One must choose the lesser of two evils 2

One must choose the lesser of two evils

ISAE 3402 July 2012

more expensive FX pricing coming years June 2012

Origins of modern treasury 2012

A victory in a battle can obscure the problem also…

RFPs: how best to formulate your needs to ensure your requests for proposals succeed?

How best to select your suppliers objectively and honestly, observing treasury management principles and best practice. This article goes over the basic rules that you are recommended to follow to make your request for proposals a success. Proper preparation of the RFP ensures a (more) successful project, and is a way of avoiding nasty surprises. 

Definition of an “RFP”

RFP is an acronym standing for “Request for Proposal”. During the procurement process, it is the first stage in which suppliers are invited to submit proposals matching specifications that are drawn up with as much precision as possible. The response to the request for proposals puts the corporation and the treasurer in the best position to make a fair selection of the company or companies to be used (depending on whether there is to be a second round and whether a shortlist is to be prepared). Simply responding to the request establishes the supplier’s interest in the request from an early date. Requests are therefore sometimes rejected. It is the means of clearly demonstrating the intention of embarking upon a competitive process and seeking the best combination of quality and price – and it is the combination of both that needs to be evaluated. Obviously an RFP is not issued when opening a bank account or buying some low-value service, or a low-cost piece of software that is easy to install. Typically, RFPs are used for purchasing treasury management systems software, major consultancy jobs, setting up “payment factories”, putting “cross-border cash pooling” in place at the European level, etc. Through the RFP document, potential suppliers are asked to commit to making their best possible effort to achieve the intended objective. It is also a preventative measure to avoid either side wasting time through misunderstanding or over/underestimating the customer’s needs and expectations. It is therefore much more than a simple price bid that is expected. The treasurer is expecting commitments, detailed information, a competitive price, details of implementation and the resources to be provided, completion time limits, any points not covered or outside the scope, etc. It should demonstrate the treasurer’s impartiality in choosing the supplier. There are certainly “false RFPs” and pseudo-RFPs. Their purpose is to beat down the existing supplier’s price at the time the request is put out. Many companies use them for this purpose, without adhering to the rules of fairness which would involve selecting the best supplier and not the existing supplier, even if it drops its price. Bogus requests for proposals should be avoided, since they damage the reputation of those issuing them. That is the price of credibility. When the supplier realises that the treasurer is prepared to dispense with the current service or product for another one if it is better and/or cheaper, that supplier then tries much harder, and competition becomes effective. 

What is an RFP for?

In treasury management, it is good practice to make use of Requests for Proposals. RFPs are the best way of respecting your partners, giving them the opportunity to put in a proposal and a price for a service or product, to adhere to certain professional ethics and finally to provide assurance of necessary and fair competition between suppliers. At a time when ethics are more than ever in the spotlight, requesting proposals is sound and good practice. It is also the surest way of guaranteeing that the service to which the seller has committed will be performed in accordance with the treasurer’s expectations. Defining your needs properly is the way to guarantee that the proposal will match the request. It will also avoid misunderstandings between the seller and the buyer. In short, it is a sort of list of specifications. You would usually ask for a quote for the smallest jobs that tradesmen would do on your house, but for major purchases for your department this is often not done on the pretext of having identified the product or service required. RFPs often show who has the motivation and capacity to do the job required. Buying treasury software is not like buying a dishwasher. The product often requires associated services and human and technical skills. Product life and the firm’s soundness are also essential to the project’s success over time. It is also often required as a precautionary measure, for internal control purposes, to avoid fraud, cronyism and other risks of misappropriation of corporate assets. If we look at the Bribery Act (www.legislation.gov.uk/ukpga/2010/23/contents) in the UK and at this focus on the fraud and ethics aspect in companies, we realise that RFPs are not only sound practice but also essential to forearm ourselves against subsequent criticism of the selection made. But the question then arises of how best to draft an RFP. Plenty of people talk about it, all too few put it into practice, some ignore it or even worse subcontract it to consultants, and far too many overlook its merits and the reasons for its existence.

Composition of an “RFP”

In general, an RFP must contain a series of pieces of information. It must be neither too short, nor too long. However, for purchasing a TMS for example, there is very often far from adequate precision, and omissions, inaccuracies or loopholes will cost dear over the project’s lifetime.

Alongside this traditional structure, it is advisable to add everything that the treasurer considers to be appropriate and necessary to the success of the project. Obtaining an absolute obligation (preferably) and/or a best efforts obligation is also important in preventing any subsequent disputes. Precision therefore acts to prevent disputes and misunderstandings. It is when the going gets tough that the treasurer will be glad he was comprehensive and precise in drawing up his RFP.

