Natural Resources and Utilities Cash Management: Change and Opportunity

ForewordWelcome to HSBC’s 2017 Cash Management Outlook for the Natural Resources and Utilities (NRU) sector. The sector looks set for

some major changes throughout the year that will directly affect cash management, so we hope that you will find the information in

this Outlook both timely and valuable.

Although some of the factors impacting NRU treasuries in 2017 will be the same as in 2016 - with M&A activity being one example -

there are also a number of new ones. Many of these factors have their origins in regulatory initiatives, while others - such as changing

oil price/supply/demand expectations - are industry-specific. A third group relates to developments in the payments industry, such

as immediate payments. However, taken collectively, they all sum to the same base state as 2016: continuous change for NRU

treasuries that has to be managed.

Some of the anticipated changes, such as last year’s announcement by OPEC and Russia to cut global oil supply, will take effect

during the year. Others, more specifically some of the regulatory factors, will only come into force in 2018, but their potential impact

will still need to be planned and prepared for in 2017.

The good news for NRU treasuries is that several of the change factors affecting them have significant opportunities embedded

within them. Prominent among these are developments in the payments industry. Immediate payments (subject to the quality of

internal infrastructure) open the door to real time cash management, while distributed ledger technology has the potential to reduce

transaction costs and enhance processes through more collaborative workflows.

Nevertheless, how accessible these opportunities are depends heavily upon the choice of partner bank. These are not opportunities

that can be grasped by simply buying a product; the maximum benefit will emerge from consultative engagement with a trusted

partner. Furthermore, that partner must itself be prepared to embrace the changes that drive these opportunities, which is

unfortunately not always the case, especially in areas where financial technology companies are becoming more prominent. This

is one of the reasons why HSBC has made a point of being a proactive and positive participant in organisations such as the R3

blockchain technology consortium. We believe that combining our engagement in these initiatives with our network and sector

expertise ultimately delivers the best value for our clients.

Lance Kawaguchi

Managing Director, Global Sector Head – Global Banking Corporates

Global Liquidity and Cash Management, HSBC

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NRU treasuries hoping for a quiet 2017 after what was an extremely busy 2016 are likely to be disappointed: a whole

host of factors look set to make things at least as challenging, if not more so. The good news is that many of these

factors have important opportunities for treasury embedded within them. As Lance Kawaguchi - Managing Director,

Global Sector Head, Global Banking Corporates, Global Liquidity and Cash Management at HSBC - explains, these range

from the prospect of immediate cost savings and efficiency gains, all the way to longer term more structural changes

that could enable strategic flexibility and long term future-proofing.

For NRU sector treasuries, 2016 was primarily concerned with the change and efficiency management associated with

‘rightsizing’ through rationalisation and the disposal of non-core assets. Costs needed to be saved wherever possible

and processes streamlined. Change looks set to be the norm again in 2017, but caused by wider range of drivers. These

can be broadly categorised as industry-specific, regulatory or payments industry developments, though there is some

overlap among them. They range across a variety of timeframes: some will have an immediate impact, while others

(many of which relate to regulation) may only come into force after 2017, but nevertheless require a more immediate

response or strategy.

Industry-specific factors

The situation in the NRU sector at present can probably be

described as ‘glass half full’. On the upside, crude prices

have recovered from their lows, with Brent crude closing

2016 at USD54.96 per barrel, though this still represents a

~50% decline on the peak of ~USD115 per barrel reached

in June 20141. Nevertheless, according to research by Wood

Mackenzie2, if prices remain above ~USD55 per barrel, then

that will be sufficient to make the oil and gas industry cash

flow positive in 2017. This seems plausible: HSBC forecasts

average Brent Crude prices of USD60 per barrel in 2017 and

USD75 by 20183.

The supply/demand outlook has also shifted significantly

following OPEC and Russia’s agreement to cut supply by 1.8m

barrels a day for the first six months of 20174. HSBC expects

this move to clear the current accumulated glut and estimates

a 0.6 million barrels per day (BPD) supply deficit in 20175.

Looking further ahead, the expectation is6 for the oil supply/

demand gap to widen and reach 20 million BPD by 2025 on the

basis of current development plans. This will mean that new

projects will need to be signed off by 2020 to meet the future

lack of supply. Also anticipated is a sharp rise in projects in the

immediate term, with new projects by oil majors set to double

in 2017, while production and exploration spend is expected to

increase by 3% to USD450bn7.

