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The latest trends in banking and finance.
CFO Staff, CFO Magazine
March 1, 2007
Ask 10 treasurers what they want from their banks and you will probably get similar answers: seamless payment solutions and multiple financing options. Those wishes are easier to fulfill these days, thanks to forces that include hybrid securities, the European Union's move to standardize cross-border payments, and a technical platform that allows companies to talk to multiple banks at once.
Hybrid securities. The term has become a catchall for everything from convertible bonds to trust-preferred stock to "anything funky," according to one investment banker. In fact, money managers, ratings agencies, and treasurers may all parse the term differently. Regardless, the debt-equity combination vehicles continue to skyrocket in popularity.
For many companies, convertible bonds rule. Corporate issues were at $68 billion in 2006 — including Ford Motor Credit's $4.95 billion convertible bond last fall — up from less than $40 billion in 2005, according to Bloomberg. "The convertible-securities market lends itself to innovation because it touches the debt, equity, derivatives, and options markets, so we're constantly in this race to put the pieces together in ways that solve problems for issuers, while giving buyers the opportunity for a decent return," says Jonathan Cunningham, head of convertible securities for Jefferies & Co. Among the more popular innovations, he says, are derivative hedge overlays that help reduce the hit to earnings per share when the security converts to equity.
Much of the action in the broader hybrid category comes from banks and insurance companies, which can count the debt toward their capital-reserve requirements with minimal damage to their credit ratings or equity base. Issues of these securities grew from $39 billion in 2005 to $71 billion in 2006, according to JPMorgan Chase, and are expected to reach $80 billion in 2007, as many banks refinance deals that they made in the late 1990s when the structures were first approved.
There seems to be little on the horizon to slow hybrids' growth. The National Association of Insurance Commissioners is considering an accounting rule that would make it less attractive for insurers to hold hybrids, but there is "no deadline" on finalizing the rule, according to NAIC spokesman Scott Holeman. Much may depend on the continued good performance — and volatility — of the underlying stock market.
One Continent, One Payment System
When the euro was first introduced in 1999, it was simply the first step toward a pan- European payments system. Now the finishing touches on the infrastructure necessary to achieve that vision are being put in place. SEPA, or the Single Euro Payments Area, is scheduled to be introduced in January of 2008 and fully implemented by 2010.
Mandated by the European Union, SEPA will require banks to price all cross-border settlements in euros at the same level as comparable domestic products. For the first time, treasurers will have access to a fluid cross-border payment framework at the low-value, or ACH, level.
The main benefit is that SEPA will allow cheaper and ultimately faster payments to be made in euros. Why? For starters, fees will become more transparent, says Michael Wagner, a director in the London office of consultancy Mercer Oliver Wyman, and that will cause "pressure to move to parity." Moreover, SEPA will allow companies to reduce their banking relationships and rethink their treasury-center locations. "What treasurer would not like to see [his] accounts consolidated from 30 to 5?" asks Alan Koenigsberg of JPMorgan Chase's Treasury Services.
For the banks, however, the conversion will not be cheap. A 2006 Boston Consulting Group study estimates that the cost to make the national banking system interoperable by 2008 could run to $650 million. The next step — eliminating or converting all domestic schemes by 2010 — will take another $6.5 billion. In addition, Wagner predicts a "10 to 30 percent erosion in fees" once SEPA is under way. The result could be more consolidation or the outsourcing of initiatives by smaller banks. There could still be roadblocks, particularly political ones. But if all goes according to plan, by 2011 the global payments landscape could be a much more level place.
Shoot and Score
One innovation may ease the transition to SEPA. In January, the Society for Worldwide Interbank Financial Telecommunication (SWIFT) released a program that would streamline communication between corporations and banks. Its new SCORE (Standardized Corporate Environment) model enables corporate members to access multiple banks through one open-access channel. At present, companies connect to only one bank at a time.
"The biggest advantage of SCORE is that it adds efficiency by allowing corporations to communicate with all banks in a very easy and straightforward manner," says Luc Meurant, head of SWIFT's corporate access program. SCORE also promises to be faster, safer, and cost-effective. Research shows that a corporation spends $20,000 to $26,000 to maintain each bank-specific communication relationship. SCORE eliminates the need for individual connections.
"It is also a highly reliable network and allows for better control in a stable environment," says Roy DeCicco, senior vice president with the Treasury Services business at JPMorgan Chase.
General Electric was one of the companies participating in SCORE Phase 1, the pilot program. Paul Bernstein, managing director of GE's Corporate Treasury, says the program will benefit companies new to SWIFT because it decreases paperwork and other administrative burdens and makes it easier to join the organization. "For GE," says Bernstein, "the real benefits come with Phase 2, which is the standardization of the ISO 20022 payment messages for corporate-to-bank communications."
Currently, SCORE focuses on cash management and treasury services, but Meurant expects to add trade and investment services as well as exceptions and investigations services in the future.