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Instant payments for treasurers
| 31-03-2017 | Alessandro Longoni |
As part of further standardization within the union, European regulators mandated the industry to develop an “instant payments” product aimed to making the funds available on the receiving side “within a maximum execution time of ten seconds”. The SCT Inst scheme has been developed to allow for consumer payments (C2C, C2B) in Euro for the SEPA and will be an optional scheme – meaning that PSPs and Banks are not obliged to join.
Practical Use Cases
From a cash management perspective, Instant Payments open an array of new possibilities for merchants, especially for those operating eCommerce operations. Currently if a customer places an order on a friday late afternoon, the funds are made available (earliest) on monday evening, while the order is most likely processed and delivered by Saturday afternoon. With SCT Inst, if the order is placed on friday at 21:00, the funds will be received (maximum) at 21:00:10 and already available to pay suppliers if needed.
From a treasury perspective, Instant Payments will also allow for more transparency on transactions and easier reconciliation, but time needs to be devoted to update the current tools to facilitate for this. As Instant Payments will gain customer adoption, the incoming payments cash account will be filled with hundreds or thousands of transactions per day, as opposed to one per day coming from your Payment Service Provider. Having direct access and insight in each single transaction will make it easier to reconcile it with the relative order, check the amount and book it in the general ledger, but the sheer number of lines in the system requires current tools to be updated to cope with the increased volume and speed.
Pros and Cons
There are several benefits this new payment method brings to the table, including a strong reduction of working capital trapped to fund operations, however, in order to extract all the benefits, ERP systems need to be updated to check the status of transactions in real-time instead of intervals. Without investing in developing the current tools further, companies risk missing out on the new opportunities to deliver better customer service and create additional efficiencies in cash management.
Alessandro Longoni
Managing Consultant at Proferus
Basel III and the impact on cost of hedging
| 30-3-2017 | Arnoud Doornbos | Treasury Services |
In the summer of 2007 a large number of defaults on U.S. mortgage loans did arise. The banks were hit hard by the global domino effect that resulted. A major financial crisis which was followed by an economic crisis led to a revision of the capital requirements of Basel I and Basel II.
New Basel III
The core of Basel III is that many banks have to hold more capital and liquidity to their outstanding investments than they used to in the past. The rules are implemented as from 2013 and should eventually be fully effective in 2019.
Basel III will be a huge challenge for banks in the coming years. The impact on the pricing of financial products and transactions between banks and their clients will be significant.
Since July 2008, the Basel Committee for Banking Supervision has been working on Basel III for all banks worldwide. The European Commission has introduced three Capital Requirements Directives which contains concrete actions and requirements in terms of risk, capital and liquidity management within a bank. The new requirements, part of Basel III, aim to improve the quality and level of capital reserves of banks.
The capital requirements of certain products have increased and banks are encouraged to create additional capital buffers during good economic times so that they are better positioned to absorb losses during periods of economic stress.
Impact of Basel III on liquidity management
Besides sharpening the capital requirements Basel III has a major impact on liquidity management. The new liquidity standards are based on a stress test. In addition Basel III also introduces new long-term liquidity standards that reduce the mismatch between the maturities of assets and liabilities.
Banks will have to increase their reserves sharply in the coming years. Previously, banks only had to keep 2 % capital to their outstanding investments. Now with Basel III this capital requirement has been increased to 7 % (4.5 % hard buffer and an additional 2.5 % margin in bad times) . As a result banks will probably not distribute their profits in the coming years but will add to their capital buffers. Furthermore many banks will have to issue new shares in order to attract extra money in order to meet the new demands.
Counterparty risk
Within Basel III it has been determined that capital must be held for the credit risk on a counterparty a bank is exposed to in OTC derivatives or equity financing transactions. In addition, market participants are encouraged to take one central counterparty (clearing houses) for OTC derivatives. Any time a bank takes a risk against another party the probability of default exists. To offset this concern, and to support on-going stability within the interbank market, banks have long emphasized the importance of measuring and managing counterparty risk. Now banks have becomes noticeably less comfortable trading with other counterparties including other banks.
The recent deterioration in credit ratings that has hit many U.S. and European banks has led to a heightened sensitivity over counterparty risk. These apprehensions may not be voiced directly, but they become evident when front office trades that would have cleared in the past, no longer do because credit lines have been reduced. There is increasing focus on limiting exposures, even among global banks. And that is starting to affect the way we do business.
CVA (Credit Valuations Adjustment) desks have grown in popularity, as banks seek more effective ways to manage and aggregate counterparty credit risk.
