Survey Financial Risk Management_Belgian Corporates

STAYING THE COURSEA survey on risk management and the use of derivatives

in non-f inancial companies based in Belgium

in collaboration with

Contents

1. Introduction

2. Main highlights

3. Survey results3.1 Facing & managing IR/FX risk3.2 Risk management objectives3.3 Risk tolerance & derivatives use since 20083.4 Hedging policies3.5 Latitude in hedging decisions3.6 Fixed/floating-rate liability mix since 20083.7 IR hedging instruments3.8 Managed FX exposures3.9 Disclosure of market value3.10 Counterparty risk & service providers3.11 EMIR implementation3.12 Looking forward

4. Conclusion

5. Demographics of companies

6. Methodology

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STAYING THE COURSE | 3

1 | Introduction

We are living a major experiment in financial history. Periods of historically low volatility interrupted by sudden peaks in interest rate and FX markets are puzzling specialists. These movements are largely driven by decisions made by central banks across the world, which are steering us into uncharted territories.

In this context, risk managers are challenged more than ever to analyse markets and protect earnings within their organisations. This survey highlights how companies adapt to the shifting risk environment and what major concerns treasury departments are confronted with today.

• The survey was conducted by BNP Paribas Fortis in collaboration with ATEB, the Association of Corporate Treasurers in Belgium. It was carried out from 14 March 2014 to 4 April 2014 through an online questionnaire, targeting a large population of Belgian-based non-financial companies. The population was segmented into large companies, small and medium-sized companies(1) and public entities(2). The questionnaire was fine-tuned with a focus group of selected CFOs equally representing all three segments.

• To guarantee the anonymity and objectivity of the responses,

the data collection was managed by an independent market research company.

• More than 400 companies participated to this survey, clearly demonstrating the relevance of the topic for the industry, and thus enabling us to draw several significant conclusions presented in this report.

• The survey results presented in this report solely reflect the views and practices of the respondents.

We warmly thank the companies that accepted to spend their valuable time to contribute to this survey.

“This unique survey underscores one of the main goals of ATEB: understanding the activity scope of

treasuries in Belgium, allowing ATEB to deliver events, knowledge sharing and training offerings that meet

our members’ needs and interests.

”Jef van Osta, Chairman, ATEB

1: Split by turnover: Large companies: > € 250 millions; Small and medium-sized companies: < € 250 millions.2: Regions and Communities, IVA/ EVA/ OIP and all entities gravitating around regions and intercommunal companies (gas, electricity, …).

4

• Generally, companies’ financial risk management is centred around stabilising cash flows and earnings.

• Simple products (e.g. IRS, IR Caps, FX Forwards) constitute the bulk of a hedge portfolio, with many companies also using structured products.

• Counterparty risk has emerged as a key risk when using derivatives. 83% of the respondents mitigate it by transacting only with banks having a sufficiently high credit rating. Also high credit rating is one of the top criteria for selecting derivatives providers.

• Disclosure of the market value of derivatives depends strongly on the accounting standards (Belgian GAAP or IFRS) companies use.

• EMIR implementation is gathering speed after a fast start (77% have obtained their LEI) but additional efforts are needed to agree on the portfolio reconciliation process.

“Some risks can’t be avoided, but they can be managed.”

Large company treasurer

• The majority of companies (56%) have a high proportion of floating-rate liabilities of between 76% and 100% (prior to the use of derivatives). This offers them a lot of flexibility when managing their interest rate expenses. However, unhedged liabilities must be monitored carefully at the first signs of increasing rates.

• Counterparty risk is managed by 71% of respondents. This is reassuring, but this topic should keep receiving adequate attention.

• In line with their swift and flexible decision making process, small & medium-sized companies value the ability of derivatives providers to execute trades quickly (44% FX and 24% IR).

“We never hedge all of our risks in 100% the same way. The different solutions emerge from discussions with our banking partner.”

Small & medium-sized company CFO

2 | Main Highlights

Overall Small & Medium-sized companies


• Hedging policies are widely utilised to frame the decision process and procedures when managing IR risk (86%) and FX risk (94%).

• 85% disclose the market value of derivatives, reflecting the importance for large structures to be increasingly transparent towards shareholders and debtors.

• 43% expect more IR derivatives with maturities longer than 7 years in 2015. This may reflect the perception that long-term rates are at their bottom levels and will increase in the years to come.

• Two corporates out of three have between 25% and 100% of their FX volume in emerging market currencies, demonstrating the high impact of globalisation on Belgian companies.

“Banks should be more pro-active in contacting us with targeted information. Sometimes a certain need is there but there is no information on the adequate solution. Maybe bankers think that everybody knows everything.” Large company treasurer

• Public organisations have almost no exposure to FX as their activities are local and in Euro.

