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Treasury and taxation

OECD Plan Offers Wholesale Revision of Global Tax Regime

By Dwight Cass Plan would require a level of international cooperation hitherto unheard of. The Organization for Economic Cooperation and Development (OECD) issued its Action Plan on Base Erosion and Profit Shifting (BEPS) on July 19, listing some 15 actions for governments to take in order to stop international corporate tax dodging. The multilateral institution has targeted December 2015 as the implementation deadline; nonOECD members can participate as of September 2015 (see chart below). The BEPS plan was unanimously approved at the G-20 meeting in Moscow the next day. However, this isnt a sign that member governments, of the OECD or the G-20, are about to pass implementing legislation. Meeting the September and December 2015 deadlines may be difficult, given anticipated corporate pushback as companies attempt to derail national legislation. Nonetheless, the idea has current momentum, not least because of the fallout from tech giant Apples multi-billion-dollar tax strategy involving Ireland. The tax structure allowed Apple, which held much of its $137bn in cash overseas as of Q1, avoid billions in taxes. Countries wanted to eliminate double taxation, but they went too far and left room for companies to achieve double non-taxation, said OECD Secretary General Angel Gurria. The OECD ticked off a number of reasons that the international tax system needs rehabilitation: the growth of digital technology and its consequences for the concept of corporate domicile, the crazy-quilt of hundreds of bilateral tax treaties among major economies, most of which are bespoke, and, the increasing sophistication of tax planners in identifying and exploiting the legal arbitrage opportunities and the boundaries of acceptable tax planning. THe 15 Steps The proposal makes detailed recommendations in 15 somewhat overlapping areas. But in the Cliff Notes version it boils down to the following five: 1) Eliminate double non-taxation by harmonizing international tax systems; 2) Use profits to locate intangibles rather than allowing them to be booked in (for example) Ireland; 3) Require a domicile so everyone knows what accounting and financial rules the company must abide by; 4) Disclose accounting practices to allow

Featured Meeting Summary: The Assistant Treasurers Group of Thirty

AUGUST 2013 OECD Offers Wholesale Revision of Global Tax Regime

By Dwight Cass

Plan would require a level of international cooperation hitherto unheard of. page 1

Optimizing the Mix of Relationship and Transaction Banks

By Joseph Neu

Bank relationships come with a cost for commitment. For most treasurers, an optimal bank group will mix in some less solid transactional banks. page 2

Proposed TImetable
Actions to be completed in 12-18 months Those in the areas of hybrid mismatch arrangements, treaty abuse, the transfer pricing aspects of intangibles, documentation requirements for transfer pricing purposes, a report identifying the issues raised by the digital economy and possible actions to address them, as well as part of the work on harmful tax practices. Relate to CFC rules, interest deductibility, preventing the articial avoidance of PE status, the transfer pricing aspects of intangibles, risks, capital and high- risk transactions, part of the work on harmful tax practices, data collection, mandatory disclosure rules, and dispute resolution. The transfer pricing aspects of nancial transactions, part of the work on harmful tax practices and the development of a multilateral instrument to swiftly implement changes to bilateral treaties.

For Cash in China a One-Way Street Looks to Go Both Ways

By Bryan Richardson

When it comes to cash, China is moving away from the roach motel model where cash checks in, but never checks out. pages 12-13

Actions to be completed in two years

Chaos and Cost in FASBs Proposed Leasing Standard?

By John Hintze

Actions that will take more than two years

The US Chamber of Commerce says FASBs proposed leasing standard may result in substantial costs to businesses. pages 14-15

Source: OECD

continued on page 3

EDITORs NOTEs
Founding Editor & Publisher Joseph Neu Managing Editor Ted Howard Contributing Editors Anne Friberg, CTP Bryan Richardson, CTP Geri Westphal Advisory Board Andy Nash SVP, Treasurer Ahold Finance Group James Haddad Corporate Vice President Cadence Design Systems Ron Chakravarti Managing Director, Global Solutions Head Liquidity & Investments, Global Transaction Services Citi Chris Growney Principal, Director of Sales & Marketing Clearwater Analytics Peter Marshall Partner Ernst & Young LLP Adam Frieman Partner Etico Capital LLC David Rusate Deputy Treasurer General Electric Company Martin Trueb Senior VP & Treasurer Hasbro, Inc. David Wagstaff Managing Director, Head of US Tech, Media & Telecom HSBC Securities (USA) Inc. Eileen Zicchino Managing Director Chief Marketing Officer, Treasury Services JP Morgan Chase & Co. Michael Irgang Senior Director, Financial Risk Management McDonalds Corporation Arto Sirvio Director, Treasury Center Americas Nokia Peter Connors Partner Orrick, Herrington & Sutcliffe LLP Robert Vettoretti Director, Treasury and Financial Management Services PricewaterhouseCoopers LLP Doug Gerstle Assistant Treasurer Procter & Gamble Susan A. Hillman Partner Treasury Alliance Group LLC Academic Advisors Gunter Dufey University of Michigan Donald Lessard Massachusetts Institute of Technology Richard Levich New York University The company and organizational affiliations listed above are for identification purposes only. Advisors to International Treasurer are not responsible for the information and opinions that appear in this or related publications and web sites. Responsibility is solely that of the publisher. ISSN:1075-5691 Vol. 20, No. 6 2013 The NeuGroup, Inc. 135 Katonah Avenue Katonah, NY 10536 (914) 232-4068 Fax (914) 992-8809 subscriberservices@itreasurer.com www.iTreasurer.com SUBSCRIPTION INFORMATION Published Monthly. Annual subscription rates are $295. International Treasurer is a publication of The NeuGroup, Inc.

Bank relationships

Optimizing the Mix of Relationship and Transaction Banks

recurring presentation by treasurers following a financial crisis is to recount the benefits of having solid relationship banks. Crises are what test these relationships, the story goes, and treasurers say they have long memories when it comes time to reward the solid and penalize the fleeting relationships. While a good bonding story makes for a memorable conference presentation, few treasurers will find only solid relationship banks in their bank group, nor should they always want this. Relationships come with a cost for commitment. For most treasurers, therefore, an optimal bank group will mix in some less solid transactional banks to lower their overall cost of credit. How do you determine the right mix for your firm?

