Approaches to FX Volatility

13-07-2022 | treasuryXL | ComplexCountries | LinkedIn |

The latest CompleXCountries report is based on two Treasury Peer Calls in which senior treasurers from Asia, the Americas and Europe discussed the latest bout of increased FX volatility, and the impact it is having on their hedging strategies. As to current volatility, some people are adjusting their strategies, but most prefer to stick with the approach which has already been defined.

Source

FX – one of the biggest and most important challenges we all face. It has a direct impact on the business, and everyone has a view.

The calls (European morning and afternoon to accommodate Asia and the Americas) were to discuss the latest bout of increased FX volatility, and the impact it is having on people’s hedging strategies – if any. Unsurprisingly, it turned into a long discussion of the way different companies approach hedging. The report below is long and very varied – we managed to reduce it to 20 pages, but they are dense. As to current volatility, some people are adjusting their strategies, but most prefer to stick with the approach which has already been defined.

What is that approach? The participants came from a variety of different industries, and covered a broad range of different ways of handling the issue.

  • Everyone has a defined hedging approach, though most contain some degree of flexibility. So, if the approach is to hedge the next 6 months, for example, there may be leeway to go down to 4 months or up to 8.
  • Most people add their hedges via a layering approach, where they build up the hedge over time. This provides an average hedge rate, and avoids the risk of choosing a single point in time.
  • Everyone tries to match their hedges to the needs of the business. This involves co-ordinating with the business units to get their input on the ability to change prices, how long it takes to do so, etc.
  • Most companies have a centralised approach to hedging, but there is variety as to whether central treasury acts as and advisor, or as a decision maker. In most cases, this is decided by the company’s internal measurements and incentive system.
  • Several companies try to insulate the operating units from the effects of currency. This is done by various means: several participants operate re-invoicing centres, which invoice the operating entities in their own currencies, and manage the resulting exposures in the centre. One participant achieves the same result by levying a currency specific working capital charge on the operating units. The income from this charge is then used to pay for hedges – which may, or may not, actually be taken out.
  • In these cases, the centre usually operates as a profit centre – but with strong risk management disciplines to contain the danger of positions getting out of control.
  • One other approach is to fix a budget exchange rate for the coming year, and try to lock that in via hedges. There was a discussion as to whether this suits all businesses.
  • Most participants use forwards for hedging, with the choice of deliverable or NDF varying from one country to another. Several use options, though cost and accounting complexity were obstacles.
  • One participant has an approach which is built entirely around options, including a sophisticated trading strategy to reduce the cost of what they view simply as an insurance policy, like any other. This company is also very opportunistic, and will be active or inactive in the market according to their view of current pricing. This company is also private, and family owned, so they have a higher tolerance for earnings volatility than most – and they are not concerned about quarterly earnings announcements. They also have a relatively high margin business.
  • In this company, as in all others, this strategy is only possible because it has the understanding and buy-in of the management and the operating units. Every participant mentioned this as being key for success.
  • Generally, the percentage of hedging is fixed by policy. However, most participants exercise some judgement, based on the cost of hedging. This is particularly relevant for some emerging market countries, such as Brazil, Argentina and many African countries. The judgement as to what constitutes a hedge which is too expensive was often empirical, but the currencies which were left unhedged usually did not represent a significant exposure for the company.
  • Most participants prioritise balance sheet hedging over cash flow hedging, but some take the opposite approach. In all cases, the accounting treatment is a significant factor in determining the approach.

Bottom line: hedging and managing currency is one of the key competences of the treasurer. For many years to come, it will continue to be one of the areas where there is the biggest variation in approaches – and endless debates. If you have an approach which is well defined and which has been fully discussed with the business, there should not be any need to change it during a period of volatility – though it can be an excellent stress test!

Contributors: 

This report was produced by Monie Lindsey, based on two treasury peer calls chaired by Damian Glendinning.

[The full report can be downloaded FREE by corporate treasury practitioners, please Log in to your account to download (if you receive emails from us – use your email address to retrieve your password), if setting up a new account, please ask for the FX report in the comments and ComplexCountries will send you a copy]

Please contact ComplexCountries to find out about their subscription packages.

GTreasury Launches New Connectivity Suite for Treasurers

12-07-2022 | treasuryXL | GTreasury | LinkedIn |

 

Workflow Brings in Third-Party Banking, Payments, and Financial Data

ClearConnect ensures the fidelity of data essential to treasurers and CFOs

CHICAGO, Ill. – July 12, 2022 – GTreasury, a treasury and risk management platform provider, today announced the launch of ClearConnect. Featuring more than 80 API calls in a dozen key categories, ClearConnect offers the most robust connectivity suite available to treasury teams and the office of the CFO. The solution provides immediate access to the comprehensive data required for confident and actionable treasury insights, and ensures the fidelity and security of that data through purpose-built connections bolstered by GTreasury’s support.

While “API” is becoming a buzzword often associated with data connectivity solutions, the terms are not synonymous. API connections are only as powerful as the underlying workflows that support them. Activating an out-of-the-box API is not an instant panacea for an organization’s data needs. Without the right underlying workflows, APIs not attuned to a business’s specific requirements will drop or fail to capture all the data sets necessary to power effective analytics and data lakes. Given the complexity of treasury and risk management, those missing insights can result in significant consequences for treasury teams and CFOs.