RFI, RFQ and RFT

As well as RFPs, there are also Requests for Information, Requests for Qualifications and Requests for Tenders. Here, the objective is to obtain additional information. They are not binding on any of the parties. An RFI does not necessarily lead to an RFP. It is also the route to a better understanding of the pricing mechanism implemented by a bank, for example for comparing the terms applied by different organisations to all of one’s subsidiaries. An RFQ is often a preliminary stage for compiling a shortlist of potential prospective suppliers who meet enough of the conditions to deliver the treasurer’s expectations. An RFQ is also often confused with a Request for Quotation, where the expectation is solely about price and where the treasurer knows that all the candidates approached are able to deliver the required product or service.

Finally, the Request for Tender is used most by public or government bodies. It doesn’t matter what the request is called, the important thing is to be certain that you get what you want. For completeness, we should mention the Best and Final Offer (BAFO) which is a sort of second and final round, or even the Best and Revised Final Offer (BARFO). (X)

Conclusions

An RFP must be meticulously and conscientiously prepared to be useful and to achieve the set objective. There are solutions offering RFP templates. Although cheap and helpful, they are not absolutely necessary. Everyone has their own method and approach. Stamp your own style on your RFP. It should have your stamp, your mark and your personal touch. Respect for the participants and fair and transparent treatment is absolutely crucial. Losers also learn about the other participants. Losing with dignity and respect is not always easy. A “good loser” should be respected and will always be well perceived at subsequent requests. If an RFP is issued, it should be genuine and honest. The best applicant must always win, and it should always be based on objective criteria. There is a real dilemma between being complete and comprehensive, and therefore producing a long and laborious document, and “making it (too) short”, with the risk of the treasurer not getting what he wants. Grey areas, or areas that have not been covered, are always pretexts for reviewing prices and claiming that the point was thought to be outside the scope. Always ask for a (detailed) breakdown of prices so that you can calculate the cost of each of the solutions on the basis of reasonable assumptions. Prices are sometimes set out in a complex manner, which makes them difficult to compare. In this case a plausible simulation must be run to make an effective comparison between proposals.  The quality and presentation of the responses is, to my mind, also a criterion to be taken into account. A company that cannot respond concisely and professionally disadvantages itself from the outset. A premium for the quality of the response should be awarded in the scoring matrix (a scoring matrix in Excel format, in general with a pre-set rating for key points). There is little useful and comprehensive literature available to help treasurers on the subject of RFPs. In time, through practice, they will end up finding a style and a template that they can keep on improving with each RFP/RFI. Even though requesting proposals imposes constraints, it is nevertheless good practice and beneficial for the issuer. Prepare yourselves well with a full and precise list of specifications so that you get back satisfactory responses that enable you to make an informed selection. A project is already an adventure full of pitfalls. Don’t make it any worse by any half measures when preparing it.

 (X) How Requests for Proposals should be used in business – http//www.negotiations.com/articles/procurement-terms/

François Masquelier,

Chairman of ATEL

Over and over and over again

Surely we have reached the end of a cycle? Are we not at one of those turning points in history where one day we will have to decide which way to go? Has the time not come to rethink our economic model? With the situation apparently so complex we are right to ask these questions.  Our economic model seems to be in need of a profound and fundamental change to seek for a more sustainable system – in everything. Today we are in dire need of a more wide-ranging overview of a balance that no longer exists and on the future of future generations. Like the profligate cricket of La Fontaine’s fable, we live in a system of “too much” and of “over”: over-consumption, too much debt, too much pollution, overuse of our limited natural resources, etc. – an excess of excess!

We followed a course that led us to our current economic problems. The problem of debt, unfortunately, cannot be resolved by yet more debt. However, that is what we keep on doing.

An accumulation of short-term fixes never produces a good long-term solution.  At the end of the day, human beings have a tiresome tendency to resist change and always favour solutions along the lines of what they are already used to and what they have always done.   This resistance to change is, in the long-term, very damaging.

These few observations, which are so simple and obvious, ought to be applied to the current financial crisis. We fight to preserve the Eurozone, to save governments from the financial abyss that looms over them and to maintain a worldwide financial equilibrium, as best we can. But is it a good idea to use resources to preserve statistics and maintain the current state of affairs? Are we not wasting resources and energy trying to fill in a bottomless pit? Is government debt (also private debt, particularly in the USA) sustainable? Even though we have a deficit of only 3%, it is still a deficit that foists the problems onto future generations. Balanced budgets are what we need, fast. The economic growth that we desire is still based on overconsumption of natural and financial resources. We need growth that is more sustainable and less artificial.