By Joseph Neu

KeY ModelIng factors

A recent working paper from the Bank of International Settlements, Relationship and Transaction Lending in a Crisis, offers a framework to help model your mix of relationship and transactional lending banks. No surprise: Determining the right mix will depend on how well your firm is set up to weather a crisis, the extent you rely on bank financing, plus the appetite your firm has for risk. And what if your assessments of the above, and the strength of your relationship banks commitments, prove wrong? However, it also will be driven by two other fundamental bank relationship factors: 1) Your willingness to pay up for credit and the services that support that credit during good times so that the relationship bank has a vested interest in remaining committed when times are bad. Ideally, the relationship bank, so compensated at the upside of the cycle, should not jack up its pricing as substantially as do the transaction-oriented banks that priced themselves low to win your business when everyone was flush. Put another way, the optimal mix should deliver a favorable all-in cost of credit over a full cycle, with some account for the risk or insurance premium your firm is willing to pay to have more banks willing to stand with them in a crisis. 2) Your willingness to share information with your banks and your banks understanding of this information to mitigate

your perceived credit risk. This aspect of banking relationship management, where relationship banks often have a distinct role in learning about a borrowers type over time, is central to the model the BIS working paper developed to assess relationship versus transactional bank lending. The good news is that the papers empirical analysis confirmed its basic prediction: (1) that relationship banks charged a higher spread before the crisis; but (2) offered more favorable continuation-lending terms in response to the crisis; and (3) suffered fewer defaults. This confirmed for the authors the informational advantage of relationship banking. The bad news is that the study was of Italian banks (before and after the Lehman crisis). More importantly, the model is biased to smaller, privately owned firms that have limited access to capital markets and where the information advantage of relationships banks is arguably highest. Having said this, treasurers wishing to apply some quantitative rigor to the fine art of bank relationship management may want to explore the model math the paper presents.

RIsk goes botH waYs

Also worth considering is the papers assessment of bank risk. Paying relationship banks a bit more in good times makes them less risky, if they manage themselves right, in good times and bad. Consistent with emerging bank regulation, banks should build up a capital cushion in good times to help sustain them (and their lending and other economically important activities) in bad times. The papers empirical analysis indicated that part of a relationship banks offering of superior loan pricing post-crisis, relative to transaction banks, is driven by their financial position. Thus, treasurers who care about relationship banking should probe their banks on capital and encourage retaining earnings for capital cushions. The information flow should go both ways. Unfortunately, the papers authors conclude that the aggressiveness of less wellcapitalized and lower-cost banks (and they should include non-banks) will continue to undermine true relationship banking. This, they imply, is why regulation is needed.

TREAsURY & TAXATION

OECD, continued from page 1

investors to ferret out tax avoidance schemes; and 5) Create dispute resolution mechanisms for the inevitable cross-border clashes. The OECD emphasizes the digital nature of the global business environment at several points in the proposal. By this, it means that many companies can have their headquarters in most any country they likeusually the one with the lowest taxes. Like Apple, companies claim that profits were made in the lowest tax jurisdictions they can findin Apples case, Ireland. France had proposed a specific tax for digital firms, but this option didnt make the final cut. The key elements of the OECDs 15 Actions are as follows: Address the tax challenges of the digital economy. Identify the main difficulties that the digital economy poses for the application of existing international tax rules and develop detailed options to address these difficulties, taking a holistic approach and considering both direct and indirect taxation. Neutralize the effects of hybrid mismatch arrangements. Develop model treaty provisions and recommendations regarding the design of domestic rules to neutralize the effect (e.g., double non-taxation, double deduction, long-term deferral) of hybrid instruments and entities. Strengthen CFC rules. Develop recommendations regarding the design of controlled foreign company rules. This work will be coordinated with other work

as necessary. Limit base erosion via interest deductions and other financial payments. Develop recommendations regarding best practices in the design of rules to prevent base erosion through the use of interest expense, for example, through the use of related-party and third-party debt to achieve excessive interest deductions or to finance the production of exempt or deferred income, and other financial payments that are economically equivalent to interest payments. The work will evaluate the effectiveness of different limitations. Counter harmful tax practices more effectively, taking into account transparency and substance. Revamp the work on harmful tax practices with a priority on improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and on requiring substantial activity for any preferential regime. Prevent treaty abuse. Develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances. Work will also be done to clarify that tax treaties are not intended to be used to generate double non-taxation and to identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country. Prevent the artificial avoidance of Permanent Establishment (PE) status. Develop changes to the definition of PE to

prevent the artificial avoidance of PE status in relation to BEPS, including through the use of commissionaire arrangements and the specific activity exemptions. Work on these issues will also address related profit attribution issues. Assure that transfer pricing outcomes are in line with value creation for: Intangibles. Develop rules to prevent BEPS by moving intangibles among group members. This will involve: (i) adopting a broad and clearly delineated definition of intangibles; (ii) ensuring that profits associated with the transfer and use of intangibles are appropriately allocated in accordance with (rather than divorced from) value creation; (iii) developing transfer pricing rules or special measures for transfers of hard-to-value intangibles; and (iv) updating the guidance on cost contribution arrangements. Risks and capital. Develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to, group members. This will involve adopting transfer pricing rules or special measures to ensure that inappropriate returns will not accrue to an entity solely because it has contractually assumed risks or has provided capital. The rules to be developed will also require alignment of returns with value creation. Other high-risk transactions. Develop rules to prevent BEPS by engaging in transactions that would not, or would only very rarely, occur between third parties. This will involve adopting transfer pricing rules or special measures to: (i) clarify the
continued on page 11

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Capital markets

Floating NAV for MMFs Will Be Costly

oving prime money market funds to a floating net asset value regime will cost billions of dollars and have material accounting impacts. Thats according to two reports released Thursday from the US Chamber of Commerce and Institutional Cash Distributors (ICD). The Securities and Exchange Commission voted in early June to proceed with new rules that would require prime money market fund managers to report marked-to-market daily net asset values. These variable or floating NAV (or VNAV) funds would coexist with standard $1-per-share constant net asset value (CNAV) funds, although the CNAV reporting would only be permitted on US Treasury and government securities funds, not prime funds. The US Chamber proffered the cost argument against the proposal, suggesting that moving to a VNAV would create costs and complexities that would force companies from using the assets. The operational complexity, systems alterations, and business process changes needed to support a floating NAV threaten continued use of MMFs for most investors, including corporations and municipalities, the Chamber said in its presentation. And complying with new rules will cost somewhere $1.8bn and $2bn, the Chamber said, with annual operating costs between $2bn to $2.5bn.

More iTreasurer Online!

For more valuable articles published on our web site visit iTreasurer.com. Latest postings include: n Capital Markets: PIK Your Poison. Toggle bonds are roaring to market. n Regulatory Watch: Mid-Sized Banks to Get Guidance on Stress Tests. New proposal on what mid-sized banks should expect from stress tests. n Treasury and Technology: Managing Your SCF Program with an App? Supply Chain Finance Manager added to Deutsch Banks Autobahn App market.
4 International Treasurer / August 2013
n

For its part, ICD detailed the operational and accounting issues associated with moving to a floating NAV. ICD says that a floating NAV will require new settlement alternatives, including either: n Delivering payments post-end of day pricing; n Pricing several times per day; or n Day-after pricing (or T+1) On the accounting side, corporations would be required to start monitoring MMFs mark-to-market value and report on any minute gains or losses. Such reporting will result in: n A need for a significant overhaul of general accounting standards; or n An additional accounting burden on US corporations. Up to now corporate treasurers have enjoyed the no-brainer aspect of MMFs. A dollar in means a dollar out, and there usually no accounting to deal with. But moving to a floating NAV could change that, opponents say. Several studies have revealed that treasurers might stop using them altogether. A survey by consultancy Treasury Strategies of 150 European institutions in March showed that European investment firms would seek out investment alternatives should the constant net asset value methodology for MMFs be eliminated. Likewise, an Association of Financial Professionals survey in 2012 revealed that: Financial professionals indicate that implementation of some or all of [SEC] proposals may cause their organizations to stop investing in MMFs and liquidate some, if not all, of their current MMF holdings. No matter what happens, users of MMFs have some time. Under federal law, rulemaking generally involves multiple stages; the SEC may not simply change regulations overnight, Federated wrote in a report in May. That means a period of time running from a few weeks to many months for SEC staff and commissioners to hash out the proposal draft, and then when there is agreement, there is a Notice of Proposed Rulemaking detailing the proposed changes along with the reasons for them. Between now and then there are certain to be more reports showing the

damage VNAV will do. In the meantime, many MMF alternatives are cropping up; treasurers and money managers should take the time to explore them.
Regulatory watch