ClearConnect provides both the powerful underlying workflows and the multifaceted purpose-built API-enabled connectivity to ensure that data capture is consistently done correctly and thoroughly—providing all the analytics an organization needs from a particular connection. The solution creates certainty, security, and seamless connections by integrating all data from business systems and financial institutions, and is capable of combining connection types for uniquely complete data sets and data fidelity.

Specifically, ClearConnect creates value for treasury teams and the office of the CFO by delivering:

  • Secure connectivity across the financial value chain
  • Extensions to corporate treasury workflows
  • Access to specialist solutions within the integrated platform
  • Lower bank fee costs through seamless connectivity
  • Access to multiple innovative FinTech products and services

ClearConnect’s market-leading API catalog features over 80 API calls, augmented by host-to-host connectivity wherever needed to bolster capabilities. The solution enables robust functionality across a dozen categories, including payment approval rules, payment workflows, payments and templates, balances and transactions, general ledgers, deal management, bank accounts, bank account management, legal entities, forecasts, operators, and data extracts. ClearConnect’s flexible connectivity architecture uses best-in-class API-enabled connections to ensure fidelity and continuity of customers’ most vital data. Connectivity into Swift, Fides, and others provides a single source of truth and visibility into an organization’s cash and financial risk, and delivers transparent workflows for payments, bank file monitoring, and more.

GTreasury’s always-expanding partnerships with leading global financial institutions and market data partners ensure seamless bank and ERP connectivity, domestic and international transactions, and access to market insights. As client needs change, GTreasury’s active collaborations with product partners further ensure the creation and delivery of modernized products and services, securing ClearConnect’s place as a market-leading solution always aligned with customers’ current data requirements.

From risk management capabilities powered by Moody’s Analytics and KYOS, to market data provided by Refinitiv and Fenics MD, to banking, ERP, investments, and payments partners, ClearConnect now enables customers to wield the full power of the GTreasury ecosystem even more easily and completely.

“ClearConnect doesn’t just offer a significantly greater breadth of connectivity options than anything else available, it also underwrites those capabilities with foundational workflows for data integrity and ease of use,” said Pete Srejovic, Chief Technology Officer at GTreasury. “Investing in API technology only to realize that you are dropping crucial data is a nightmare that has come true for many CFOs and treasury teams. With today’s launch of ClearConnect, we’re proud to offer not only the largest and most powerful API connectivity solution on the market, but one that customers can entrust to deliver absolute data integrity along with the comprehensive and future-proof solutions of the GTreasury ecosystem.”

       

About GTreasury

GTreasury believes there is opportunity in complexity. We connect treasury and finance teams with industry-leading experts, technology solutions and untapped possibility. By simplifying complexity, teams can unleash their organization’s potential to gain strategic advantages and grow. GTreasury helps organizations reach that potential by connecting treasury and digital finance operations through a world-class SaaS treasury and risk management platform and integrated ecosystem where cash, debt, investments, and exposures are seamlessly managed within the office of the CFO. GTreasury delivers intelligent insights, while connecting financial value chains and extending workflows to third-party systems, exchanges, portals, and services. Headquartered in Chicago, with locations serving EMEA (London) and APAC (Sydney and Manila), GTreasury’s global community includes more than 800 customers and 30+ industries reaching 160+ countries worldwide. Visit GTreasury.com

Recording Webinar | How successful master data management can help you secure financial processes?

12-07-2022 | treasuryXL | Nomentia | LinkedIn |

Recently, treasuryXL partnered with Nomentia on a live webinar on how successful master data management can help you secure financial processes.

Watch the recording of this session for free now by clicking on the image below!

In this webinar, we discussed how you can manage your Master data in a safe way, how you can prevent fraud and sanction risks through the management of this data, and the subsequent processes that make use of your master data. This ranges from the creation of counterparties in your ERP to the safeguard checks in your payment process and system.

More specifically, we will discussed the following topics:

  • Introduction to Master Data management
  • Managing the counterparty Master Data in your ERP
  • Trends that companies face related to Master Data
  • High-risk processes using your master data
  • Steps to create a safe and secure culture within your company
  • Setting up appropriate processes and systems to enable security

Watch the recording now!

 

 

 

marcus evans | 9th Annual Liquidity and Funding Risk Management | 14-16 September | New York

07-07-2022 | treasuryXL | marcus evans | LinkedIn |

We are proud to announce our media partnership with marcus evans for the 9th Annual Liquidity and Funding Risk Management conference taking place in New York, on September 14-16, 2022.

New York, USA

14 – 16 September, 2022 

Understand how to adapt to a new normal where regulatory demands, macroeconomic pressures and technological developments are posing a myriad of challenges to liquidity professionals

The landscape for liquidity has changed drastically over the last few months as a result of the changing rates and transition out of the pandemic. During the COVID-19 pandemic banks generated a lot of liquidity via retail and commercial deposits, and the government’s support and stimulus packages. The Basel III regulations, such as the LCR, helped banks to avoid the liquidity crunch leaving them in a good overall financial position. As we are now transitioning out of the pandemic, the biggest concern for banks is understanding how they are going to manage as spending is going up and people are not depositing money in the way they have been over the last two years. Banks need to model and forecast liquidity fluctuations so they can position their balance sheets in the best way.  They also need to make sure their operations stay as resilient as possible in the new post-COVID-19 environment.