The market has changed now in terms of how counterparty credit risk was calculated. Now, no client is assumed to be truly risk free. Different prices are now expected for different clients on that same interest rate swap, depending on variables including the client’s rating and the overall direction of existing trades between both parties.
On all new interest rate, FX, equity, or credit derivatives, CVA desks price the marginal counterparty risk for inclusion into the overall price charged to the client. CVA is a highly complex calculation.
CVA looks at default through the spread of the counterparty. A swap facing a single B credit that trades at 1200 in CDS is going to be charged a lot more than the same swap facing a AA counterparty. The CDS spread is normally a core input of CVA pricing.
What we see in practice is that in the manual process, the CVA desk team of a bank often passes along suggestions to the salesperson for improving the credit risk in a trade and enabling the sales person to offer the trade at a lower credit price. Examples of that would include improving the collateral agreement with a client, or inserting a break clause.
In the traditional CVA approach, a bank accepts a new trade, takes a fee and uses that fee to buy good hedges for all the risks in that trade. These hedges should eliminate all of the bank’s risk, but this is not necessarily the case once Basel III is taken into account.
Basel III does not recognize all types of hedges that the bank might want to use. Therefore the regulatory capital for certain trades will not be zero, even if the bank has used the full CVA fee to hedge all its risks.
The first impact Basel III has on CVA desks is on pricing. Pre-deal pricing needs to be reviewed to ensure the costs of imposed regulatory capital are covered. If not, additional pricing may need to be added. And the decision on which risks are efficient to hedge also becomes affected not just by strategic or business reasons, but also by the regulatory capital impact.
As part of Basel III’s updated regulatory capital guidelines, a new element has been added: V@R on CVA. Regulators have specified very precisely how the underlying CVA must be calculated for this charge. Banks will therefore need to decide whether to adjust their pricing and balance sheet CVA to match the Basel III rules, or to use different CVA calculations for pricing and regulatory purposes.
The Dodd-Frank / EMIR financial reform bill gives a new set of derivatives rules that either will clean up the market or send the world spiraling off the deep end. The truth is probably somewhere in between. The crux of the derivatives regulation is the requirements that standardized swaps be centrally cleared and traded on a Swap Execution Facility, or SEF. This moves derivatives from bilateral agreements between bank and client to centrally cleared products where credit risk is no longer bank-held, but is centralized in a clearinghouse where daily margin is managed. Once clearing is in place, customers no longer are locked into a single dealer, long and short positions can be netted, and SEFs can begin to match buyers and sellers without having to worry about the credit lines of each counterparty or dealer.
This will begin the migration of the derivatives business from a principal-based OTC market toward an agency-based bid/offer SEF market.
The advantages of the OTC market compared to exchanges has become questionable. High cost savings can be achieved by shifting your hedging activities to exchanges such as Chicago Mercantile Exchange (CME).
Shifting hedging activities to an exchange such as CME requires changes in your risk management function. This supplies the possibility to bring the cost of hedging back in your control.
Arnoud Doornbos
Associate Partner
How to combat Payment Fraud
| 29-3-2017 | Mark van de Griendt | sponsored content |
Payment Fraud is one of the biggest threats to a treasurers’ reputation and career path in an organization. One of the most common ways to reduce payment fraud is to reduce human intervention and to increase the levels of automation in payment structures. With cyber-attacks and payment fraud regularly making headlines, treasurers must be vigilant in safeguarding financial assets. Only 19% of treasurers list cybersecurity as a critical concern. By contrast, 45% of CFOs name cybersecurity as a priority, pointing to a significant misalignment in CFO and treasury agendas in this regard (PWC Global, 2017).
That is why it’s really important for treasurers to know what they can do to reduce payment fraud. There are two ways to lower the risk of payment fraud in payment processing:
Higher level of Straight Through Processing
Corporates sometimes have hundreds of banking relationships and thousands of bank accounts, all managed manually on spreadsheets. Redesigning these treasury processes based on STP creates an integrated treasury workflow that streamlines processes effectively and provides treasurers with timely access to financial information. No more manual entries, no more errors.
Implementing a Payment Hub
A centralized payment platform combats payment fraud while also ensuring treasurers of having the money they need to manage day-to-day business obligations.
Some key benefits include:
Please refer to our company page on treasuryXL or contact Mark van de Griendt if you’d like to receive more information about reducing payment fraud by a corporate payment hub.
Mark van de Griendt
Cash Management Expert at PowertoPay