Another industry-specific factor is the likelihood of increased

M&A activity. Despite a busy 2016 for upstream activity, two

thirds of industry CFOs expect a further rise in M&A activity in

2017, according to survey by BDO8. If recent trends persist, a

significant proportion of this activity will consist of cross border

deals. These have a close connection with another (not strictly

industry-specific) factor: the major changes underway in

Natural Resources and Utilities Cash Management: Change and Opportunity

1 http://blog.ihs.com/upstream-oil-and-gas-ma-deal-count-and-asset-transaction-value-plunged-in-2015 2 http://www.pwc.com/us/en/industrial-products/publications/forging-ahead.html 3 HSBC Oil Insights January 11th 2017 4 http://www.cnbc.com/2017/01/16/asia-pacific-oil-production-declining-at-record-levels-wood-mackenzie.html 5 HSBC Oil Insights January 11th 2017 6http://www.reuters.com/article/oil-production-spending-idUSL5N1F03US 7 http://www.reuters.com/article/oil-production-spending-idUSL5N1F03US8 http://www.ogfj.com/articles/2017/01/bdo-energy-industry-looks-optimistically-towards-2017.html

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international trade agreements. Brexit, US withdrawal from the

TPP and its intended renegotiation of NAFTA have contributed to

a febrile trade environment. These developments, or future new

ones, may all affect matters such as the domicile and/or value of

existing or potential assets.

So what does this all mean for NRU treasuries? Assuming

crude prices perform as expected in 2017, liquidity levels in the

industry should improve during the year. Some or all of that

increase may be quickly diverted into improving shareholder

returns, share buy backs, increasing exploration spend, debt

reduction or M&A activity, but for any that isn’t, the position on

investment has started to change on the back of rising interest

rates. The Federal Reserve hiked US interest rates in December

and HSBC’s view is that there will be two further increases of

25 basis points apiece during 2017, in Q2 and Q49. Given USD is

the functional currency of the NRU industry, this is an important

change. The exceptionally low base rates that have prevailed

in the aftermath of the financial crisis have somewhat reduced

corporate treasuries’ sensitivity to credit interest rates, but

there is now more of an incentive and opportunity to seek out

better yields.

High levels of M&A activity are hardly unfamiliar territory for

NRU treasuries. Nevertheless, disposals/acquisitions, both

domestic and cross border, still have to be implemented as

efficiently as possible to ensure business continuity. Processes

will still need to be streamlined and efficiencies maximised.

The generic demand across all these factors is a further increase

in the need for NRU treasuries to anticipate, prepare and respond

swiftly in a volatile global business environment. Almost by

definition, this situation makes the choice of partner bank ever

more critical. Global implementation experience is one obvious

qualification, as is a global network and the ability to design and

implement sophisticated global liquidity management structures

and products. Interest enhancement facilities that enable cash

in countries that apply currency controls to contribute to global

interest rate tiering are just one example.

Some desirable qualities in a partner bank are less immediately

obvious. For instance, post-Brexit (and assuming the European

Payments Council does not grant special permission) it will

not be possible to send EUR SEPA payments from the UK.

That means that a partner bank that holds a banking licence in

another Eurozone country will become essential for making cost

efficient SEPA payments and collecting EUR direct debits in the

SEPA zone. This is not a concern for HSBC which already has

multiple local banking licences and established operations in the

SEPA zone.

Regulatory factors

Basel III: optimising deposits

Looking beyond treasury drivers specific to the NRU sector, it is

hard not to notice the impact of current and pending regulation.

Prominent among the former is Basel III, which is especially

relevant when USD interest rates are rising and treasuries are

9 HSBC Global Research: Global policy rates February 6th 2017

10 http://www.allenovery.com/SiteCollectionDocuments/Radical%20changes%20to%20European%20data%20protection%20legislation.pdf (page 6)

therefore likely to be more sensitive to yields available on surplus

cash. Two elements of Basel III - the net stable funding ratio and

the liquidity coverage ratio - are compelling banks to take a very

different cash management approach. More specifically, the

liquidity coverage ratio has the effect of making it more difficult

to place money with a bank for less than 30 days.