• Top objective is to improve the organisation’s credit rating and borrowing rate.

• Counterparty credit risk is rightly a major priority and is handled by nearly all public segment respondents (93%). This is usually done by transacting only with banks with a sufficiently high credit rating.

• The public sector is structurally financed via fixed-rate debt with half of the entities having less than 25% of floating rate liabilities (prior to the use of any derivative).

“Public debt is a big responsibility: we have to report to ministers; and ultimately to the citizens.” Public organisation treasurer

Large companiesSmall & Medium-sized companies Public entities

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3 | Survey Results

3.1 | Facing & Managing IR/FX risk

Risk management in companies facing IR/FX risk

Companies exposed to risk frequently manage this risk through derivatives (IR 63% - FX 74%). Companies not using derivatives cite insufficient risk exposure and internal policy restrictions as the main reasons behind this decision.

Belgian companies are naturally exposed to a variety of risks. IR and FX risks are amongst the most significant, as they can have a large impact on the short- and long-term performance of companies. For controlling or preventing risks, companies can consider different methods depending on their goals, constraints and resources. For example, they may use insurance policies, derivatives or diversification of their operations. We asked the participants whether they are exposed to IR or FX risks and if they manage these risks with derivatives(1).

• 82% of all respondents face FX or IR risk. Certain companies may not be exposed to IR risk simply because they don’t have any debt or other liabilities. When risks are not managed with derivatives, the primary reason cited by 29% of respondents is “insufficient risk exposure”.

• However, the vast majority of companies do have a non-negligible exposure to IR and/or FX risk. Sometimes this

exposure relates to their competitive position. For example, a company financing itself only via fixed-rate debt may pay higher interest expenses than other companies relying on variable-rate debt and managing the associated IR risk. A competitor may have a lower cost structure because it manages well the FX risk linked to imports.

• Of those companies facing FX risk, 74% actually manage it with derivatives. For IR risk, this is 63%. These proportions are fairly high and probably reflect the ease to enter into a derivatives contract perfectly matching the underlying risks and risk constraints of the company.

• Public entities have very limited exposure to FX risk as their activities are local and in Euro (22% face FX risk and 4% manage it).

n Not managing with derivatives n Managing with derivatives

26%

74%

FX (*)

37%

IR

63%

* Public entities excluded due to a lack of FX exposure.

1: IR derivatives include futures, options (caps, floors, collars,…), swaps and forward rate agreements; FX derivatives include futures, options, forwards and FX swaps.


Insufficient risk exposure

Internal policy restriction

Natural hedging

Difficulty pricing & valuing derivatives

Costs of establishing and maintaining a derivatives program exceed the expected benefits

Lack of knowledge

Accounting treatment

Derivatives are considered too risky

Large losses on derivatives experienced in the past

29%

16%

11%

10%

8%

8%

7%

7%

6%

Reasons for not managing IR/FX risk (*)

* Respondents could select multiple answers.

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3.2 | Risk Management Objectives

For risk managers, stabilising cash flows and earnings are the main strategic objectives.

Ideally, risk managers should ensure that companies correctly identify, measure and manage their main risks. They play a central role in optimising the volatility of cash flows in order to avoid losses and improve investment decisions. The precise objective of risk management will vary greatly from one company to the next. We therefore asked the participants to rank their most important objectives:

• Unsurprisingly, stabilising cash flows (54%) and stabilising earnings (53%) stand out as the most important purposes of the risk management activity.

• It is interesting to note that stabilising costs (31%) is a more frequent strategic objective than stabilising revenues (17%). This may be due to the fact that companies tend to have more non-Euro exposure on their imports rather than on their exports.

• For public entities, the main objectives are different and relate to IR risk: improving the organisation’s credit ratings and borrowing rate (34%), mitigating particularly large increases in costs (27%) and stabilising cash flows (27%). Indeed, this segment has substantial funding needs and tends to be risk averse as it manages public money.

Additional comments made by participants:

• ‘‘Improve budget forecasts’’. This is very important as high uncertainty may lead to under-investments. By removing market volatility from a company’s P&L and balance sheet, derivatives can facilitate investment decisions.

Strategic Risk Management objectives - Ranking (*)

Stabilise cash flows

Stabilise earnings

Stabilise costs

Mitigate particularly large falls in revenue

Mitigate particularly large falls in earnings

Mitigate particularly large increase in costs

Stabilise revenues

Mitigate particularly large falls in total cash flow

Improve the firm’s credit ratings / borrowing rate

54%

53%

31%

30%

28%

22%

17%

14%

13%

Other 7%

6%

1%

3%

4%

5%

2%

1%

4%

4%

6%


n Low n High


3.3 | Risk Tolerance & Derivatives Use Since 2008

For the majority of companies, risk tolerance and derivatives usage have remained unchanged since 2008. However, the perception in the financial industry is that volumes of derivatives with non-financial companies have decreased.