For Swap Dealer Designation, Character Shouldnt Count

egulators who want to know the content of a swap dealers character should actually be paying more attention to why and for what purpose they use swaps. Thats the argument Commodity Futures Trading Commissions Scott OMalia used in testimony Tuesday in advocating for clearer rules. The 2010 Dodd-Frank legislation defines a swap dealer as any person who: n Holds themselves out as a dealer in swaps; n Makes a market in swaps; n Regularly enters into swaps with counterparties in the ordinary course of business for their own account; or n Engages in any activity causing the person to be commonly known in the trade as a dealer or swap market-maker. But, Mr. OMalia said in testimony before the US House Agricultural Committee, the structure of the rule makes it too difficult for firms to determine whether they are end-users or swap dealers. The swap dealer rule is a good example of how the Commission failed to accurately interpret Dodd-Frank by broadly applying the swap dealer definition to all market participants and ignoring the express statutory mandate to exclude endusers from its reach, said Mr. OMalia, currently the lone Republican member of the CFTC and a persistent proponent of making the rules clearer and subject to cost-benefit analysis. Instead, the swap dealer rule makes it unnecessarily difficult to determine whether an entity is a swap dealer or an end-user. In fact this was par for the course for the CFTC, which Commissioner OMalia said has repeatedly overstepped its mandate in drafting and proposing rules. This despite repeated attempts by Congress to not broadly apply the rules. Members

For additional information visit iTreasurer.com

BEsT Of ITREAsURER.COm
of Congress who drafted the Dodd-Frank Act repeatedly [have] attempted to make it clear to the Commission that commercial end-users should be exempted from Dodd-Franks swap provisions, Mr. OMalia said, even citing a joint letter circulated by former Senators Chris Dodd and Blanche Lincolnno fans of derivativesthat Congress does not intend to regulate end users as Major Swap Participants or Swap Dealers just because they use swaps to hedge or manage commercial risks associated with their business. In order to fix the problem, Mr. OMalia said Congress should expressly exclude end-users from the swap dealer definition. Alternatively, he said, Congress should consider ways that would encourage risk-mitigating behavior by endusers and also remove the costly burden imposed by the swap dealer definition. Mr. OMalia went on to suggest other ways that the CFTC might lessen the burden on business. These included fixing hedging and clearing: I am concerned that the swap dealer rule does not provide any legal or factual justification for the threshold amounts used in aggregation of swap dealing activity, he said. It also includes clarifying the term Financial Entity in the CEA, he said, which addresses mandatory clearing. Also, raising the de minimis threshold for special entities, which includes state, city, and county municipalities that fall within the swap dealer rule. This, Mr. OMalia said, was another group that deserves to be re-evaluated for fair treatment.
Risk management

A Swap Execution Facility Just for FX

mid the recent rash of applications to run swap execution facilities (SEFs), foreign exchange (FX) trading technology provider Integral Development filed earlier this week to launch the first SEF specializing in FX. FX swaps and FX forward are exempt from clearing, and rules stemming from the Dodd-Frank Act require FX options and non-deliverable forwards (NDFs) the latter necessary to hedge currency risk when doing business in countries with capital controls such as China and Indiato be cleared. Integrals SEF will initially trade NDFs, with other types to follow. Integrals move follows several SEF application filings by a variety of other Wall Street firms, indicating the likelihood of abundant liquidity and competi-

tion in the market for more standardized FX swaps. Firms that have announced applying for SEF status include Tradeweb Markets, MarketAxess, GFI, trueEx, State Street and TeraExchange. Firms anticipated to apply include ICAP, Tullet Prebon, BGC Partners, and Tradition Financial Servicesall inter-dealer brokersas well as start-up platform Javelin Capital Markets. Integral appears to have submitted the first SEF application to trade only FX swaps. Its FX Grid network provides global access to virtually every type of business involved in FX, including liquidity providers, prime brokers, banks, brokers, investment management firms, hedge funds and corporates. Pending regulatory approval, Integrals SEF will provide the necessary connections to liquidity providers, clearinghouses, and swap data repositories via the cloud, requiring no upfront costs for users and providing a pay-as-you-go fee model. We have created an SEF that preserves what is best about [OTC] marketsrelationships, choice, resiliency, and bespoke business modelsthereby minimizing any potential disruption to our customers foreign exchange trading businesses, said Integral CEO Harpal Sandhu in a statement.

In wHat assets Is Your pensIon allocated?

Fixed Income Domestic Equity Global Equity Global Fixed Income Real Estate Hedge Funds Other 0 20% 40% 60% 80% 100%

RISK ON OR RISK OFF?

Despite the low return environment, participants in a recent NeuGroup Dened Benet Pension Webinar (which included members of the NeuGroups Treasurers Group of Thirty 1 and 2) said they have not been tempted to increase risk. Those polled said that their appetite for risk either remained unchanged or had been reduced in recent years. Risk had not increased for the members despite the fact that almost everyone participating faced underfunded pension obligations. One member mentioned that the current gap does not concern them and expects the gap to narrow as rates rise and the investment yield on their plan increase.

Source: NeuGroup T30 & T30-2 Pension Management Survey Poll For additional information visit iTreasurer.com
n

International Treasurer / August 2013 5

2013 SPRING MEETING

The Corporate ERM Group

May 1 - 2, 2013

Thank You

A successful NeuGroup Network Peer Group depends on the participation of its members. We thank you, the members and sponsors of The Corporate ERM Group, for your open dialogue and peer knowledge exchange at the recent Spring 2013 ERM Meeting. Your active involvement is the key to maintaining an unrivaled level of interaction and networking within the group, as well as providing highly valued contributions to the entire NeuGroup Network of 300+ members at 180+ companies.