 

The GFMI 9th Annual Liquidity and Funding Risk Management conference will offer case studies on the best strategies liquidity and funding professionals can use when adapting to the current volatile market. The best methods of handling the current regulatory environment will also be assessed, as well as the latest developments within intraday liquidity and data management. This conference will also discuss the challenging funding environment and the best current practices to optimize balance sheets. Furthermore, emerging concerns within liquidity and funding risk management, such as climate risk, ESG and cryptocurrency will be examined and evaluated.

 

Attending This Premier marcus evans Conference Will Enable You to:

 

  • Determine the best practices to adapt to the current volatile market and macro influences
  • Evaluate how to manage the current regulatory environment
  • Assess the latest developments of intraday liquidity and data management
  • Discuss the challenging funding environment and analyze how to optimize balance sheets
  • Examine the emerging concerns within liquidity and funding risk management

 

Best Practices and Case Studies from:

 

  • Yujush Saksena, Managing Director, Treasury Risk, Morgan Stanley BNY Mellon
  • Shahab Khan, Subject Matter Expert- Regulatory Capital and Liquidity, JP Morgan Chase
  • Bridgit Chayt, Head of Commercial Payments & Treasury Management, Fifth Third
  • Armel Romeo Kouassi, Senior Vice President – Head of Balance Sheet Modeling, Northern Trust Corporation
  • Michael Berkowitz, Managing Director, Treasury and Trade Solutions, Citi
  • Oresta Mehta, Managing Director, Markets Treasury. Global Treasury Climate Lead, HSBC

 

For more information and registration discounts please contact: Ms Ria Kiayia, Digital Media and PR Marketing Executive at [email protected] or visit: https://bit.ly/3n7h0pb

 

 

 

 

 

CFO Perspectives: 3 ways CFOs can use currencies to boost their business’s value

05-07-2022 | treasuryXL | Kantox | LinkedIn |

As a CFO, you are aware of the benefits of FX hedging for treasury. However, are you also aware of the macro-level advantages for your company and its value?

A new CurrencyCast series has just been introduced by Kantox. They examine five ways that efficient currency management may benefit your entire business in the first episode of their CFO Edition miniseries, including how to incorporate it into your strategy and how to decrease cash flow fluctuation. Watch below the video or read the corresponding blog.

Credits: Kantox
Source

In the first edition of CFO Perspectives, we’ll draw from our work with CFOs to explore three ways senior finance executives can make currency management a winning growth and cost-saving strategy for their business.

Looking at the concerns expressed by CFOs in most risk management surveys, a number of familiar themes seem to reoccur: the importance of cash flow forecasting and monitoring, the centrality of FX risk management and the ongoing digitisation of treasury processes

Yet, this picture is far from complete. 

Ultimately, among the tasks assigned to CFOs, there is the need to make a contribution toward enhancing the value of the business. But what is the role —if any— played by currency management in that regard? Answering this question allows us to single out three strategic contributions of currency management that CFOs should prioritise.

Value and FX hedging: time for a reassessment

Does currency management create value? The traditional view has been ambivalent: a ‘glass half full, half empty’ kind of appraisal. While the benefits of hedging FX have never been in dispute, the problem lies with the perceived high costs of currency management.

This is precisely where things are changing—and quite fast. Digital, API-based technology is putting to rest the notion that currency management is always a costly, resource-intensive task. Meanwhile, Multi-Dealer Platforms (MDPs) such as 360T, embedded in these solutions, sharply reduce trading costs.

CFOs: three strategic contributions of currency management

(1) Create opportunities for growth

Feeling concerned about exchange rate risk, managers may neglect the growth opportunities that come from ‘embracing currencies’. Buying and selling in more currencies allow firms to capture FX markups on the selling side while avoiding markups on the contracting side. Two examples will suffice:

(a) On the selling side: In e-commerce setups, currencies can be leveraged to increase direct, high-margin sales on company websites with many payment methods. Multi-currency pricing is the secret weapon for reducing cart abandonment, which still stands at about 77% globally.

(b) On the buying side: Buying in the currency of their suppliers allows firms to (1) Avoid inflated prices charged by suppliers who seek to manage their own FX risk; (2) Widen the range of potential suppliers by putting them in competition; (3) Obtain extended paying terms.

By taking FX risk out of the picture, currency management enables firms to reap these and other margin-boosting benefits of using more currencies in their day-to-day business operations. Ultimately, it is about removing the disincentives that prevent firms from ‘embracing currencies’.

(2) Provide more informative financial statements

Informative financial statements allow investors to assess the quality of management by removing noise from the process. To the extent that the variability in net income is perceived as a measure of management quality, effective currency hedging creates a sense of discipline in the eyes of investors.

The good news for CFOs is that technology is making great strides in cost-effectively managing the accounting-related aspects of currency management. Here are two examples:

  1. Balance sheet hedging. Automated micro-hedging programs for balance sheet items take the impact of FX gains and losses out of the picture, as invoices are hedged with great precision.
  2. Traceability and Hedge Accounting. The perfect end-to-end traceability made possible by automated solutions eases the costly and time-consuming process of compiling the required documentation for Hedge Accounting.