Risk-conscious companies may decide to either avoid a risk (when possible) or manage it carefully. Steady risk management requires companies to define their risk tolerance and the situations in which they should use derivatives. We asked the respondents to assess how their current risk tolerance and derivative usage have evolved compared to 2008.

• 51% of companies consider their risk tolerance to be at the same level as in 2008. This is surprising as we would expect risk managers to find today’s environment more risky (more complex, more difficult to anticipate) and with less investment opportunities.

• As to the use of derivatives, 54% see no change since 2008. However, this contradicts a survey from the NBB(1) showing a marked decrease in average daily turnover between April 2007 and April 2013 for the four major Belgian banks(2). A reduction would be more consistent with what is observed by the financial industry: a decrease in import/export (impact on FX), lower investments (impact on IR and FX) and lower rates (tendency for some companies not to cover IR risk with derivatives).

1: Nationale Bank van België, driejaarlijkse Enquête over de Valutamarkt en de Markt van de Afgeleide Producten: Resultaten voor België. Brussel, Communicatie Nationale Bank van België, 2013.2: -64% for FX forwards, FX swaps, cross-currency swaps, options and other OTC derivatives traded by non-financial companies in Belgium with four major Belgian banks.

Risk tolerance/derivatives usage compared to 2008

Derivatives usage compared to 2008 - Segments

Decreasing

Unchanged

Increasing

27%13%

54%

33%

51%

21%

n Risk tolerance n Derivatives usage

n Increasing n Unchanged n Decreasing

Risk tolerance compared to 2008 - Segments

n Increasing n Unchanged n Decreasing

SMEs

28%

52%

20%

Public entities

12%

41%47%

Large companies

11%

54%

35%

SMEs

32%

57%

11%

Public entities

35%

59%

6%

Large companies

35%

46%

19%

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3.4 | Hedging Policies

Generally, companies have hedging policies in place, in particular for FX risk management, but in many cases these policies are not written down.

Having a hedging policy in place for the use of derivatives is a fundamental aspect of a solid risk management programme. We asked our respondents if they have a hedging policy for their IR and FX risk management and whether this hedging policy is written down.

• Most companies using derivatives report having a hedging policy in place: 75% for IR and 89% for FX risk management. However, only 28% (IR) and 48% (FX) have formulated their policy in writing. We can expect a policy to be clearer, more detailed and auditable when it is written down. Besides, a written policy often goes through an approval process validated by a company’s most senior management.

• Almost all large companies surveyed have hedging policies (95% for FX and 86% for IR).

• Small & medium-sized companies and public entities: a large proportion (respectivelly 60% & 76%) has a hedging policy, but further efforts could be made to formalise the risk management approach.

Hedging policy - All segments

28%

n Written hedging policy n Hedging policy but not written down n No hedging policy

48%

47%

25%

41%

11%

FXIR



IR hedging policy - Segments

FX hedging policy (*) - Segments



SMEs

16%

44%40%

Public entities

38% 38%

24%

Large companies

27%

59%

14%

SMEs Large companies

29%

74%

49%

21%22%5%

“One of the objectives of this survey is to clarify how derivatives are used and show best pratices, for example in terms of transparency and governance.

”Eric Charléty, Head of Fixed Income Business Development, BNP Paribas Fortis

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3.5 | Latitude In Hedging Decisions

Companies, in particular large ones, generally allow limited latitude in hedging decisions.

When designing a risk management programme, a company needs to find the appropriate balance between flexibility, enabling it to react quickly to risk changes, and control of the risk management activity. In order to evaluate the discretion given to risk managers, we asked our respondents to indicate the allowed degree of latitude in a series of decisions related to their role in risk management.

• Overall, there is slightly more latitude in FX risk management decisions. For example, 49% have broad to moderate latitude concerning the decisions on time horizon of hedges in IR, compared to 58% in FX. One important factor is that the underlying risk is not always present or certain at the time of the decision (22% of companies manage expected but not yet committed transactions and 22% economic exposure(1)). The risks are also shorter-term in FX and rarely extend beyond 3 years.

• On the other hand, risk managers have less latitude in IR risk management. Indeed, decisions are often linked to a specific committed liability and many companies choose to hedge 100% of the risk.

• Large companies: There is a propensity towards having very little elbow room, probably driven by the fact that most companies are subject to a hedging policy and stricter accounting constraints(2).

• Small & medium-sized companies and public entities: There is slightly more autonomy than for large companies. This may reflect the proximity of risk managers and the ultimate responsible persons (e.g. executive committee, board, owner, minister, etc.).

1: See section 3.8, Managed FX exposure, p.17.2: See section 3.9, Disclosure of market value, p.19.