This places the onus on NRU treasuries to improve their cash

flow forecasting and liquidity management processes so as

to maximise the amount of cash they can place on deposit for

more than 30 days. It also places the onus on banks to create

new channels in obtaining yield. HSBC has recently launched

Liquidity Investment Solutions (“LIS”), an innovative new

automated solution to sweep funds directly into money market

funds held with a choice of four Asset Managers. The funds

are all well rated, can be tailored to sweep with user-defined

parameters and offer the possibility of enhanced yields due to

the nature of the fund.

Data management and control

Data control is becoming a huge focus for the financial

services industry. Successful data management brings strong

competitive advantage to those companies who adopt robust

data analytics tools. Some regulators are keen to assist in this

by allowing free movement of data flows, but at the same time

they also want to protect data privacy. For example, the EU

General Data Protection Regulation is very focused on the latter

aim. Coming into force in May 2018, it has more immediate

implications for NRU treasuries, particularly if those NRUs hold

any consumer data. Apart from important measures relating

to data protection, the regulation also enshrines a right for

consumers to portability in relation to their personal data. They

will be able to request a copy of these in a format usable by

them and electronically transmissible to another processing

system. Corporations who breach customer data can be fined

4% of annual turnover or EUR20 million whichever is the

greater10. Companies may also have to appoint a data protection

officer and set out their data protection policy for the regulator.

While European regulators may be favouring the sort of data

portability that facilitates cloud based treasury management

systems, the complete opposite applies to some regulators in

Asia, where it is obligatory for data to be kept locally.

Cyber security: people and process security

Regulators have also been active for some time in the field of

cyber security, with the EU’s Network Information Security

Directive and the US Federal Reserve’s Cyber Security

Consultation being two examples. This sort of regulation

has moved beyond just the banking industry to affect

corporates directly.

From an NRU treasury perspective, where high levels of M&A

activity result in appreciable levels of staff turnover, this is

particularly relevant. The temptation is to assume that the risks

can be mitigated by buying technology solutions. In practice,

it is the human factor that often accounts for the most severe

breaches, either accidentally or by design. Mining of social

media data is frequently used to craft more convincing phishing

emails and thus increase the probability of a poisoned link or

attachment being opened.

This is another area where the right choice of banking partner

can add value. A bank with process consulting expertise will

quickly be able to spot gaps in processes (often involving manual

activities) that are vulnerable to exploitation. These could be

anything from a lack of two level transaction authentication, to

overly open access to vendor payment data.

APIs: better data visibility and business intelligence

Another area of regulatory activity that connects with the data

portability mentioned above is the application programming

interface (API), which is covered by PSD2 in Europe (taking

effect in January 2018) and the Competition Markets review

in the UK. PSD2 obliges banks to allow third-party providers

real time access to their customers’ accounts, so that these

providers can offer services such as payments processing and

account aggregation/monitoring. Access has to be provided

using a common API standard, work upon which is already

underway by such industry bodies as the Open Bank Working

Group in the UK.

This API access will allow NRU treasuries to partner with

providers to obtain advanced data analytics services in addition

to cash management, such as long term forecasting and

behavioural trends analysis (e.g. looking for patterns in group

entities’ internal payment activity or supplier payments).

Historically, some banks have been resistant to API initiatives,

believing that they would result in loss of business to financial

technology companies (fintechs). By contrast, others see it as an

opportunity to collaborate with fintechs to the ultimate benefit

of corporate treasury clients. For example, HSBC has launched

two financial technology innovation laboratories in Singapore

and Hong Kong where it works with fintechs in developing new

digital banking solutions in areas such as bio-metrics,

distributed ledger technology and big data analytics. While APIs

are still at an early stage, HSBC is already exploring possible

third party payment/account aggregation solutions that it can

provide to clients.

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Payments Industry Developments Immediate payments:

real time working capital management

The quality of internal systems and processes also influences

the extent to which NRU treasuries can take advantage of

another change in their environment: the growth in immediate

payments systems, where transmission and receipt of a

payment happen in real time, rather than on a batch basis. At

present, 18 countries around the world have implemented

immediate payment systems, with another 12 either planning

or building them, and a further 17 countries exploring them11.

Of particular interest for NRU treasuries is that the group

of countries that already have immediate payment systems

includes several with major oil resources, such as Nigeria,

Mexico and Brazil.