(3) Lower the cost of capital

Companies can reduce cash flow variability thanks to a family of automated hedging programs and combinations of hedging programs, including layered hedging programs that make it possible to maintain steady prices in the face of adverse currency fluctuations.

In challenging times, when the availability of external financing at a reasonable cost is scarce —an all too common occurrence in years of pandemics and wars—reduced cash flow variability makes it possible for companies to execute their business plans and meet all cash commitments.

An impaired capacity to raise financing has implications in terms of valuation, especially for smaller businesses. This ‘cost’ has been variously measured, with some estimations ranging from 20% to 40% of firm value. Currency management enhances the capacity to raise finance and, by extension, lowers the cost of capital and boosts firm valuation.

A wide range of opportunities to create value

We have singled out three major contributions of currency management in terms of creating value for the business: (1) stimulating growth while protecting and enhancing profit margins; (2) lowering the variability of cash flows; (3) presenting more informative financial statements. We can mention even more benefits:

  • Taxation is optimised as smoother earnings reduce the tax burden when higher levels of profits are taxed at a higher rate.
  • Capital efficiency is raised when pricing with the FX rate improves the firm’s competitive position without hurting budgeted profit margins.

While most of these advantages have been known by CFOs for many years, there is a new factor to consider: they can be implemented with Currency Management Automation solutions that remove most of the resource-consuming, repetitive and low-value tasks performed by the finance team, eliminating unnecessary operational risks along the way.

With an added bonus: by leveraging currencies, CFOs have the opportunity to take decisive steps in terms of digitisation. According to a recent HSBC survey, digitisation is seen as the most positive factor by 84% of CFOs overall, as they expect investments in digital technology to have a “positive impact on their business”, with more than half of them expecting it to give the business model “a large boost”.

The time to act is … now!

Get new episodes of CurrencyCast delivered to your inbox every week by signing up the Kantox newsletter

Ask the treasuryXL expert #1 How might digital trade transactions reduce the threat of fraud and money laundering?​

04-07-2022 | treasuryXL | Vincenzo Masile | LinkedIn |

treasuryXL is the community platform for everyone with a treasury question or answer!

Today, we discuss a question that treasuryXL expert Vincenzo Masile often gets to hear within his treasury network about digital trade finance.

This edition, the following question will be answered:

“How might digital trade transactions reduce the threat of fraud and money laundering?”


Vincenzo Masile

“That is a question I think is very relevant right now, especially after Covid. Firstly, let me look back at trade finance over the past few years. In 2019 and 2020, trade finance came under scrutiny following a number of high-profile defaults, suspected frauds and double financings and, in some cases, the failure to provide proper collateral for goods.

While legislation to recognize electronic trade documents will not bring about an overnight change in financier confidence, it is likely to do so in the medium term.

A game-changer for digital trade

The availability of fully enforceable electronic trade documents recognized by the most widely used trade jurisdiction will in itself have a major impact on the approach of both companies and financiers towards digital trading solutions.

Transferable records, such as bills of lading, are the most important commercial documents in trade and currently, less than 1% of bills of lading are in electronic form. This is a huge missed opportunity, given that electronic transferable records will make trade safer, paperless, easier, cheaper, faster, and greener for companies.

Implications for the security in trade transactions and regulatory treatment of trade finance: URDTT

The Uniform Rules for Digital Trade Transactions (URDTT) version 1.0 are the result of the mandate given by the ICC (International Chamber of Commerce, Paris) Banking Commission to develop a high-level structure of rules, obligations, and standards for the digitalization of trade transactions.

The ICC Uniform Rules for Digital Trade Transactions (URDTT) are intended:

1. For a fully digital environment;

2. To be neutral with regard to technology and messaging standards; and,

3. To extend into the corporate space, including commercial transactions and the growing community of non-bank providers of financial services.

The URDTT are designed to be compatible with UNCITRAL (United Nations Commission on International Trade Law) Model Laws, including those Electronic Commerce, Electronic Signatures and Electronic Transferable Records.

The rules will serve as an overarching framework for digital trade transactions thereby providing global standardization, consistency and conformity, providing a collective understanding of terms and definitions, whilst promoting and supporting the usage of electronic records/documents/data.

Various technology service providers have already publicly stated their intention to work with the URDTT, in fact, a number have already incorporated the URDTT into their platform rulebooks and are actively looking at developing trade products based upon the URDTT.

Conclusions            

Trade finance functions that adopt appropriately targeted automation and advanced analytics as integral parts of their compliance operations will be more important than ever in this uncertain international environment. With such high volumes of transactions and increasing complexity, efficient trade financing is key to ensuring that warehouses, harbors and supply chains are running smoothly – thus keeping the age-old business of  international trade firmly afloat.”


Do you also have a treasury-related question? Feel free to leave your question on our treasuryXL Panel. The panel members are willing to answer your question, free of charge, with no commitment.

marcus evans | 3rd Edition Commodity Markets Modelling, Analytics & Risk Management | 12-14 September | London

30-06-2022 | treasuryXL | marcus evans | LinkedIn |

We are proud to announce our media partnership with marcus evans group for the 3rd Edition Commodity Markets Modelling, Analytics & Risk Management conference taking place in London on 12-14 September 2022.

