Trade wars, Brexit, and constant commentary on an impending recession all contributed to market volatility in 2019. Somehow, though, markets steadied over the latter half of the year as equities hit all-time highs, the yield curve went from inverted to flat, and FX volatility hit multi-year lows. Heading into 2020, new opportunities and risks enter the treasurer’s horizon, including evaluating capital structure and interest rate risk, navigating the transition away from LIBOR, and using a calmer market period to identify and develop operational efficiencies within daily workflows.
1. Evaluating capital structure and risk profile
As global interest rates have decreased over the past year, so too have funding costs for most corporates across the entire credit spectrum. Tighter term loan and bond pricing enabled many companies to efficiently refinance debt or fund acquisitions. In the coming year, we anticipate companies will continue to evaluate not only debt capital markets activities but also using derivatives to reduce interest expense or future financing risk. Specifically, multinationals continue to evaluate and execute cross-currency swaps to obtain cheaper synthetic cost of debt, particularly swapping USD denominated debt into EUR. The new hedge accounting rules have created an additional benefit as now cash and accounting interest expense are aligned on a company’s financial statements. While many have already executed this strategy in the past 18 months, far more have yet to do so, and the next 12 months will continue to provide meaningful savings opportunities for multinationals executing cross-currency swaps.
2. Capitalizing on reduced hedging costs
In addition, while interest rates have generally been trending lower, they have done so with some meaningful short-term volatility. The U.S. 10-year treasury has traded in a 140-basis-point range causing some challenges for those firms anticipating debt issuances to either refinance or fund acquisitions. Short- and medium-term forward hedging of anticipated debt issuances can reduce risk that companies face while waiting to issue debt. A flat yield curve has reduced the cost of hedging, leading to expanded consideration of the strategy itself. Companies need to consider the appropriate structure and accounting treatment for their hedges, especially when evaluating treasury locks or forward swaps. The next year will continue to provide opportunities to hedge refinancing risk for proactive treasury teams that monitor markets and have evaluated different alternatives.
3. Preparing for the transition from LIBOR
An additional debt market challenge facing treasury teams is the impending transition away from LIBOR. The global reform of benchmark interest rates continues to move forward, with LIBOR slated to go away in December 2021. For those firms refinancing in 2020, interest rate benchmarks may not immediately move towards replacement benchmark rates (like SOFR). Still, the year will bring firms closer to the transition and focusing on fallback language in existing or new pieces of debt. Inventorying LIBOR exposure and negotiating fallback language is a critical objective for treasury teams in 2020.
4. Reviewing FX risk management programs
In addition to capital markets opportunities, treasury teams continue to identify and execute on ways to improve efficiency in operations. For those multinationals with balance sheet or cash flow hedging programs, the burden of maintaining and executing such programs has continued to push legacy systems and processes to beyond their capabilities. Tight labor markets in various geographies continue to contribute to the need to drive efficiency across the firm as well. Increasingly, companies are utilizing specialist systems that focus specifically on derivatives, particularly those that run the entire process from gathering exposures through to hedge accounting and valuations. Solutions that truly understand corporate treasury needs on derivatives that come with expert support have a significant impact on reducing time and risk in managing FX programs.
FX risk management current state
FX risk management specialist program
5. Preparing for a changing market
As eventful as 2019 has been, the next year will continue to present challenges and opportunities to create value for treasury teams. Markets change incredibly quickly – recession expectations have come and gone repeatedly in the last 12 months, creating rapidly vanishing opportunities. Creating the space for treasury teams to focus on such opportunities by reducing manual work can be a key driver of value. We encourage you to reach out to Chatham to access our unparalleled database of client experiences, transactions, and processes in order to support your objectives for 2020.
Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal/notices/.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved. 19-0313
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