The problem of debt will not be resolved by growth. We have to find a more radical solution, simply spending less and spending better. The crisis is not just a crisis of capitalism, it is also due to aberrations of a certain socialist system approach (not in its objectives, but in the way it carries them out) and is also due to Keynesian policies. In our view, the future will be slower and more sustainable. We therefore need to look further ahead, not just to the next quarter or year. The difficulty rests in the art of making things healthier while looking after the interests of the whole community, with moderation, without excessive greed, and favouring quality over quantity.

For more sustainable finance, we have to be daring. It is naive to suppose that zero interest rates will be a solution for apathy on the markets or that they will encourage any recovery.

Excess wrecks everything. Our economic model seems to have become obsolete. We need to get back to a more virtuous circle. We are living beyond our current and – even worse – our future means. We are at the dawn of a new era.  Our grandparents told us of the 1929 crisis.  Today, the G20 is sticking patches on punctures, whereas what is needed is a change of inner tube, a change of tyre, or even perhaps the wheel bearings. For that, you need vision and most of all courage. Unfortunately, politicians work to the short-term, as do many CEOs, and refuse to take a long-term view. They fend off problems, pushing them ever further away, without ever fixing them now. It is high time we woke up and attacked problems in a durable manner.

F. Masquelier, ATEL Chairman

ESMA Consultation Paper, Part Two

 What will be the final outcome on the OTC Derivatives reform (EMIR). What could we expect in terms of exemptions?  ESMA has recently published a second Discussion Paper (DP), end of June 2012, to address some of the issues raised by interested stakeholders. ESMA made progresses and this new DP seems to go in the right direction at least. The path remains long. However, we have a new opportunity to comment the DP and to make sure Corporates are heard.

 Back into 2009

The regulatory changes mandated by G20 countries back in 2009 will finally come into force. This is expected to happen in the USA (where the changes come under the Dodd-Frank Act) by end of 2012. In Europe, which is expected to follow somewhere around middle of 2013, the changes will be implemented as part of EMIR (European Market Infrastructure Regulation). The changes will affect mandatory collateral levels in ways that will have clear implications for corporate clients of banks. Collateral levels will be set higher than previously, to reflect the perception that the instruments are higher risk. The increase is related to the fact that OTC contracts have a longer lifecycle than most of the current cleared products. They are measured in years or decades rather than days, which increases the risk of counterparty default and hence margin requirements. Costs will also be higher for those transactions that will continue to be cleared bilaterally rather than clear centrally. The processing of collateral will become more complicated, more sophisticated and possibly more fragmented as the number of potential service providers grows.

Second Consultation Paper on OTC Derivatives reform

On 25^th of June 2012, ESMA has issued its second Consultation Paper (DP – Draft technical standards for the regulation on OTC Derivatives, CCPs and Trade Repositories – ESMA/2012/379). As previous document, the second one is rather long and technical. No one would dare to pretend it is an easy reading for summer holidays. However, summer holidays or not for treasurers, they should read it if they want to comment it. ESMA invites comments on all matters in that paper. These potential comments would be helpful if they contain a clear rationale, if they include quantitative elements to support any concerns and if they describe any alternatives ESMA should consider, including alternative drafts. ESMA promised to consider all comments received by 5^th of August 2012. All contributions should be submitted online to www.esma.europa.eu under the heading “consultations”.

All contributions received will be published following the close of the consultation period, unless requested otherwise by commenters. All interested stakeholders are invited to respond to this consultation paper. In particular, responses are sought from financial and non-financial counterparties (i.e. corporate treasurers) of OTC derivatives transactions, central counterparties (CCP) and Trade Repositories (TR).

One of the essential elements in the development of a technical standard drafting is the analysis of the costs and benefits that these legal provisions will imply. The information collected during first consultation dated from the 16^th of February 2012 doesn’t allow ESMA to assess quantitative impact. They would like to focus on (1) clearing obligation, (2) risk mitigation techniques for contracts not cleared by a CCP and eventually exemptions to certain requirements. There is also a part focusing on trade repositories and in particular the content and the format to be reported to TR.

Exemption mechanism

In the section III.V non-financial counterparties (article 10 of EMIR) (annex, chapter VII, NFC), ESMA recognises that non-financial counterparties use OTC derivatives to protect themselves against commercial risks or treasury financing. These operations and those which do not protect such risks but which don’t exceed the threshold limits are not subject to the clearing obligations. In case, these deals exceed the threshold, the clearing obligation will apply to all future OTC derivatives concluded by corporates after it has exceeded the clearing threshold.