* Public entities excluded due to a lack of FX exposure

Latitude in FX hedging decisions (*)

Type of product

Time horizon of hedges

Hedge ratio

Deviation from benchmark

52%

42%

47%

47%

23%

22%

22%

20%

25%

36%

31%

33%

Latitude in IR hedging decisions

Type of product

Time horizon of hedges

Hedge ratio

Deviation from benchmark

58%

51%

54%

58%

21%

25%

27%

20%

21%

24%

19%

22%

n Little to no latitude n Moderate latitude n Substantial to broad latitude

n Little to no latitude n Moderate latitude n Substantial to broad latitude

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3.6 | Fixed/Floating-Rate Liability Mix Since 2008

Since 2008, many companies have shifted towards more floating-rate liabilities in order to benefit from current low interest rates.

Liabilities exposed to IR risk are typically composed of loans and to a lesser extent leases, factoring and bonds. The choices companies make in their fixed and variable-rate liabilities mix can have a significant impact on their financing costs depending on the IR context. We asked companies to which degree their liabilities are based on a floating rate today and how this compares to 2008, without taking into account the use of IR derivatives.

• Generally, companies have more floating-rate liabilities today compared to 2008, as shown by the evolution of the median from 51-75% floating to 76-100% floating. Some companies take the opportunity of historic low rates to decrease costs in the short term by not hedging the entire IR risk(1). However, unhedged liabilities create a risk that materialises when rates move up.

• Small and medium-sized companies and Large companies: these segments show a clearer trend towards more floating-rate liabilities. However, unhedged liabilities should be carefully monitored at the first signs of increasing rates.

• Public entities: the liability mix between floating and fixed rate has remained mostly static. This is probably due to the fact that these organisations are structurally financed via fixed-rate loans and bonds. While this increases the predictability of interest expenses, it does not necessarily lead to the lowest cost of debt.

1: Some companies appreciate the flexibility offered by derivatives, e.g. in terms of timing and notional.

“Financial Risk Management must correspond to fundamental company needs. Ensuring that the right product is used by the right company for the right situation is key.

”Alain Vande Reyde, Board member of ATEB

STAYING THE COURSE | 15 * FY 2013

Proportions of f loating-rate liabilities today (*) and in 2008 -SMEs and Large companies

Proportions of f loating-rate liabilities today (*) and in 2008 -Public entities

76-100% floating

76-100% floating

Median TODAY

Median 2008

Median TODAY & 2008

51-75% floating

51-75% floating

26-50% floating

26-50% floating

1-25% floating

1-25% floating

0% floating

0% floating

51%

13%

42%

14%

13%

0%

23%

21%

11%

57%

11%

7%

11%

13%

13%

20%

15%

47%

10%

7%

n Today n 2008

n Today n 2008

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3.7 | IR Hedging Instruments

The bulk of derivative instruments used for IR risk management are relatively plain vanilla, with IRS leading the pack.

The interest rate derivatives market is the world’s largest derivatives market(1). IR hedging decisions are intertwined with financing decisions which can commit the company for many years. Therefore, companies appreciate products which are simple and easy to understand and track. At the same time, they may decide to diversify their hedging portfolio by including more structured products. We asked the respondents what type of instruments they use.

• Plain vanilla OTC products, like IRS and IR caps, are widely used. However, many companies include structured instruments in their portfolio of hedges to reduce directional risk or benefit from other features. Authorised hedging instruments are typically defined in the hedging policy.

• Interest rate swaps enable companies to transform a variable-rate liability into a fixed-rate one or vice versa. They are used by almost all respondents (97%) managing their IR risk with derivatives. The popularity of this product is probably due to the fact that it can be tailored to the particular needs of each company, yet still remains relatively simple in use. However, as for any fixed-rate liability, it obliges the company to pay the agreed rate even if interest rates decrease in the market.

• Interest rate caps enable companies to put a cap on the interest rate they pay on a variable-rate liability. They are less popular than IRS but still used by almost half of the respondents. This lower use may be due to the need to pay a premium upfront very much like for an insurance – this cost might be felt more directly than the advantage to benefit from a potential decrease in interest rates.

1: Average of USD 7.4 trillion per trading day in April 2013 against USD 5.5 trillion traded in FX (source: Bank for International Settlements).


“Since 2008, politicians, regulators and banks have worked hard to

regulate and standardise the OTC market. However, the need to tailor

a hedge to a specific and unique underlying risk and hedge portfolio

remains fundamental for companies. Derivatives providers will continue to

fulfil that need.”Ivo Mertens, Head of Fixed Income Sales, BNP Paribas Fortis

Interest rate swaps (IRS)

Interest rate caps

Forward rate agreements (FRA)

Collars

Cross-currency swaps

Interest rate floors

Structured derivatives

Constant maturity swaps (CMS)

97%

45%

35%

32%

29%

25%

16%

13%

Use of hedging instruments (*)


Most companies have an exposure to FX risk as a result of their normal business with non-Euro countries via import, export, production, distribution, partnerships and participations. The volatilities on foreign currency markets affect those companies’ P&L (revenues, costs) and balance sheet (assets, liabilities and equity). The decision to manage FX risks or not depends on several factors including the materiality of the risk and its degree of certainty. We asked the respondents which FX risks they manage and whether the exposures relate to G10 or emerging markets currencies.