London, UK

12 – 14 September, 2022 | 08:30 BST

There are many challenges involved with Commodity Markets Modelling. A major one at the moment is the volatility within the energy markets, specifically the spike in the price of energy including gas throughout the European and world markets. Another challenge which has been there for slightly longer is the generating and accessing of quality data which can feed modelling, in particular AI and machine learning models. There also exists a specific challenge around the modelling of renewables which has become an area of increased interest over the last few years. Finally, there is always a push to have new techniques which can help to improve the performance of trading teams in a very competitive market.

With this in mind, the marcus evans 3rd edition Commodity Markets Modelling, Analytics & Risk Management conference held between 12-14 September, 2022 in London, UK will provide the much-needed techniques on optimising modelling and trading within commodity markets. The event will deliver attendees tailored sessions on accessing the best data types to assist accurate modelling and forecasting. Practical solutions will be delivered regarding battery storage and modelling of intermittent weather sources such as wind and solar energy. Finally, new innovation tools which can assist traders and decision makers in commodity markets spaces will be explored and evaluated.

Attending This Premier marcus evans Conference Will Enable You To:

  • Obtain the best practices for quantitative modelling in commodity markets
  • Appreciate the current need to adjust existing quantitative modelling and trading techniques
  • Overcome the limitations caused by spikes in energy price data
  • Assess business priorities in consideration of macroeconomic change
  • Ensure your institution is insulated from market volatility

Best Practices and Case Studies from:

  • Michael Haigh, Managing Director, Global Head of Commodities Research, Societe Generale
  • Cetin Karakus, Global Head of Quantitative and Analytical Solutions, BP
  • Barbara Lempp, CEO of EFET Deutschland, European Federation of Energy Traders
  • Richard Fu, Head of Commodities, Shanghai Pudong Development Bank
  • Mario Dell’Era, Quantitative Market Risk Senior Manager, Citi
  • Emmanuel Gincberg, Managing Director – Quantitative Strategist, Macquarie Group

Special discounts available to Treasury XL subscribers! For more information please contact Ria Kiayia, Digital Media and PR Marketing Executive at [email protected] or visit: https://bit.ly/3HvwFYs

 

 

 

Invitation Open Evening: Treasury Management & Corporate Finance | July 5 | Vrije Universiteit Amsterdam

29-06-2022 | treasuryXL |  VU Amsterdam | LinkedIn |

Boost your professional skills, knowledge and expertise in Treasury Management & Corporate Finance thanks to these high-level modules. Complete the programme and be awarded with the title of Registered Treasurer (RT).

The Vrije Universiteit Amsterdam invites you to join the Online Open Evening on Tuesday, 5 July 2022.

Treasury Management & Corporate Finance 19.00 – 20.00 hrs.

Sign up for the Online Open Evening

The postgraduate Executive Treasury Management & Corporate Finance programme combines two finance disciplines which largely overlap and are inextricably connected: Treasury Management and Corporate Finance. For this reason, it is a unique programme both in the Netherlands and abroad. It has now been running for more than 20 years at Vrije Universiteit Amsterdam. This postgraduate programme aims to promote development as an academic professional through a mix of academic theory and case studies of real issues in the field of treasury management and corporate finance.

Upon successful completion of this 18-month programme, you will be awarded with the title of Registered Treasurer (RT), a well-known and widely recognised title within the treasury professionals’ community. Exemptions apply to alumni of Dutch RC and RA programmes.

There are five key benefits of attending this programme

  • Broaden the perspective on the corporate treasury and finance disciplines that all-round corporate treasurers and finance professionals should master
  • Gain and master hands-on knowledge crucial in the daily practice thanks to a balanced mix of academic and professional expertise
  • Career development opportunities in a different setting thanks to the participation in the Thursdays lectures, leading to new ideas, insights and development
  • Interactive sessions are an added value of the programme, which explain and apply the main principles to professional practice through practical examples and business cases
  • Connect with the treasury community and fellow participants and build your own professional network

The programme Treasury Management & Corporate Finance at a glance

  • Start date: September 2022
  • Duration: 1,5 year (part-time)
  • Modules: 6
  • Time Investment: 130 hours per module including 8/9 weeks of four-hour teaching sessions and approximately 10 hours of self-study per week.
  • Tuition fees: € 22,500
  • Lectures:  Thursdays
  • Form: Physical classes (VU Amsterdam follows the advice of the RIVM for public health).

View all admission requirements, costs & practical information

Partners in delivering this programme are Orchard Finance, KPMG, PWC, Zanders and EY.

Best regards,

 

Herbert Rijken
Programme director

Unstable stable coins: how to regulate?

29-06-2022 | Carlo de Meijer | treasuryXL | LinkedIn |

 

The crypto market was shocked by the sudden collapse of the third largest stablecoin TerraUSD early May. Long-time isolated from the falls in crypto coins like Bitcoin and Ethereum, stablecoins were designed to sidestep crypto volatility and supposed to remain stable across the crypto ecosystem.