In order to calculate whether it exceeds clearing thresholds, a non-financial counterparty does not include contracts objectively measurable as reducing risks directly related to its commercial activity or treasury financing activities. ESMA defines in its document the criteria for “objectively measurable” as reducing risk directly related to the commercial activity or treasury financing (DP III V par. 56 & 57).  OTC is deemed to be qualifying for exemption if its objective is to reduce potential change in the value of assets, services or commodities (e.g. because of FX, IR, etc.. changes and market fluctuations) or when accounting treatment of derivative contract is that of a hedging contract pursuant to IFRS principles (see IAS 39 paragraph 71-102 on hedge accounting as endorsed by EUC. These two criteria are alternative and not cumulative. ESMA also included the proxy hedging and hedging via closely correlated instruments in case the underlying exposure is not negotiated as such (e.g. commodity hedging via similar products). All these activities will have to be clearly and precisely defined. As already mentioned in several previous articles, we believe the risk resides in the judgemental approach, difficulty to demonstrate this objective and way corporates will demonstrate their goals and intention in dealing the derivatives.  Conversely, ESMA considers derivatives dealt with speculation or trading intentions are not exempted.  

Clearing threshold limits

The clearing thresholds should be fixed at low levels according to ESMA (which is fine provided exempted derivatives are not calculated for thresholds), simple to implement (which is a real progress compared to previous DP from February) and based on nominal value of derivatives (without considering whether they are “in” or “out of the money”) . The clearing thresholds will be fixed per asset class (i.e. 5 main asset classes: CDS, equity, IR, FX and commodity). In case a threshold is hit for one asset class, it taints the other classes as from the date it starts exceeding the threshold. It means all other future derivatives whatever the class will automatically be cleared.  Eventually these threshold limits will be frequently reviewed by ESMA based on BIS data published and market evolutions.

The Trade Repositories (TR) will help to define the thresholds and bring more granularities with data they will have collected. Whatever the type of derivative, exempted or not, all will have to be confirmed as soon as possible and by the second business day following the trade day (which is also an additional day compared to former DP). We don’t want to specify rules for clearing as we assume the cleared contracts will be limited for corporates. There are numerous paragraphs and provisions on clearing techniques and rules to be applied.

The exemption of intra-group transactions has been confirmed too. The definition of what an “intra-group” transaction is was not addressed on this second DP. It will be necessary to do it. The de facto control under IFRS and consolidation rules should be the appropriate approach to avoid any dispute and discussion on whether HQ dealt with an affiliates or a simple participation within a portfolio of assets.

Trade Repositories

Inevitably, the reporting to TR will generate costs for corporates. No one was able so far to assess the cost and to provide ESMA with quantitative feed-backs. Obviously, none of the TR’s mentioned the cost of reporting as an issue. However, we know it will depend on number of transactions. The cost will not be minor. We should be prepared for couple of thousand EUR a year depending on volumes reported. This reporting issue and its related cost element are as far as we are concerned the two main problems lots of corporates have still not yet incorporated into their OTC derivative (re-)organisation. Some treasurers will be highly surprised by this compulsory reporting. The automation of reporting will certainly be an interesting issue to sort out to limit the administrative burden as much as possible. Automation will also be a mean to reduce reporting costs and fees paid to TR’s. The SWIFT MT 300 format could be the easiest and cheapest way to report for companies using such messages.

There is a general support worldwide to adopt common trade identifiers (Unique Trade Identifier – UTI) and trade ID. Here again, these new requirements could technically affect TMS and IT systems to become compliant. The initial data entry of historical/existing outstanding portfolio could also be an issue. The reporting purpose is the transparency required by G20 in Pittsburgh declaration. ESMA is convinced it will improve the monitoring of systemic risks. The coordination of reporting under MiFID and EMIR has been addressed and will be considered to avoid duplicates and confusions.

Where are we now?

In our opinion, some of the main concerns have been rightly addressed by ESMA despite some remaining open issues. It listened to stakeholders and in particular to “the real economy” representatives.  The rules and provisions have been simplified. Furthermore, ESMA wanted to check whether the proposed document makes (more) sense, contains a clear rationale, includes quantitative elements to support any concern and describes any alternatives it should consider in the final version. It is another opportunity for corporate treasurers to alert ESMA on potential practical and technical issues related to this regulation. Eventually, 2 principles have been now restated and confirmed: (1) exemption for non-financial counterparties and (2) compulsory reporting to TR without any exemption.

 François Masquelier, Chairman of ATEL