Facilitated by:

2013 Spring meeting briefing

The Assistant Treasurers Group of Thirty

The NeuGroup for assistant treasurers at large MNCs

More Clarity for MNCs as Regulations Muddy Waters

The NeuGroups new peer group for assistant treasurers of large MNCs (AT30) met for the second time in April in Minneapolis, MN. The meeting was sponsored for the second time by Citi. 1) Managing Liquidity Structures: In-house banks offer benefits in organizing and minimizing inter-company transaction volumes and costs for multinationals while supporting helpful liquidity structures such as cash pooling. Key Takeaway: Their adaptability is a reason why IHBs have become a key centralization enabler for many multinationals. However, they should be vetted against current legal and tax structures before implementing. Location is a significant consideration. 2) Regulatory Update: Basel III is mired in differing interpretations while SEPA is simply a transactional change. Key Takeaway: Members will need to be in close communication with banking partners to understand how the regulations will impact the cost of products and services and the overall global relationship. 3) SAP Treasury Gets a Second Look: Members reviewed the pros and cons for those considering this TMS solution based on the experience of both seasoned and new users. Key Takeaway: While there are drawbacks to the SAP TMS, ERP compatibility is the primary benefit. Additional bolt-on tools allow greater flexibility and functionality, but for new users thoroughly mapping the business landscape and requirements from the outset is necessary for avoiding pitfalls.

SPONSORED BY:

THE ASSISTANT TREASURERS GROUP OF THIRTY

RELATED GROUPS:

The Engineering & Construction Treasurers Peer Group

n

From In-House Banks to Global Pooling

There are numerous considerations when evaluating an IHB to aid in consolidating treasury operations. Many companies are deliberating about designing such structures as well as transitioning cash management activities, thereby minimizing transaction volumes and costs. But a collaboration with the tax and legal teams along with a review of the various jurisdiction benefits and limitations are a few important boxes to check. KeY TakeawaYs 1) The IHB approach to liquidity management. Liquidity structures have always been an integral part of treasury organizations. Now more than ever, you can observe a growth in multi-region IHB structures. The practical considerations for the evolution of the IHB can be directly attributed to global expansion and increased revenue mix overseas in addition to complexities related to time zones, language, growth of regional shared services and decision execution. 2) Clarify your legal structure prior to establishing an IHB. Growth in international operations, a legal re-organization, and increased volume in intercompany transactions between subsidiaries were all drivers to consider an IHB for one large multinational with presence in nearly 100 countries. After a failed first attempt to set up a IHB due to legal structure hurdles, the second effort set out to support its growing business and change in legal structure. A new approach to allocating responsibilities between treasury at headquarters, regional staff and shared services centers,

The Tech20 Treasurers Peer Group

n

The Treasurers Group of Thirty 1, 2 and 3

NeuGroup NetWorK 15+ GROUPS
n part of the

300+ MEMBERS
n

180+ COMPANIES

FACILITATED BY:

For more information: www.NeuGroup.com

2013 The NeuGroup. This information is sourced from The Assistant Treasurers Group of Thirty.

Basel III progress is moving at a snails pace. Further, there is a lot of discretion at the national level for interpretation.

coupled with a global review of the companys cash positions and consolidation of cash into pools followed by closures of unnecessary bank accounts, allowed for an easier transition to a SAP-based IHB implementation. 3) Design your IHB strategy. Creating efficient liquidity structures and organizational models can be vastly different and complex to assemble. Ron Chakravarti, Managing Director with Citis Treasury and Trade Solutions group, explained that global treasury organizations in various regions may have a solid line into an IHB center while others may find certain functions with dotted lines from the SSC or possibly other functions. Again, it is difficult to use an IHB effectively without rationalizing the organizational structure. 4) Find the right location. Considerations for establishing an IHB start with choosing a favorable location, suggested Mr. Chakravarti, along with important tax considerations. Primary areas of focus should be defined prior to kicking off an IHB project, including local regulations, tax structure, and withholding effects to the businesses. 5) Liquidity structures are defined by IHB scope. Companies must consider trading models in conjunction with local regulatory policies before having an IHB in scope. After this step is fully vetted with legal and tax, then the scope and functionalities can be considered to help define an efficient liquidity structure. 6) Build out the IHB scope. One member company has expanded its IHB by including intercompany netting and paying on behalf of affiliates. As activities are centralized, account structures progressively get simpler, thereby reducing the number of accounts. By dividing the responsibilities of the entities, an organization can have one entity handling the commercial flows and another considering the appropriate scope and the location-based regulatory and tax requirements for the IHB. The objective is to drive an efficient bank account and bank relationship structure. 7) Picture the IHBs evolution. The graphic below illustrates the efficiencies gained along the IHB evolution timeline. n Traditionally, IHBs have been set up to alleviate the voluminous amount of intercompany transactions between legal entities and to comply with tax policies. Phase 1 includes mapping the organizations landscape.
n

Basel III Mired in Interpretations

Basel III is mired in differences between many stakeholders including banks, regulators and politicians from multiple countries.

KeY TakeawaYs
1) The balkanization of the international banking system. The input on Basel III is voluminous in both content and origin. Everyone is jumping into this discussion and it is not cohesive, noted Elyse Weiner, Global Head of Citibanks Liquidity Management Services. Everyone includes bankers and regulators in every country. Consequently, its progress forward is moving at a snails pace. Further, Ms. Weiner noted that there is a lot of discretion at the national level for interpretation, which can lead to conflict between local country regulations and specific US regulations. 2) Bank branches vs. subsidiariespick your risk. The regulations are forcing banks to rethink their structure abroad. Banks prefer a branch structure because there is a lesser regulatory burden and lesser capital requirements. But local jurisdictions sometimes require a subsidiary structure in order to be able to fully regulate the bank locally. Bank customers prefer the branch because of the legally binding commitment to the operation by the parent which is not explicit for a subsidiary. 3) The subsidiary double standard. Members believe banks should be held to the same standard they place on corporates for the parent entities to guarantee the debt of their subsidiaries. However, Ms. Weiner pointed out that banks are different because of the regulations that govern them. 4) Who gets FDIC insurance? Some of the squabbling within the Basel III discussions is simply jockeying for better position in the case of liquidation. There is some debate over whether
Continued on page 9 8 8 THE ASSISTANT TREASURERS GROUP OF THIRTY

 Phase 2 focuses on cross-entity liquidity management on a global scale, while maintaining clear segregation of liquidity management to avoid co-mingling of funds.  Phase 3 focuses on enhanced cross-entity liquidity management on a regional scale with centralized external deposits and investment.  Phase 4 of a more established IHB will often have centralized the cash forecasting and foreign exchange management process to the regional IHB centers. IN-HOUSE BaNK EVOLUtiON
Centralization Cross-entity Liquidity Mgmt Global 2 Cross-entity Liquidity Mgmt Regional 1 I/C Fixed Loans/ Deposits Segregated Liquidity Mgmt 5 Intercompany Netting InternalCashless 6 POBO / ROBO External IHB (Integrated with Business Units)

3 Centralized External Deposits/ Investments 4 Centralized Cash Flow Forecasting/ FX Risk Mgmt

IHB (Treasury Functionality) Netting Cash Settlement Finance Company Range of Services

(no co-mingling/ intercompany loans)

Improve management of liquidity and FX exposures; returns from greater tax efficiency; extension to working capital management Source: NeuGroup Meeting Material; AT30 Spring 2013

 Phase 5 begins to include intercompany netting and internal cashless settlements leveraging internal systems.  The last step to establishing an IHB on steroids is to incorporate POBO/ROBO and include the integration of business units, treasury functionality, and finance companies.