The significant crash of TerraUSD that lost more than 90% of their value in a few days and the resulting crypto market turmoil however has put stablecoins in the regulatory spotlights. Regulators worldwide are prompting new calls for regulation highlighting the risk of certain cryptocurrencies and especially algorithmic stablecoins.

In this blog I want to highlight why TerraUSD, also called UST,  dropped below its target value, what the risks are of the various stablecoins, how regulators should react and what investors can learn from the crash of TerraUSD.

TerraUSD collapse

TerraUSD, also called UST, a so-called algorithmic stablecoin, had been another popular option for cryptocurrencies and was even the third largest stablecoin in the world at the threshold of the collapse. That system appeared to work well until then.

But TerraUSD was not able to withstand a panic outburst amongst investors, this notwithstanding they were providing a 20% interest. Sparked by a massive drop in the value of the crypto markets overall, investors lost faith resulting in a mass sell-off in the TerraUSD stablecoin. Luna Foundation Guard (LFG) tried to stop this slide by liquidating part of its 10 billion Bitcoin holdings.

The collateral, partly existing of Bitcoin, was insufficient to maintain its one to one peg to the dollar. As a result it slipped far from its $1 target price and dropped in value beginning May 9, 2022, hitting a low value of $0.015 at the time of publication of this blog.

As of this writing, the combined market capitalization of TerraUSD and partner stablecoin Luna was just over $4.5 billion, indicating a market decline of approximately $14 billion.

How did the  markets react?

Cryptocurrencies
In the wake of the TerraUSD collapse, other signs of the crypto sector’s vulnerabilities have emerged. When the Luna Foundation Guard sold almost its entire holdings of Bitcoin following the crash early May, as a result the price of Bitcoin, that lost already more than half of its value since last November from $64.000, sank to a 16-month low below $28.000 per coin. But also other cryptocurrencies were hit, triggered by  higher inflation and fears of raising interest rates. TerraUSD’s woes contributed to a slide in crypto markets that saw over $357 billion or more than 30% of digital asset market capitalization wiped out week-on-week. 

Stablecoins
While the TerraUSD collapse has spelled trouble for Bitcoin and other cryptocurrencies, the chaos is somewhat contained in the stablecoin sector. That especially goes for the fiat collateralised segment, where most of the stablecoins such as Tether and Binance have the backing of actual cash and other valuable assets. TerraUSD  is however different from most of its stablecoin peers.

Investors fled TerraUSD into more trusted stablecoins such as DAI and USDC, which drove the price of TerraUSD further down. This increased demand for DAI and USDC temporarily increased their price and were shortly after arbitraged back to $1.

DeFi
The failure of TerraUSD’s peg already has sent shocks through the decentralised finance (DeFi) sector, with a key saving and lending protocol, Anchor, seeing massive liquidation of TerraUSD-collateralised loans and the pricing of other crypto tokens also being affected. This has led to further liquidation triggers throughout the ecosystem. ‘Bouts’ of volatility will probably continue as the cryptosector digests the repercussions of the failure of the TerraUSD peg, while US policy rate increases and equity volatility may pressure so-called ‘high-beta assets’.

Regulated financial markets
Recently the Financial Stability Board (FSB) pointed to the increased intertwining of the crypto world with the traditional financial world. Up till recently links between crypto markets and regulated financial markets remained weak. The potential for crypto market volatility to spill over and cause wider financial instability was limited. But that has changed.

A growing number of regulated financial entities have increased their exposure to cryptocurrencies, DeFi and other forms of digital finance in recent months. If crypto market volatility becomes severe the risks for the financial stability of the real economy could as a result escalate.

 

But not all stablecoins are the same

Stable coins are cryptocurrencies designed to be protected from the wild volatility of crypto currencies like Bitcoin and Ethereum. They attempt to maintain a constant exchange rate with fiat currencies, mostly through a 1:1 US dollar peg.

Stablecoins are often used for transactions within the crypto world and between cryptocurrencies and the traditional financial system. They have played a crucial role for cryptocurrency traders, allowing them to hedge against spikes in Bitcoin’s price or to store idle cash without transferring it back into fiat currency.

Regulators should however be aware that not all stable coins are the same. Some stablecoins are more vulnerable than others. The stablecoin sector is a critical and complex part of the crypto ecosystem. Stable coins are an umbrella term. They are not a monolithic asset class and every stablecoin operates differently.

Stablecoin models

Stablecoins can be divided into two broad groups based on how they choose to pursue price stability: collateralised stablecoins and non-collateralised stable coins. Collateralised stablecoins can be split into fiat-collateralised and crypto–collateralised. The newest group of non-collateralised stablecoins are so-called algorithmic stablecoins like TerraUSD.

Fiat collateralised
The value of fiat-collateralised stablecoins is backed by reserves comprising assets, such as fiat currency, mostly the dollar, as collateral assuring stablecoin’s value. Collateral can also consist of bonds, commercial paper, commodities like gold and silver as well as crude oil. But most fiat-collateralised stablecoins have reserves of US dollars.

Dollar-based collateralised stablecoins like Tether and true USDC use a more fluid collection of traditional assets to secure its stable coin. Most of these reserves consist of treasury bills, certificates of deposit, and cash deposits to match the value of outstanding tokens that are maintained by independent custodians and audited regularly to ensure that holders of these stablecoins guarantee they can redeem them for actual fiat money, at some point.

