findings of Ernst & Young’s 2008 European Treasury Survey.

Rohan Baboolal, Financial Services Director and Kabelo Malapela, Tax Director at Ernst & Young, agree that while traditionally, the major focus within corporate treasury departments has been hedging against foreign exchange, interest rate and commodity price fluctuations, the global credit crisis has shifted this to a more immediate priority of managing counterparty credit as well as liquidity risks, in particular the ability to refinance debt.

“Treasury needs to have a contingency funding plan in place in these tumultuous times; geographically speaking, while the crisis has its roots in the US and Europe, the impact is being felt here by South African organisations which face many of the same challenges,” says Baboolal
He notes that local banks are re-examining undrawn borrowing and revolving credit facilities provided to corporates, and the ability to access these may no longer as certain as in the past. Lenders are now demanding significantly higher collateral when transacting. “Certainly, the impact of the liquidity crisis is being felt locally, even if it is not as severe. Corporates should consider re-confirming these facilities with banks. In addition breached debt covenants which may have been waived in the past, may find a less sympathetic counterparty in the present environment. Debt may have to be paid well in advance of the contractual maturity date, should a breach occur, placing significant strain on the company’s liquidity.”

With the financial crisis having increased the cost of funding; companies are putting major projects on hold until the situation stabilises or until alternative sources of funding can be found. This, says Malapela, is not restricted to companies in the financial services sector, but is widespread across industries. “Again, the underlying issue is that of liquidity. Cash is in short supply and has become expensive to access.”

Where regulation is concerned, Malapela says the survey notes that corporate treasurers have had to embrace several changes in recent years. “These include the Sarbanes-Oxley Act, Basel II and IAS 39. In addition, with the adoption of International Financial Reporting Standard 7, European companies faced difficulties in terms of the requirement for enhanced disclosures in financial statements regarding financial instruments,” she says.

The survey shows that many companies struggle to comply with disclosure requirements, with a significant amount of work required for historical data research, as well as liquidity and sensitivity analysis. “Despite its implementation several years ago IAS 39, a standard which establishes principles for recognising and measuring financial instruments is still a major challenge for many companies,” she adds.

Many companies found it difficult to comply with strict rules which limit the eligibility of some hedged items to be designated as part of a hedging relationship and in testing hedge effectiveness.

Even as spending scales back across the private sector, there is some relief in the fact that government is obliged to forge ahead on key infrastructure projects related to expanding electricity generation capacity and preparing for the 2010 World Cup. “We cannot pull out as a country; there may be forced innovation in terms of sourcing funding given the challenge of liquidity,” says Malapela; these projects will play a part in supporting employment and consequent value-chains.

Turning her focus to the ever-present challenge of appropriate skills in the treasury function, Malapela says many companies find themselves competing with banks which have better resources to attract suitably qualified persons. “This is a serious challenge for corporate treasury departments. Without the right skills, they cannot deliver on their mandate. What we are beginning to see is an increase in corporates exploring the option of outsourcing certain functions within treasury which is also in line with efforts at cost reduction,” adds Baboolal.

Baboolal goes on to add that given the increasingly hostile financial environment, ISDA agreementswill be scrutinised more closely than in past. “These agreements, which govern the general terms and conditions of trading derivatives, including what constitutes a default event and the process to be followed in the event thereof, is receiving increased focus from treasury and audit committees. Companies will want assurance that in the event of default there are contracts in place which mitigate the risks posed,” he concludes.

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