outlook The adaptability of IHBs, as indicated by their ongoing evolution, is a key reason why they have become the centralization enabler of choice for many multinationals. Their ability to interact with a variety of different legal entities also makes them useful to consider when new legal structures and other organizational changes are contemplated. Creating a separate legal entity that mimics bank activity aims to avoid subjecting IHBs to any of the regulatory challenges confronting real global banks.
Continued from page 8

SAP Treasury Gets a Second Look

Many practitioners are taking a second look at the benefits SAP Treasury has to offer. Although SAP Treasury is not known for providing flexible technology for running a treasury organization, it is important to note that there are significant benefits, such as the seamless integration with the rest of the ERP. The meeting session led by two members, one a 10-year user and the other in the throes of implementation, raised many of the pros and cons, as well as key elements of successful implementations. KeY TakeawaYs 1) User perceptions do not necessarily align with reality. SAP Treasurys most vocal detractors are those practitioners who havent deployed it. 2) Not the solution for everything. Multiple members discussed the need for complementary bolt-ons to enhance the SAP Treasury module. Such aftermarket stabilizers and their uses include: n Reval: FX activity and trade repository n FXall: hedging positions calculations n FiREapps: exposures management However, the bolt-ons do not cover every shortfall, and they have issues of their own. There is an assertion that SAP alone can be a solution if the exposure is apparent and the system is clean. For instance, one member company has worked with IT to develop a customized report to provide them with transactional currency exposure by entity for one-click viewing and management of exposures. But the caveat is that the SAP data must be properly maintained, otherwise practitioners will need to adjust FX exposures, ultimately negating the potential of the SAP system as a stand-alone. Further, members caution that there can be an explosion in the need for multiple ad hoc reports, which has soured the SAP experience for some users. See the sidebar on pros and cons for SAP Treasury. 3) SAP reporting is improving. One member complains that SAP reporting reminds him of DOS. Fortunately, SAP has acquired HANA (high performance analytical appliance), a database meant to analyze SAP transactional and analytical information across the entire enterprise. With HANA, which replicates data from SAP, treasury practitioners can expedite requests using Business Intelligence. SAP is reported to be building out the HANA infrastructure. 4) Simple infrastructures are the best environments. The challenge with SAP Treasury is when more complicated tasks are required; the assessment of the requirements has to be clearly outlined from the onset of the project. Once you have the SAP ERP system established, then you can proceed to implement SAP Treasury; it is primarily an accounting system and demands strict discipline in journal entries.

or not, in fact, FDIC insurance covers deposits beyond the US. If it does not, local depositors in foreign subsidiaries of US banks are at greater risk in a failure. Regulators, such as the Financial Services Authority (FSA) in the UK, in particular, are trying to establish the rules to give their citizens the same protections as US depositors. 5) The current low-rate environment is easing the transitionfor now. Everyone has been warned that Basel III (and Dodd-Frank) will add significant cost to banks, especially after rates rise, which will be passed on to customers. Will early adopters be bold enough to raise their pricing before their slower-moving competitors? Or will they choose to absorb the cost and risk short-changing shareholders in the short term?

SEPA Viewed as Transactional Change

SEPA is a transactional paradigm shift, not a regulatory change, according to Elyse Weiner, Global Head of Citibanks Liquidity Management Services. Regardless of which label you apply, the majority of AT30 members are using SEPA as a catalyst for change. Companies are taking the opportunity to rationalize their banking relationships and to minimize the number of bank accounts. Others are upgrading to the XML standard, with a goal to become more bank-agnostic while at the same time consolidating AP/AR transactions in SSCs, treasury centers, or other regional hubs. And fewer are considering alternative plug-in solutions to be in compliance with the upcoming SEPA deadline.

9 THE ASSISTANT TREASURERS GROUP OF THIRTY

5) Updates are a downside for treasury. The mention of SAP Treasury updates for current SAP users is enough to make them cringe. Because treasury is fully integrated into the ERP, any change to it has to be tested by treasury to ensure there was no unforeseen impact. Update pitfalls may be bypassed if testing for the treasury module is built into annual schedules. Modifications and upgrades are not likely to be avoided where IT support for SAP Treasury is heavy: IT supports the whole system, and treasury has to go along for the ride with every modification. 6) Success is in the planning. Dont take shortcuts in the planning stages. Taking time to map operational and functional requirementsin careful alignment with tactical and strategic goals, such as reducing repetitive tasks, standardizing procedures, etc. will ensure that all needs are accounted for. This might include activities such as rationalizing bank relationships and bank accounts and thoroughly documenting and reviewing all of the treasury processes. This critical stage can help you determine where operational flow could be improved prior to or as part of the SAP Treasury implementation. Planning should include time for testing, as well. As with the implementation of any technology, the entire process (from identifying where SAP Treasury could benefit your organization to rollout and integration) can take several months. 7) Secure IT support, but maintain control. Although not every treasury has dedicated IT support in the department, many have strong partnerships with IT, which is critical to the rollout of any system. Treasury should be intimately involved in the project and scope to ensure that IT is allowed to function as a critical support partner without becoming a de facto decision maker for strategic business initiatives. outlook: Treasury organizations where SAP is the ERP seem to be increasingly pressed to give a hard look at SAP Treasury as a replacement for their legacy TMS, primarily because IT likes the consistency of the technology. Implementing SAP Treasury allows treasury to link directly to the G/L system without needing to develop additional interfaces. Although not viewed as being flexible, it is a solution that allows for added automation, simplification, and acceleration of processes, versus no TMS at all. As companies grow their global footprint, many issues are facing them. Yet there are numerous practices, structures and tools in the market that can lessen the burden. Regulatory changes will require a close alliance with strategic bank partners in order to stay informed on how these changes might impact organizations. Corporate growth and expansion into new markets will require companies to re-evaluate their legal and tax structure to optimize compliance and liquidity. The regulatory evolution and the ongoing threat of tax overhauls from many countries will keep this item on the radar for many years to come. Along with this will also be the need to monitor and possibly modify the operational structure of treasury in order to maintain departmental efficiency. CONCLUSION & NEXT STEPS
The AT30 will meet next on September 18 19 at Googles offices in Mountain View, CA. The meeting will again be sponsored by founding sponsor, Citi. The preliminary agenda has been developed and include topics such as: Treasury Management SystemsPart 2: A discussion on the counter-view of SAP Treasury which will include the pros and cons to non-SAP Treasury TMS solutions and how to overcome the political pressure to use SAP Treasury. Bank Relationship Management: A discussion on the various approaches to measuring and reporting bank performance, processes for assigning additional business, and developing solid global bank partnerships. The session will shift into a secondary discussion on approaches for consolidating banks. Developing an Optimal Investment Policy: Led by a member that has made a dramatic shift from an ultra-conservative and liquid portfolio to one with a greater focus on returns, this session will address the philosophies and mechanics behind a well-structured investment policy.