• Most respondents (79%) manage the committed transactions resulting from their daily business. This is logical, as many companies use FX swaps to manage treasury shortages/excesses across different currencies (e.g. a company with a deficit of euros, but a surplus of dollars, can sell the dollars against euros to compensate). Another widely used product is the forward, enabling to fix the FX rate at a future rate.

• As to the uncommitted transactions, 22% state they manage the related FX risk. In such cases, companies typically hedge a lower proportion of the risk.

• Interestingly, a relatively high proportion of respondents (22%) state that they hedge their economic exposures. An FX-linked economic exposure means that FX rates have an impact on the long-term cash flows of a company. Even smaller companies focused on the Belgian market can have a significant FX-linked economic exposure, for example if they compete locally with non-Euro based competitors.

• Half of the respondents have between 25% and 100% of their annual FX volume in emerging markets currencies. This reflects the high impact of globalisation, international trade and cross-border currency flows on the Belgian economy.

3.8 | Managed FX Exposures

A large proportion of companies manage FX risk linked to committed transactions. Many also manage risk from uncommitted transactions and economic exposures.

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* The list of G10 currencies consists of Euro - US Dollar - British Pound - Japanese Yen – Canadian Dollar - Swiss Franc - Australian Dollar - New Zealand Dollar - Norwegian Krone - Swedish Krona.


Daily business committed transactions

Foreign repatriations (dividends, royalties or interest payments)

Daily business anticipated transactions (not yet committed)

Economic exposures

Income statement (net income hedging)

Balance sheet (net investment hedging)

M&A

Other

79%

28%

22%

22%

15%

14%

6%

9%

FX risk - Managed exposures (*)

100% G10

75% G10 - 25% Emerging markets



100% Emerging markets

51%

35%

8%

3%

3%

Annual FX volume - Split G10/Emerging markets (*)

49%

All

SMEs

Public entities

Large companies


3.9 | Disclosure of Market Value

A large proportion of companies operating under Belgian GAAP do not disclose the market value of their derivatives.

Transparency on the use and value of derivatives helps stakeholders assess the risk of companies. Opaque disclosure regarding derivatives may limit the willingness of shareholders or banks to support a company. IFRS and US GAAP impose the disclosure of the market value of derivatives. Belgian GAAP, however, is less clear on the subject so that companies can decide whether they disclose this information or not. We asked respondents what accounting standard they use and if they disclose the market value of their derivative contracts.

• 56% of the respondents reported that they disclose the market value of their derivatives contracts, whereas 44% do not. Companies not disclosing this

information use Belgian GAAP. It is worthwhile to note that the Belgian Accounting Norms Commission has recently recommended disclosure of information about the market value of derivatives when those are not accounted for at market value(1). This percentage is therefore expected to increase in the future.

• IFRS is used by listed companies and larger companies in general in Europe and in many countries in the world (except USA(2)).

• Public entities: Belgian GAAP is mandatory for a company’s fiscal reporting and no other standard is used by 67% of the public entities.

17% use IFRS (and therefore disclose the market value of derivatives) and 16% use other standards such as IPSAS. Of those not using IFRS (i.e. Belgian GAAP or other standards), 50% do not disclose the market value of derivatives.

• 85% of large companies disclose the market value of their derivatives. This is the highest observed percentage of disclosure and is driven by their use of IFRS (55% of corporate companies use IFRS).

• 56% of small and medium-sized companies choose not to disclose market values (61% report in Belgian GAAP and are thus not obliged to do it).

Companies disclosing market value of derivatives Accounting standards

n Belgian GAAP n IFRS n US GAAP n Other

56%

29%

4%11%

1: Commission des Normes comptables/Commissie voor Boekhoudkundige normen - Advice CNC 2013/16. 2: Only 5% of respondents use US GAAP. This standard is used by companies belonging to groups based (or at least with a strong presence) in the US. It also requires them to disclose the market value of derivatives.

All

SMEs

56%

45%

44%

Public entities 59% 41%

Large companies 81% 19%

n Yes n No

55%

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In the wake of the bankruptcy of Lehman Brothers, the liquidity crisis amongst banks and the European banking crisis, banking counterparty risk has emerged as a considerable risk for tax payers. As a result governments and regulators are putting in place measures to allow banks to default without state intervention. This in turn creates risk for companies transacting with banks. We asked respondents about their ways of mitigating counterparty risk and their criteria for choosing a derivatives provider.