Crypto-collateralised 

Another category of stablecoins are crypto-collateralised stablecoins, with their underlying collateral being another cryptocurrency or basket of cryptocurrencies. Because the reserve cryptocurrency may be subject to high volatility, such stablecoins are often over-collateralised, whereby the value of cryptocurrency held in reserves exceeds the value of the stablecoins issued. The Dai stablecoin for instance which is pegged to the US dollar uses a basket of crypto assets as collateral at a ratio of 150% of the value.

Non-collateralised stable coins
And there is the newest group of stablecoins which are algorithmic or ‘decentralised’ stablecoin. While most stablecoins are reserve backed and are supposed to always be exchanged for one dollar, algorithmic stablecoins ‘forgo this failsafe’ and attempt to maintain their pegs through other means. Their primary distinction from collateralised stablecoins is the strategy of keeping the value of their stablecoin by controlling the supply through an algorithm and smart contracts to control the supply of tokens.

TerraUSD (UST)

TerraUSD, which trades with the symbol UST, is one of those algorithmic or decentralised stablecoins. To get somewhat more insights in this new type of stablecoin, let’s go more deeply into how it works.

The purpose of TerraUSD was to create a “crypto-native” dollar – with all of the supposed benefits of blockchains, like censorship resistance – that would be cheaper to use than a fully or partially collateralized option. It was intended to be worth exactly one dollar, enabling transactions to process with predictable results and giving cryptocurrency investors and traders an option to store their assets in cryptocurrency without the risk and volatility associated with typical digital currencies. Its peg to the dollar was supposed to be maintained by a complex algorithmically driven mechanism rather than by reserves of dollars or other assets, as is typical for stablecoins.

As TerraUSD’s popularity took off, its partner stablecoin Luna increased in value as well. The coin popped from around $5 in July 2021 to a high of $116 in early April 2022. Before its collapse TerraUSD was the third-largest stablecoin by market capitalization with about $18 billion and the largest algorithmic stablecoin.

 

How does TerraUSD work?

TerraUSD as an algorithmic stablecoin, is fundamentally different from most of its peers. Their value is assured not by financial collateral in the traditional markets – though owner Kwo diversified earlier this year their backing by purchasing $10 billion in Bitcoin – but backed by lines of computer code so-called algorithms to stay pegged to the dollar.

This stablecoin used a sophisticated but complex automated system of arbitrage to maintain its valuation at the 1:1 level. This mechanism relies on two coins: the TerraUSD stablecoin and the Luna governance token. It involved swapping TerraUSD coins with this free-floating cryptocurrency Luna to control supply.

The value-protecting transactions are executed by smart contracts on the Terra network. A computer algorithm thereby creates (mints) and destroys (burns) both TerraUSD and Luna to bring the price back into equilibrium. When the price of TerraUSD drops below $1, traders can burn TerraUSD—removing it from circulation, thereby reducing the overall supply —and raise the price back up. If the value of TerraUSD goes higher than $1, traders can burn Luna for TerraUSD, increasing the overall supply and lowering the price. This creates trading margins and supply and demand models that help keep the coin pegged to $1.

Another key part of the Terra ecosystem is the interest rates on TerraUSD deposits. These are offered through Anchor Protocol, a decentralized finance (DeFi) platform, which can garner annual percentage yield rates of 20 percent on TerraUSD tokens that could be borrowed by investors in need of dollar-like capital. The Terra decentralized finance (DeFi) network incentivized traders, holders, and users to either use, lend, or stake these crypto assets. This system worked reasonably well in practice from the inception up till early May.

Regulations

As things stand nowadays, stablecoins are very lightly regulated. A significant part lays outside the control of regulators. Given the explosive growth of the $130 billion market and its potential to affect the broader financial system, it is not strange that stablecoins have come under growing scrutiny by regulators. The recent turmoil has reignited calls in virtually every major financial market in the world for increased regulation of the crypto asset market in general and of stablecoins in particular.

Common themes in the discussions are the volatility, the lack of transparency with regards to crypto operations and the reserves they are supposed to hold, the overly optimistic promised returns and investors that are not well informed with regards to what is being purchased.

 

Reactions
Politicians have increased calls for tighter regulation of stablecoins. The falls in cryptocurrencies and the collapsing value of TerraUSD have further alarmed policymakers in both the EU and the US such as Treasury Secretary Janet Yellen and Securities and Exchange Commission Chair Gary Gensler.

US Treasury Janet Allen
US Secretary of the Treasury Janet Yellen has cited risks to broad financial stability due to stablecoins. She told a Senate Committee that the TerraUSD debacle has reinforced the need for proper oversight and for a “consistent federal framework” for regulating stablecoins and said that stablecoin guidance could come as early as this year.