The Realities of SAP Treasury

Technology is a necessity to effectively manage Treasury functions globally, but choosing the right fit is a challenge. Limitations and resource constraints increase the importance of making the right decisions. In the instance of TMS solutions, AT30 members discussed various offerings but focused on case studies from members that have adopted SAP Treasury. In exchanging their common and unique challenges, members developed a list of pros and cons related to the use of the SAP solution: Pros: n Consolidated system and data n Ability to fully automate intercompany balances n Simplified bank communication, statement management, reconciliation n Secured data n Customizable deal types, accounting treatments and reports n Newly enhanced analytics n Bolt-on third-party SAS products n Leverages broad IT footprint Cons: Cost to support technical infrastructure n Lack of flexibility n Reporting hard to access n Heavy testing requirements n Lack of user-friendly interfaces n Limited Treasury-specific functionality
n

The benefits are considerable, but so are the drawbacks. Some members have called in consultants to help map requirements, guide the selection process and manage implementation, testing rollout and integration.

To Learn More CONTACT:

Bryan Richardson 501-217-9925 brichardson@neugroup.com Joseph Neu 914-232-4069 jneu@neugroup.com
10 10 THE ASSISTANT TREASURERS GROUP OF THIRTY

TREASURY & TAXATION

OECD, continued from page 3

circumstances in which transactions can be characterized; (ii) clarify the application of transfer pricing methods, in particular profit splits, in the context of global value chains; and (iii) provide protection against common types of base eroding payments, such as management fees and head office expenses. Establish methodologies to collect and analyze data on BEPS and the actions to address it. Develop recommendations regarding indicators of the scale and economic impact of BEPS and ensure that tools are available to monitor and evaluate the effectiveness and economic impact of the actions taken to address BEPS on an ongoing basis. Require taxpayers to disclose their aggressive tax planning arrangements. Develop recommendations regarding the design of mandatory disclosure rules for aggressive or abusive transactions, arrangements, or structures, taking into consideration the administrative costs for tax administrations and businesses and drawing on experiences of the increasing number of countries that have such rules. Re-examine transfer pricing documentation. Develop rules regarding transfer pricing documentation to enhance transparency for tax administration, taking into consideration the compliance costs for business. Make dispute resolution mechanisms more effective. Develop solutions to address obstacles that prevent coun-

tries from solving treaty-related disputes under Mutual Agreement Procedure (MAP), including the absence of arbitration provisions in most treaties and the fact that access to MAP and arbitration may be denied in certain cases. Battles aHead How does the OECD expect to herd its cats? Secretary General Angel Gurra laid out the challenges in the speech he gave to announce the plan on July 19: 1) First, international tax rules will be developed to address the gaps between different countries tax systems, while still respecting the sovereignty of each country to design its own rules. Actions will be taken to neutralize hybrid mismatches and arbitrage, reinforce domestic legislation to protect the tax base of countries against shifting of profits to tax havens (through strengthening the so-called CFC rules Controlled Foreign Companies) and limit interest deductibility). 2) Second, the existing rules on tax treaties and transfer pricing will be revisited to fix their deficiencies and to align them with substance and value creation. The Action Plan aims to prevent treatyshopping and to revise the definition of the permanent establishment, to prevent BEPS. Three actions are identified in the area of transfer pricing to put an end to the divorce between the location of profits and the location of real activities. Importantly, there is recognition that if

the arms length principle is not fit to address these issues properly, measures that go beyond it will be introduced. 3) Third, more transparency will be established, including through a country-bycountry reporting by companies to tax administrations on their worldwide allocation of profits. It also requires more transparency between governments, with the need for countries to disclose tax rulings and other tax benefits to their partners. Going forward we will carry out a comprehensive analysis of the economic impact on BEPS, including the effects on taxpayers behavior and on public finances, and we will look at their macroeconomic implications including international spill-overs. Many companies benefit from the current international tax mess, with its host of arbitrage opportunities. Saving on taxes gives a multinational an unfair advantage over a domestic company. So corporate lobbies will be hard at work to kill this effort. The OECD goes to some pains to show that BEPS is a real problem, to counter lobbyists assertions that the tax system works fine. The chart below, from an earlier OECD report on the subject, shows the percent of corporate taxes as a percentage of GDP. Corporates have a host of counter-arguments, most obviously, that the tax system works as it is. A partial list is available on The Tax Analysts Blog, (How Will Business Lobbyists Spin the OECD Action Plan?) by Martin Sullivan.

Taxes on corporate Income as a percent of GDP

4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1965 1975 1985 1990 1995 2000 2007 2008 2009 2010 2011
OECD weighted average

Source: OECD 2012

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International Treasurer / August 2013

11

CAPITAL mARKETs
Cash management

For Cash in China a One-Way Street Looks to Go Both Ways

By Bryan Richardson China moving away from the roach motel model where cash checks in but never checks out.

There is a little bit to be excited about in the world of treasury management in China. In case you havent heard, the border is opening up to currency flow, at least on a limited basis. But while it is in the early stages, the initiative being tested by the Chinese financial regulators is big news and is a big step for the country. The Chinese financial regulatory bodies, SAFE (State Administration of Foreign Exchange) and the PBOC (Peoples Bank of China) are both testing several schemes where currency can cross the border for both incoming and outgoing transactions. For a country that historically has been known for its very strict currency controls, this is major progress. So, one might wonder, why the change of heart? Locals on the ground cite several reasons. China has been actively reaching out to Western firms and banks. First, it is common knowledge that China wants the RMB to become more of a globally accepted and utilized currency and ultimately a reserve currency. None of that will ever happen if the currency cant trade freely. Second, China wants Shanghai to evolve toward becoming a global financial center on par with New York, London, Hong Kong and Singapore. To make this happen, the country cant be perceived as one where cash goes in and never comes out. China is acknowledging that these old policies severely limit their ability to draw foreign business investment. As much as it has occurred already, foreign business investment would be even greater if companies knew they could get their profits out. Third, China wants to be the location of choice for Asia-based regional treasury centers (RTCs). Many companies such as Ford, GM, P&G and Cargill have substantial treasury operations already based in China but many others are evaluating
12 International Treasurer / August 2013
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where to set up an RTC as their business seeks to expand in the region. In the current state, Singapore and Hong Kong often win out as the best location. However, given the growing importance of China for western businesses, RTCs based there would make good sense provided the business needs can be met. Acknowledging their policies present significant challenges for Western firms wanting to do business in China, the Chinese government has been actively reaching out to Western firms and banks to solicit input on what they need to be more productive. Clearly they are listening and are moving to make life less painful. Regulations are fluid and numerous but positive. Lewis Sun, head of sales for HSBCs Global Payments and Cash Management team, notes that 2012 and 2013 to date have seen both SAFE and the PBOC loosen their respective rules for the purpose of foreign currency control reform. SAFE is relaxing the administrative requirements while PBOC is broadening the role of the RMB. The overall focus has been on three areas: n Exchange-rate liberalization n Interest-rate liberalization n Full convertibility Mr. Sun says that these are more fundamental to cash and trading than even the pilots. The cross-border currency programs being piloted are of keen interest to most MNCs, but particularly those with cash accumulating in significant quantities. For companies that are heavy users of cash, the pilots are less applicable. But several NeuGroup members are participating or preparing to participate in the various pilots. The topic has come up at peer group meetings in Singapore, China and the US, which gives further evidence of the level of interest globally. PIlot HIgHlIgHts HSBC, a recent NeuGroup China peer