• Most companies (83%) transact only with banks having a sufficiently high credit rating to mitigate counterparty risk. For example a company may choose not to transact with banks having a rating worse than A.

• Public entities: All responding organisations but one manage counterparty risk, illustrating their high awareness of this market risk.

• Large companies and small & medium-sized companies: 14% of corporate companies and 29% of commercial companies do not manage counterparty risk in spite of the importance of the subject.

• However, when choosing derivatives providers, pricing is by far the main motivator for 87% of the respondents, followed by the availability of lending facilities (54%) and the quality of a bank’s rating (45%).

• In line with their swift and flexible decision making process, small & medium-sized companies put more emphasis on the ability to execute trades quickly (44% FX and 24% IR).

3.10 | Counterparty Risk & Service Providers

Companies carefully select their counterparty by transacting only with banks having a sufficiently high credit rating.


Mitigating counterparty risk (*)

By transacting only with banks having a sufficiently high credit rating

My company does not manage counterparty risk linked to derivatives

By using collateral

By using early termination option (ETO)

By using credit default swaps (CDS)

83%

21%

6%

3%

2%

Hedging ideas


Main reasons for choice of derivatives IR/FX service provider

Pricing

Hedging ideas

Availability of lending facilities

Quality of bank’s rating

Strategic advice

Quality of bank’s expertise in derivatives

Corporate Banking capabilities (e.g. Cash Management, Trade Finance)

Provision of interest rate & foreign exchange derivative credit lines

Ability to execute trade quickly (bank’s decision time & requirements towards clients)

89%87%

54%

45%

36%

34%

26%

30%

16%

16%

26%

85%

25%

49%

37%

36%

12%

32%

19%

31%

58%

22%

53%

19%

40%

13%

36%

n IR n FX

Average

22

3.11 | EMIR Implementation

Although EMIR came into force in August 2012, it has not been fully implemented yet.

EMIR is part of the European set of regulations to improve transparency, enhance market safety and provide a regulatory oversight of market practices. We asked about companies’ current progress in implementing EMIR and the difficulties encountered during the implementation process.

• While almost all companies in the EU are subject to EMIR(1), only 74% of the companies state they fall under the regulation, even though they use derivatives subject to reporting obligations. This probably reflects a misunderstanding regarding the scope of the new regulation’s application and the lack of clarity regarding the exemptions for the public sector.

• 77% of companies have acquired a Legal Entity Identifier (LEI) and 73% have acknowledged their classification (usually as Non Financial Counterparties/NFC).

• Under EMIR, companies need to agree with their banks on a portfolio reconciliation process. This takes the form of an adjustment of the existing master agreement (EMA or ISDA). Only 36% state this step has been completed.

• Overall, the high number of non-compliant companies is partly due to the fast implementation of EMIR and the perceived complexity of the subject. This explains why only 31% report having no difficulties complying with EMIR. The risk being that penalties are imposed in case of non-compliance. So far regulators have been lenient, but eventually they will have to complete the implementation of EMIR. Therefore companies need to dedicate more resources and regulators, industry associations and banks will need to upscale training efforts.

1: Some public entities fall entirely outside the scope of EMIR: the European Central Bank, the national central banks of the member states, other governments or EU bodies charged with intervening in the management of the public debt and the Bank for International Settlements. Also since 2013: the U.S. Federal Reserve, the Bank of Japan and the debt management offices of these countries.

Subject to EMIR-Segments

All segments 14% 12% 74%

Large companies 6% 94%

Public entities 55% 9% 36%

SMEs 18% 16% 66%

n Don’t know n No n Yes

To read more about EMIR: http://cpb.bnpparibasfortis.be/EMIR


Progress in implementing EMIR

Legal entity identifier obtained (LEI)

Classification known (NFC- or NFC+)

77%

73%

36%

13%

17%

7%

10%

10%

19%

18% 2%

1%

1%

1%

5%

Reporting of trades to trade repository (reporting can be made by your bank) 56% 28% 5

Reconciliation of trade portfolio with your banking counterparties 49% 22% 9%

32%

n Completed n In progress n Not started n Don’t know n Not applicable

Portfolio reconciliation process agreed in master agreement (EMA/ISDA)

5

2%

2%

Main difficulties with EMIR

Insufficient information on new obligations

No difficulties

Deadline too tight

Insufficient internal resources available

Insufficient management attention

Limitations of internal systems

42%

31%

24%

17%

9%

5%

24

3.12 | Looking Forward

Still catching up with EMIR, a relatively high number of companies expect more regulatory burden, disclosure and internal controls. This may overstate the upcoming regulatory change impacting non-financial companies.