“A stablecoin known as TerraUSD experienced a run and declined in value” “I think that this simply illustrates that this is a rapidly growing product and there are rapidly growing risks.” Janet Yellen

Fed semi-annual Stability Report
In its recent published semi-annual Stability Report, the Fed discussed the uncertainty of what is actually backing stablecoins and the lack of oversight in that market. The Fed repeated its concerns that stablecoins are vulnerable to investor runs because they are backed by assets that can lose value or become illiquid in times of market stress. The increasing use of stablecoins to meet margin requirements in leveraged crypto trades may further heighten redemption risks. A lack of transparency around the assets may exacerbate those vulnerabilities. A run on the stablecoin could therefore spill over into the traditional financial system by creating stress on these underlying assets, according to the report.

 

What sort of regulation

There are however still different visions on how to regulate stablecoins. Some regulators are preparing rules for stablecoins to make them look and function more like banks. Some others come up with proposed regulation that will look like more as governance tokens being considered securities. According to them, as tokens have claims against assets, or claims against cash flows, they are looked at the easiest target for regulators.

The International Organization of Securities Commissions (IOSCO) said stablecoins should be regulated as financial market infrastructure like banks alongside payment systems and clearinghouses. The proposed rules should focus on stablecoins deemed systemically important by regulators, with the potential to disrupt payment and settlement transactions.

The ECB is also increasingly worried about the risks for the financial stability of crypto investments. They are urgently calling for accelerating the implementation and acceptance of regulation to implement constraints to crypto currencies and stable coins. The EU’s Markets in Crypto Assets regulation, that would enter into force from 2024 onwards, is expected not not permit the issuance of algorithmic stablecoins and would require crypto providers to have a (bank-like) license and systemic stablecoin issuers  be backed by enough reserves.

What issues for regulators to consider?

There are important lessons to be learned from this crypto collapse, that regulators should keep in mind when designing legal frameworks for cryptocurrencies in general and for stablecoins in particular.

Like all new technologies, these assets — including dollar-backed, crypto-collateralized and algorithmic models — deserve a smart and thoughtful conversation around potential regulation, in order notto  frustrate financial innovations.

Regulators should thereby be aware that this collapse of TerraUSD is not a reflection of all stablecoins, because they weren’t all built the same under the same philosophy. As has been described before algorithmic stablecoins are very different compared to the collateralised stablecoin types.

Stablecoins in general should therefore not be forbidden but should be firmly regulated to prevent that a collapse like TerraUSD will happen again.  Buyers should understand what the risk are especially of these algorithmic stable coins. It therefore needs standards

Factors to keep in mind for regulators

There are a number of important factors policymakers and investors should keep in mind as stablecoins continue to develop and mature. This latter group take deposits without any insurance that customers rely upon to know their money is protected.

Regulators should likely pay more scrutiny to the risks surrounding stablecoins and their reserve attestations especially algorithmic stablecoins, given that UST’s problems have sparked wider crypto market volatility.

Stablecoins backed by reserve assets with clear fiat currency value however face a fundamentally different set of credit issues to algorithmic stablecoins, in our view. In such cases, the stablecoin’s stability risks can be more manageable, depending on various factors, notably the safety and liquidity of the reserve assets.

Asset-backed stablecoins therefore should become transparent about what is in their reserves. With traditional stablecoins, regulators also want to know that their operators have sufficient assets to pay out customers in the case of a run on the system.

Factors relevant to the credit profiles of issuers of reserve-backed stablecoins should include regulatory risk, counterparty risk (including reserve custodians), transparency over reserves and the extent to which the underlying assets are truly uncorrelated, the legal rights of stablecoin holders, as well as governance and operational risks.

In the case of algorithmic stablecoins, they should, in regulatory terms, not be [backed] one-to-one, but being over-collateralized because these are inherently more risky. Other issues to keep in mind that are relevant for regulators are:  what are the permissible reserves?;  who can issue a stablecoin?; how should an issuer and the reserved be audited?; and, what kind of disclosures are made to consumers?”

Factors relevant to the credit profiles of issuers of reserve-backed stablecoins should include regulatory risk, counterparty risk (including reserve custodians), transparency over reserves and the extent to which the underlying assets are truly uncorrelated, the legal rights of stablecoin holders, as well as governance and operational risks.

Final remarks

It is clear that regulation of stablecoins is urgently needed to prevent collapses like that of TerraUSD. There are still many open questions.

It is however still unclear how this new regulation will look like and what impact this new upcoming regulation will have for the future of stable coins in general and algorithmic stablecoins specifically. But also what would it mean for the further development of underlying technologies.

What is clear is that stablecoins are here to stay but in a more regulated framework. It does seem very likely that many more investors will choose collateralized stablecoins in the future. This will most likely result in a growing number of stablecoins with lower risks.

In the end this may further benefit the crypto industry as thanks to lower risks and increased transparency it may attract more players from the traditional financial world.

 

Carlo de Meijer

Economist and researcher

 

 

 

 

Source

Hedge Trackers, a GTreasury Company, Offers Advice to Treasurers Amid Interest Rate Uncertainty

28-06-2022 | treasuryXL | GTreasury | LinkedIn |

With interest rates rising and remaining unpredictable, corporate treasurers need to have a hedging plan in place. For many, this can be easier said than done.

Farah Lotia, the Director of Interest rate and Quantitative Analytics at Hedge Trackers, recently spoke with both Treasury Today and Euromoney Magazine about the purpose of interest rate hedging and how they can use it to their advantage.

Hedge Trackers was recently acquired by GTreasury.