group meeting sponsor, notes that there are multiple pilots between SAFE and PBOC for three different purposes and that there are three different types of customers that benefit from the pilots: n Those with trapped cash in China n Those who need to borrow offshore n Those with cash pools outside of China The pilots seek to ease restrictions associated with these circumstances and specifically moving RMB and USD in and out of the country. Following are summaries of three pilots: 1) SAFEs cross-border foreign currency (FCY) centralized management. This pilot is for cash sweeping and foreign currency payments/loans between onshore and offshore legal entities. The scheme requires an International FCY Master Account and a Domestic FCY Master Account be set up with the same bank. See illustration next page. 2) PBOCs cross-border lending. This pilot is aimed at broadening the channels for onshore RMB flowing into the offshore RMB market. Eligible participants must be a holding company or regional RTC, genuinely cash rich and self-funding, or funding from RMB cash pooling. Mr. Sun outlined some key considerations around this pilot: n This is one alternative to deal with excess liquidity in China. n Transfer pricing issuemust be an arms-length basis for inter-company loan rates. n Potential tax impact with onshore/ offshore transactions. n Single company or via cash pooling determines different lending quotas. n Usage of the RMB funds in the overseas market. 3) PBOCs simplified documentation for RMB cross-border settlement. The objective for this pilot is to further simplify the process of using RMB for international trade by allowing qualified entities to

For additional information visit iTreasurer.com

CAPITAL mARKETs
pilot RMB cross-border settlements without supporting documents. Criteria for participation includes: n More than one year of sound relationship maintained with the pilot bank. n Relatively stable global trade counterparties. n Comparatively stable in nature, frequency and scale for its cross-border settlements. n No bad records on credit, operational fraud, etc. 4) SAFEs cross-border netting. Target is for inter-company netting of payables and receivables. Companies expect this program will ease FX transactions. 5) SAFEs centralized payment and collection. Similar to number 4, it is intended to do just as the name implies and allow payments and collections in RMB from a centralized corporate entity such as an RHQ, holding company or even an SSC, on behalf of other company entities. THere are lImIts The pilots do not allow unlimited volume. Quotas vary by pilot but are based on total investment in China for the sweeping pilot or the net outstanding balances for the inter-company settlements. However, quotas are not necessarily set in stone. One pilot participant observed different quotas between SAFE and PBOC and negotiated a higher quota with one regulator by referencing the higher quota allowed by the other regulator. Are the challenges worth the benefits? This same pilot participant highlighted the big benefit of freeing up otherwise trapped cash to be used much more efficiently. However, he also highlighted some drawbacks: n Resource implications. The application process and subsequent reporting requirements and monthly meetings with regulators are a huge strain on resources. n Tax implications. Consultation with your tax department is recommended. Also note that inter-company loans are likely to attract a 5 percent business tax and dividend payments can garner a 10 percent withholding tax. n Scalability of the pilot program. It is uncertain how these pilot programs will evolve. In their current form, expanding the resource strains could be a non-starter. need tHe rIgHt bank partners These programs require a partnership with a participating bank. The Chinese regulators prefer participants use Chinese banks but that is not required. Naturally, Western firms will be more comfortable with Western banks. Deutsche Bank, JP Morgan and HSBC have been cited as qualified partners. But wait, I dont want to move my cash. An irony in this situation is that interest rates in China are notably higher than in other regions. Consequently, excess cash there will earn a much better return than in an investment portfolio somewhere else. The Chinese authorities frown on participants who dont actually move any money. Mr. Sun advises, Dont apply unless you plan to act. THe fIve-Year plan Opening the currency borders in China is a huge step toward globalizing the RMB and for making investment in the country more palatable. It also demonstrates how serious China is about bringing the RMB to full convertibility and a more dominant role in global markets. Mr. Sun says HSBC believes the RMB will be fully convertible within five years. As everyone knows, Chinese regulators are very slow and cautious to evolve. But the Chinese government has been is driven by a strong desire to internationalize the RMB and broaden its financial influence globally. In the meantime, not all is lost. As mentioned, interest rates in China are notably high, so your trapped cash is at least working for you. Additionally, some companies have used their trapped cash as guarantees to foreign loans to reduce their borrowing costs.

Sample of a SAFE Approved Account Structure

Cross-border foreign currency (FCY) centralized management from SAFE

HK Domestic FCY Master Account (DFMA)

n Domestic

Within the concentrated foreign lending quota Within the concentrated foreign debt quota

International FCY Master Account (IFMA)

Singapore

Australia
n Cross-border n Long-term

FCY cash concentration

n Cross-border

FCY transactions inPOBO/ROBO, gross-in/gross-out or netting FCY with LCY to repay onshore FCY loans

fund ows to/from the IFMA unrestricted foreign debt/lending quota pools

Border

n Purchasing

Source: HSBC

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International Treasurer / August 2013

13

ACCOUNTINg & REgULATION

Lease accounting By John Hintze The US Chamber of Commerce says FASBs proposed leasing standard may result in substantial costs to businesses, lack any benefits for investors and drive economic activity rather than reflect it. Imagine an accounting proposal that causes companies to breach loan covenants and contracts. As a result, it adversely impact banks capital, businesses ability to borrow, lease costs, capital formation, and equipment valuations, and even cost a bundle in terms of compliance and revamping accounting systems. Those are less than half the concerns the US Chamber of Commerce lists in its June 26 comment letter on the Financial Accounting Standards Boards (FASB) proposed standard to update accounting for leases. In its current state, it is our opinion that the proposed leasing standard may result in substantial costs to businesses, lack any benefits for investors and drive economic activity rather than reflect it, the Chamber sums up. Some Solace The current version of the proposal, for which comments are due September 13, offers significant refinements from the original version issued in 2010, especially by exempting real estate leasesa major sticking point back then. The project to update lease accounting has been driven by FASBs concern that the current rules-based approach has enabled many operating leases to be taken off-balancesheet, disguising companies liabilities. The latest version puts all leases more than a year in length on the balance sheet, a comfort to at least some financial statement users. Robert Moulton-Ely, an investor supporting FASBs proposal, commented in May that pharmaceutical chain Walgreens reported debt at a mere 7.6 percent of equity for its 2008 fiscal year. However, he added, its operating lease commitments of more than $33 billion would have brought pro forma debt to 166 percent of equity, and other credit ratios would have been similarly impacted. Public companies must already report lease obligations in the footnotes of their
14 International Treasurer / August 2013
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Chaos and Cost in FASBs Proposed Leasing Standard