2008 was the greatest shock to the worldwide financial system since the Great Depression. Since then, companies are struggling to generate growth while the financial markets are being transformed by an ambitious regulatory reform agenda. Against this background, we asked respondents what they expect in 2014/2015 with regard to a series of items influencing their derivatives use.

• Several participants expect an increase of the “regulatory burden” (46% for IR and 38% for FX), increasing internal controls (33% IR and 27% FX) and reporting/public disclosure (26% IR and 27% FX).

• As mentioned above, this perception is likely to be influenced by EMIR. However, new upcoming regulations (e.g. MiFID2) should not create new obligations for non-financial companies. Once EMIR has been implemented, the regulatory burden linked to derivatives for non-financial companies should normalise.

• Large companies and small & medium-sized companies expect more IR derivatives with maturities longer than 7 years in the coming year (43% and 30% resp.). This may reflect the anticipation that long-term rates are at their bottom levels and will increase in the years to come.

• Overall, companies do not expect major changes for 2014/2015 in the following areas(1):

» degree of latitude of the person(s) managing risks » internal restrictions in terms of products » time horizon » hedge ratios » product scope » number of providers

1: Not shown in the graphs but part of the questionnaire.

“The derivatives industry is undergoing a major transformation following the 2008 events. Eventually these efforts will lead to a new paradigm with a more solid market structure and stronger protection for investors and tax payers. In the meantime, banks and non-financial companies should work hand in hand to adapt to this shifting reality.

”Frédéric Van Gheluwe, Head of Capital Markets, BNP Paribas Fortis



2014/2015 expectations for FX (*)

2014/2015 expectations for IR

Regulatory burden

Internal controls

Reporting/public disclosure

Degree of latitude of the person(s) managing risks

Internal restrictions in terms of products

38%

27%

27%

6%

5%

61%

71%

72%

88%

84%

1%

2%

1%

6%

11%

n Increase n No change n Decrease

Regulatory burden

Internal controls

Reporting/public disclosure

Degree of latitude of the person(s) managing risks

Internal restrictions in terms of products

46%

33%

26%

6%

5%

49%

62%

67%

88%

92%

5%

5%

7%

6%

3%

n Increase n No change n Decrease

26

4 | Conclusion

Today’s companies are operating in a challenging environment, faced with a long-lasting economic stagnation and unpredictable financial markets. In this context, risk professionals bear the heavy responsibility to protect their company’s earnings. This requires them to rethink conventional ways of managing financial risk.

1. Increasing globalisation and risk of low-probability, high-impact eventsIncreasing financial and economic integration across the world compounds the likelihood and potential magnitude of shocks as well as the speed at which cascading effects may occur across geographies and financial markets, eventually affecting the real economy. Current low volatilities may give a false sense of security, but systemic risks remain present. We are in a long lasting period of low rates and abundant liquidity, which is likely leading to mispricing of certain risks. Recent history has shown that market corrections lead to volatility peaks, affecting companies’ cash flows – sometimes leading to major financial impacts.

In order to deal with low-probability, high-impact events, certain companies have incorporated scenario analysis in their financial risk management, next to traditional forecasting and planning. Scenario analysis enables to simulate the impact of uncertain but significant events without being constrained by approaches based on recent history and normal probability distribution. Companies using scenario analysis tend to mitigate more systematically particularly large falls in revenues or increase in costs. This mitigation can take many forms, including monitoring the credit quality of derivatives providers and entering into derivatives (e.g. out-of-the-money caps and floors).

2. IR/FX risk management is part of a company’s competitive toolboxIR and FX risks linked to committed import/export and financing transactions are usually well known and managed. However, the IR/FX-linked economic risks are more complex to evaluate and only managed by a few companies, even though they can have a more significant impact on a company’s competitive position and earning power.

In the case of FX, a company may be threatened in Belgium by a US competitor when the dollar is weak. However, it may be advantaged by a weak Indian rupee if it has delocalised or outsourced part of its value chain to India. IR risk management also impacts the competitive position of a company. In the case of IR, a variable-rate financing decision (without hedge) may impair the competitiveness of a newly launched business line if interest rates increase.

The relationship between IR/FX decisions and competitiveness is complex and specific to each company’s product line. However, going beyond the purely transactional hedging decisions and making the link with the competitiveness of a company, enriches the strategic thinking around markets, value chain, physical model and financing structure.


3. Emerging regulatory paradigmAn unprecedented wave of new financial regulations impacting derivatives has been triggered by the 2008 events. Regulation is not new in this industry sector which has changed a lot since the late 1980s. Prior large failures triggered waves of new regulations (e.g. Basel I in 1988, Sarbanes-Oxley in the US in 2002), but the current wave imposes a new regulatory vision of risk. The changes, being more prescriptive and broader in reach, have a profound impact on the market structure, practices and products. Basel III, EMIR and MiFID2 are prompting market actors to adapt their business models. Eventually these regulatory efforts will lead to a new paradigm with more transparency and more effective protection for companies and tax payers. Banks and companies need to work hand in hand to adapt to this shifting reality.