Immediate payment systems open the door for NRU treasuries

to real time reconciliation of receivables and near-immediate

control of working capital cycles. However, the caveat is the

state of their own internal systems: if they cannot process

incoming data in real time, then the practical advantage of

immediate payment systems becomes academic.

The good news is that remedying this situation does not

necessarily require buying and installing a new treasury

management system. Cloud based systems, such as

Kyriba, can be implemented far more quickly and by virtue of

being cloud based, come at a reduced cost. They have the

additional benefit of rapid re-configurability to accommodate the

various acquisitions or disposals that are commonplace in the

NRU sector.

Distributed ledger technology: cost reductions, efficiency

gains

Distributed ledger technology (DLT), where a transaction

ledger is shared across all participants attached to a computer

network, is now generating serious corporate interest. This

is hardly surprising, as there are various fields in which it can

add value. The collaborative nature of the technology allows

all the elements of complete end to end business processes

to be carried via a single medium. One obvious example is

international trade, where importers, exporters, banks, shippers,

customs authorities, inspection agencies, insurers and others

could all participate directly and update transactions in near real

time, subject to consensus agreement/authorisation by others

on the network. Blocks of transactions are processed and

entered in the ledger and once recorded become irrevocable,

with copies of the same ledger being distributed among all

participants. As well as presenting a barrier to hacking, this

distribution also has the advantage of reducing exception

processing, as participants are not creating their own

private records (which might conflict with other participants’

private records) but are using identical copies of the same

‘public’ record.

A practical illustration of how DLT could work for trade finance

processes is getting underway in Europe with the Digital Trade

Chain (DTC), where HSBC is one of the founder members. DTC

targets small and medium enterprises (SMEs) and aims to give

them a simplified means of managing, tracking and securing

domestic and international trade transactions.

Another area where DLT shows considerable potential is cross

border payment systems. Existing cross border payment

systems typically involve various intermediary participants,

which can increase both costs and complexity from the end

user’s perspective. One example of the DLT alternative to this

is the SBI Ripple Asia Venture. This promises round the clock

settlement for domestic and cross border transfers and is

estimated to offer a 90% reduction in payments fees versus

conventional payment systems12.

The credibility of DLT as a viable technology for critical financial

functions is also reflected in the fact that several central banks

are actively investigating its potential for supporting new

digital currencies. In the UK, the Bank of England is exploring

the creation of a digital currency and looking to offer deposit

accounts and payment services via a DLT platform. The

Bank of Canada is piloting Cadcoin, a digital currency for

interbank transfers, while the MAS in Singapore looking at a

similar initiative.

Nevertheless, despite the promise that DLT offers NRU and

other corporate treasuries, the extent to which that promise is

actually realised depends on corporates’ banks. Some banks still

regard DLT in much the same way as they view fintechs: as a

threat to their business that must be resisted. Others by contrast

are very much embracing the DLT opportunity. For instance,

HSBC is a major participant in the R3 blockchain technology

consortium13 and is having conversations with various cross-

border payment distributed ledger technology platforms.

11 http://www.digitalistmag.com/finance/the-global-market-place/2015/11/05/real-time-payments-whos-ahead-whos-behind-global-trend-03726030 12 https://ripple.com/insights/sbi-ripple-asia-announces-japanese-bank-consortium/13 http://www.reuters.com/article/us-banks-blockchain-idUSKCN0RT1Y320150929

Conclusion:One of the most striking features common to many of the factors currently driving change for NRU treasuries is the

implicit paradigm shift they also drive in the nature of bank relationships. Many treasurers were already weary of banks

pushing products at them, but this archaic approach is now rendered utterly inappropriate and irrelevant. Many of the

changes treasurers need to make in the current environment are inextricably linked with their own specific processes

and technology. Threats such as cyber security breaches cannot just be mitigated by ‘a product’, but require in depth

process consultancy expertise that can deliver rigorous analysis and a situation-specific solution.

Another increasingly important concern for NRU treasuries is the breadth and depth of their primary bank’s network.

Some have been quick to point to recent geopolitical events as evidence of the end of globalisation. However, the NRU

sector is implicitly a global business and at present this particularly applies to M&A activity, where many companies

are diversifying into new countries. Coupling this with the global nature of many of the regulatory and technical factors

outlined above makes the global reach and expertise of banking partners business-critical.

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Published: February 2017

For Professional clients and Eligible Counterparties only. All information is subject to local regulations.

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