financial statements. Including them on the balance sheet may more directly display the level of a companys debt obligations for many investors. Companies filing financial statements, however, would have to report higher expenses at the start of the lease, similar to a debt obligation, a requirement that could significantly impact the economy. In essence theyre very much frontloading the expenses, because when you own something and account for financing it, theres more interest in the beginning. FASB is saying everything should look like debt, said David Mirsky, co-founder and CEO of Pacific Rim Capital, a major lessor of forklifts. Ive already had one customer say that its not leasing anymore, because if they have to book the equipment leases they might as well buy the forklifts, although they dont have the money to buy. John Althoff, a partner at PriceWaterhouseCoopers, said the proposalas currently writtencould impact treasurers from several perspectives. Large companies often have thousands of operating leases, and depending on the circumstances many of those would have to be treated as financings. Companies that dont want additional debt on their balance sheets may now reconsider their lease-versus-buy decisions and may simply opt for buying over leasing. As a result, the proposal would impact the appearance of companies financial statements, and it could impact critical financial ratios, loan covenants and other financial measures, Mr. Althoff said. A less obvious result, he added, may stem from leases that combine contracts; for example, an operating lease with a contract to service the equipment wrapped into it. Now, if the lease is on balance sheet, the company must split those components apart and account for the service contract separately from the lease, Mr. Althoff said. The Chamber notes in its comment

that recognizing lease expenses upfront could have an adverse impact on the ability of businesses to borrow, the cost of leases, and capital formation. Leasing is estimated to comprise upwards of one third of companies capital expenditures, and the vast majority of Fortune 500 companies lease equipment despite their typically strong cash positions. The accounting change may not adversely impact their sourcing of equipment. However, for companies carefully monitoring their capital expenditures in a slow-growth economy, the accelerated upfront expenses they would have to report could make the difference between sourcing more equipment or not. Lessors wIll need to cHange Mr. Mirsky said that as a lessor the proposal would require Pacific Rim Capital to make some accounting changes, although as a private company the impact will be relatively minor. Toyota/Lexus Financial Services would primarily be impacted as a lessor by the change, and then only in a minor way because a relatively small portion of its business involves leasing to other commercial entities, according to Grace Mullings, director of accounting policy and governance at Toyota/Lexus Financial Services. Nevertheless, the company will have to make a one-time adjustment to its books, to account for the accelerated revenue recognition. I have to take everything thats on my books now and switch to the new method, so thats a big one-time change, she said. As we go forward, well be recognizing revenue at an accelerated level in the beginning, and assuming the portfolio remains the same size it wont have a big impact on the volatility of our revenues. If the portfolio were to grow, wed see the trajectory of revenue growth at a higher rate than under the old rules. The greater material impact would be on the lessee, such as Toyotas fleet

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ACCOUNTINg & REgULATION

customers or customers of its forklift unit, since leasing would require the lease obligation to be recorded. If a company is not going to own the equipment, then a lease is just another way for it to find capital to source equipment, Mr. Mirsky said, adding the current proposal would likely result in less demand for equipment. Youre going to see less equipment purchased, and thats going to cause a ripple effect through the economy. Mr. Mirsky said his comment letter will instead suggest identifying an amount of money, whether the present value of the lease streams, the sum of the payments, or even the cost of the equipment, and put that on the balance sheet as the asset. The liabilities then become the payments the company owes. You would reduce the asset and the liability, and it would straight-line the expenses to match whats actually happening in an operating lease, he said. a new asset class The FASBs approach, instead, creates a new right to use asset by arguing that leasing a piece of equipment to a company gives the lessee a right to use it, making it an asset. The accelerated recognition of lease expenses stems from this new asset, because companies would depreciate it from the onset and account for that depreciation as well as the interest component of lease payments. The new accounting proposal creates both the interest and the depreciation components of the lease. Sherif Sakr, a partner in Deloittes financial accounting, valuation and securitization practice, noted that generally accepted accounting principles (GAAP) in the US have been very rules based, prompting concerns that companies have excessively designed lease contracts to fit the rules and achieve off-balance-sheet treatment. The proposal is trying to make a more principles-based approach, so you have the right to use any assets you lease, and that right is a kind of asset that should be recognized on the balance sheet. And you would also have an obligation to make lease payments, and that obligation should also be shown on the balance sheet as liability, Mr. Sakr said. While that may seem a balanced approach, it strays from the traditional concept of a lease, in which equal payments are made over the term of the lease. The Chamber notes that accounting standards are intended to present financial information so financial statement users can make informed decisions about how best to deploy their capital, and FASBs proposal will drive economic activity rather than reflect it. In addition, the proposal appears likely to create a new level of complexity. The proposed treatment will require financial statement users to assimilate right to use assets and future lease payment liabilities with discounting and interest components, writes Peter Kennedy, audit director at regional accounting firm Cover Rossiter. From a purely theoretical standpoint, the treatment may make sense to academicallyoriented CPAs, but it will need a lengthy translation to most others. operatIonal cHange? The proposal could also be complicated from an operational standpoint. Ms. Mullings said Toyota has a team of people working on the companys comment letter, and analyzing its impact on the companys systems, what it will need to report, and what that changes from an internal operations standpoint. From an internal operations standpoint, youre going from a straight-line methodology to an effective-yield methodology, and the systems youre using will need to change to accommodate the new way of doing things, Ms. Mullings said. She added that as new accounting standards seemingly approach finalization, Toyota typically runs its internal data through the proposed rules, to better understand the changes it will have to make. That approach has been especially pragmatic when it comes to FASBs leasing proposal. People have been talking about this issue since 2008 and there have been a couple of white papers, two exposure draftsif we had pulled the switch during the first exposure draft, we would have been going down the wrong path, Ms. Mullings said.

PRINCIPLES FOR AN EFFECTIVE LEASING STANDARD

Here is a list of must-haves for effective leasing standard from the US Chamber Of Commerce: New lease accounting standards must reect economic activity, not drive it New lease accounting standards must permit nancial statements to represent the true effect of lease transaction New lease accounting standards should not raise the cost of capital or unnecessarily create adverse impacts upon nancial statements FASB and IASB should ensure that the benets of revised rules outweigh the costs New lease accounting standards must take into account non-accounting issues, such as contractual obligations, industry-related practices, and potential regulatory environments, to truly represent lease transactions To ensure accuracy, lease accounting standards should be consistent for the lessor and lessee Standard-setters should transparently identify the investor interests and needs they seek to address.
Source: US Chamber of Commerce For additional information visit iTreasurer.com
n

International Treasurer / August 2013

15

Join Another NeuGroup

Whether its for you or for a colleague, joining an additional NeuGroup will build a wider network of peers that will enhance your drive toward a world-class nance function. Your rm may be eligible for membership fee discounts and other benets. Contact your peer group leader for more information about joining additional groups.

BUILD YOUR FIRMS PEER NETWORK

SEnior TREASURY
n The Assistant Treasurers

FUNCTIONAL TrEasury
n The n The

Group of Thirty n The Bank Treasurers Peer Group n The Engineering & Construction Treasurers Peer Group n The Tech20 Treasurers Peer Group n The Treasurers Group of Thirty 1, 2 and 3

FX Managers Peer Groups 1 & 2 Global Cash and Banking Group n The Treasury Investment Managers Peer Group

REGIONAL TrEasury
n The Asia Treasurers

RISK & AuDit

n The

Corporate ERM Group n The Internal Auditors Peer Group

Peer Group n The European Treasurers Peer Group n The Latin American Treasury Managers Peer Group

To learn more, go to www.neugroup.com

or contact Joseph Neu (914) 232-4069
n

jneu@neugroup.com