4. Hedging policyCompanies increasingly use hedging policies to formalise their IR/FX risk management and clarify its contribution to the firm’s value creation. This enables them to increase the effectiveness of their derivatives use by outlining their business approach, appetite for risk and approach to financial risk management. This exercise typically encompasses many aspects including the type of risks covered, the objectives, authorised products, delegation, constraints, performance measurement and reporting process. One of the challenges is to find the right balance between the latitude and the constraints so as to be able to react quickly upon sudden changes in a controlled and transparent manner.

Today’s risk managers need to monitor risks in a more complex and fast-changing world. Their companies are exposed to many countries, including emerging markets, requiring a deep expertise of the foreign countries (e.g. political context, economy, regulation). Additional challenges to the financial risk management function are the monitoring of low-probability, high-impact events, participating to the strategic planning by identifying links between risks and competitiveness, and adjusting to the new regulatory paradigm also represent major challenges for risk managers.

Companies might benefit from allocating more resources to the management of these changes and may consider involving their banks and other partners in the process. A first concrete undertaking could be to revisit or draft a written hedging policay in light of today’s challenges.

Consequence for IR/FX risk management

28

5 | Demographics of Companies

> €25bn

€5bn-25bn

€1bn-5bn

€500M-1BN

€250-500M

€100-250M

€50-100M

€10-50M

< €10M

3%

3%

8%

8%

8%

11%

12%

19%

27%

Companies by operating revenue

Location of Headquarters Companies by segments (*)

86%

10%

n Belgium n Europe n Rest of the world n SMEs n Large companies n Public entities

4%

77%

15%

8%

* Split by turnover: Small and medium-sized companies: <€250M; Large companies: >€250M


Companies by segments (*)

* Statistical Classification of Economic Activities in the European Community, Rev. 2 (2008).

Companies by NACE Classif ication (*)

Manufacturing

Information & communication

Human health & social work activities

Other service activities

Agriculture, forestry & fishing

Public administration & defense; compulsory social security

Wholesale & retail trade; repair of motor vehicles & motorcycles

Water supply; sewerage, waste management & remediation activities

Electricity, gas, steam & air conditioning supply

Construction

Professional, scientific & technical activities

Accommodation & food service activities

Transportation & storage

Administrative & support service activities

Arts, entertainment & recreation

Activities of extraterritorial organizations & bodies

Financial & insurance activities

Real estate activities

Mining & quarrying

Education

30%

3%

2%

16%

3%

2%

10%

3%

1%

8%

3%

1%

6%

3%

1%

0%

4%

3%

1%

0%

30

The data were collected through an online survey questionnaire between 14 March and 4 April 2014. An invitation to participate to the survey was sent by e-mail to clients of BNP Paribas Fortis and through newsletters to members of ATEB. In-house relationship managers were invited to encourage client companies to complete the survey. Follow-up e-mails were sent to non-clients of BNP Paribas Fortis to encourage their participation.

The scope of the survey was very large with a sample size of 12,206 Belgian non-financial companies. The target population was further divided into three segments: small and medium-sized companies (turnover < €250 millions), large companies (turnover > €250 millions), and public entities.

To guarantee the respondents’ anonymity and the objectivity of their responses, data collection was outsourced to an independent market research company.

BNP Paribas Fortis only received the names of respondents who agreed to have their names and/or companies linked to their answers, so as to be able to provide those clients, if requested, with additional information on topics such as markets and economy, regulation, trade ideas, products and services and emerging markets.

In order to refine the questionnaire, a focus group was organised with six CFOs, equally representing all three segments. Their comments and suggestions provided valuable insights, which contributed to enriching the proposed topics and answer possibilities. It also offered CFOs the opportunity to interact with peers, evaluating and discussing their respective practices.

The survey covered six areas: General Company Information, Risk Management Strategy, Regulation (EMIR), Risk Management Structure, Interest Rate Management and Foreign Exchange Management.

A total of 402 companies participated successfully to the survey. This gives an overall response rate of 3.3%, which is one of the highest observed for similar studies.

Respondents within surveyed companies were active in the Finance department (44%), Treasury department (27%), CFO office (14%) and CEO office (12%), which corresponds to the profile we aimed to reach.

The median operating income of participating companies was €60 million. This is significantly lower compared to similar studies, as there are large discrepancies in operating revenue due to the incorporation of SMEs.

6 | Methodology


Authors

Eric Charléty, CFAHead of Fixed Income Business Development

Najois SabraResearcher Fixed Income Business Development

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