Trésorier/Treasurer magazine - N°94 - Juil/Août/Sept 2016 - (Page 26)

THE IMPACT OF NEGATIVE RATES ON TREASURY AND RISKS MANAGEMENT SYSTEMS In a situation where interest rates have become very low - particularly in Japan and in Europe - and where certain deposit and market rates are negative, corporate treasurers have become increasingly aware that in certain cases the information system they use no longer enables them to come to grips with this new market paradigm, whether at front office, back office or accounting levels. And yet, the situation is likely to last. As a consequence, the adjustments to be made to the various components of the Treasury and Risk Management Systems are absolutely necessary. - N°94 - JUL / AUG / SEP 2016 Negative rates have generated issues that affect multiple stages in the processing chain. 1 - Market data When it comes to managing the impact of negative rates in the lifecycle of a transaction, the first area to focus on is the management and storage of market data. First, it is necessary to have the capacity to store negative rate values, as most short term EUR rates now have negative values. Moreover, it is necessary to manage and store negative yield curve values, especially as far as short term tenors are concerned. In the event of curve reconstruction upon data collection (e.g. construction of a 0coupon curve from deposit and swap rates), the reconstruction must properly take into consideration negative rate values. Finally, it is necessary to store negative values for all market transaction valuation processes (see below). LE MAGAZINE DU TRESORIER / TREASURER MAGAZINE 2 - Entering transactions and back-office processes 26 The information system must allow users to enter negative rate values for all financing, investment and interest rate derivative transactions. Consequently, it is necessary to determine negative interest values in back-office processes such as fixing and maturity processes. Many Treasury and Risks Management Systems (TRMS) thus lack the possibility to generate interest expenses on investments and interest incomes on financings. Furthermore, it is necessary to manage the back-office and accounting impacts resulting from this situation. As a result, it should be possible to handle payment instructions according to the interest calculated, regardless of whether the transaction is approached from the lender's or the borrower's side: the calculation of an investment's interest should generate a payment instruction. The accounting impact of such a situation also matters, as the interest resulting from an investment generates an accounting expense. Accounting systems must therefore be designed to challenge the fact that the interest on an asset is not necessarily positive. By the same token, they should accommodate the fact that a liability can generate a positive interest value. Derivative transactions are imbued with similar issues. For example, it is necessary to consider Negative rates have that the interest on an IRS can be in the same positive - or negative generated issues that - territory on both legs, which affect multiple stages in implies a number of back-office the processing chain. and accounting consequences. Finally, current account interest scale calculations must be designed to factor in pre- and post-margin negative interest values, once again with due consideration for the accounting consequences, so as not to floor the interest of the current accounts. This is particularly important in the context of Cash Pooling. 3 - Valuation Valuation algorithms were not initially designed to accommodate negative rates. Pricers must often be adjusted in order to determine all the risk indicators for front- and middle-office processes as well as the fair values that affect accounting, given these new requirements. a. Instruments with linear payoffs, such as fixed or floatingrate plain vanilla financing/investment transactions, non optional rate derivatives such as interest rate swaps. Straightforward forex transactions such as forwards and swaps are also concerned, especially when it comes to determining time value. Although adapting the calculation rules is relatively simple, TRMS design must factor this in, as it should be possible to use negative rates in all the intermediary calculations such as 0coupon rates, discount factors, forward rates (in particular when it comes to simulating the future interest of floating-rate transactions) and the determination of payoff projections. b. Instruments with non-linear payoffs, such as caps/floors or swaptions. In these instances, the implementation is far more complex.

Table of Contents for the Digital Edition of Trésorier/Treasurer magazine - N°94 - Juil/Août/Sept 2016

Table of contents
INTERVIEW Philippe Gelis - Kantox - Fintech and the future of banks
Lost in transformation
Everything has a price – a transfer price
Treasury Survey - an unprecedented picture of treasury activities in Luxembourg
The impact of negative rates on Treasury and Risks Management Systems
Towards reporting harmonisation?
Understanding the Treasury impact of BEPS
Impacts of Single Resolution Mechanism and Bail-in for European Banks
Supply chain? Not concerned?
Collateral management and the Corporate Treasury function.
Efficiently Managing Cross-Border Payments in Turbulent Times
How Mid-Market Companies Can Efficiently Manage Enterprise-wide FX Risk as they Grow
Investing surplus cash in repos
A wind of technology changes in the treasury management world
Invoicing can be fun….?
Comment améliorer la performance des fonds de pension européens

Trésorier/Treasurer magazine - N°94 - Juil/Août/Sept 2016