Topic Category: Trade & Finance

Right now, U.S. corporations and their treasurers are working hard to comply with the Sarbanes-Oxley Act and all its requirements. This is no easy task, considering that compliance with the requirements in Section 404 of the Act could mean a complete overhaul of internal financial reporting and procedures for most corporations.

In general, Section 404 of Sarbanes-Oxley (and new Item 308 of Regulation S-K) require management to prepare an annual report on the company’s “internal control over financial reporting.” This term is defined as a process, under the supervision of the company’s CEO and CFO, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements. In addition, the company’s external auditor must provide an attestation report on management’s assessment of internal control.

Treasurers are gradually warming up to the idea of online FX. Once limited to a dial-up system in the early 1990s, FX transactions quickly moved to the Internet, thanks to the development of and improvements in global communications. Today, the Internet’s proven to be a fast, convenient and secure medium for FX transactions.

Although online FX volumes have grown steadily, experiencing their biggest increases over the last two years, many treasurers are still reticent to jump on the online FX bandwagon. According to a GTNews survey conducted in 2002, treasurers stated that they were unwilling to buy into eFX unless they were convinced of its straight through processing (STP) benefits.

Automation Is Key

The automation or STP of FX transactions eliminates a number of manual steps, including the keying of tickets that brings the possibility of transposition errors. What’s more, the processing of an online transaction can now be completed in seconds instead of minutes. That means treasurers will be able to spend fewer hours on administration and more time on critical issues, such as risk analysis and risk management.

Automating some or all of the trade process also provides a better audit trail, greater structure especially in setting individual trading limits, reduced trading costs, and more control for the treasurer and corporation.

Finding the Right STP Solution

When looking for the STP system that will work best for their company, treasurers need to consider several key points:

1. What system offers the best end-to-end processing of transactions with the least chance of human error?
2. How important are real-time data and updates? Does the STP have to be real-time? Does the transaction need to be in the Treasury Management System (TMS) seconds after the trade or is a 10 to 15 minute delay okay?
3. How secure is the system, and can the data integrity be trusted?
4. Does the TMS have an interface? If so, what type? What message formats does the interface support?

Automating the End-to-End Trading Chain

The ability to automate FX transactions from quote to settlement may give treasurers a compelling reason to move to online FX. This would involve allowing front-office staff to link into trading portals from their internal work processes and systems. Deal tickets, confirmations and settlements, accounting entries, and hedge tracking systems should all be automated to provide the convenience, speed and productivity treasurers are seeking.

Many participants in the E-trading industry have been working to develop and deliver standardized interfaces and messaging formats to facilitate integration between the buy and sell sides — and to simplify automation of information and processes within the corporate front and back offices. For these initiatives to be successful, however, the corporation needs to have up-to-date treasury automation in place.

The Value of Real-Time Data and Updates

Some corporations only need hourly or daily updates of their back and front office positions. However, a number of large corporate treasuries have invested in an integrated treasury system to ensure that their front and back office positions are always the same, and that positions are maintained in real-time so that treasurers have the most accurate and up-to-date record of their positions as possible.

If an STP system doesn’t offer true real-time capability, the position records in the treasury system could very well be inaccurate and unreliable. In addition, if the data update needs to be manually input immediately after the deal is executed, there is a greater risk of both human error and an inaccurate position record.

The Importance of Security

Commitment to Internet security has to be considered a top priority from management on down for treasurers to feel comfortable about online FX. A corporation’s security will not only depend on internal controls and awareness, but will involve its partners, banks and other third parties.

The first step to ensuring security is to establish and write down specific security policies — and clearly communicate them to all staff, partners and third parties. Even with established policies, companies need to be aware of internal and external risks that exist, such as employee fraud, misunderstandings or disagreements with formal procedures, and hackers.

To prevent a single person from committing fraud, corporations should split duties and critical decisions between two or more people. A good Internet security program also uses procedures that protect physical systems, including:

Authentication

An identification used to prove that the people online are who they say they are. This could be a user name, password or mother’s maiden name; a digital certificate, hardware token or private network; or an iris or retinal scan, fingerprint, or hand geometry. The best authentication procedures use at least two identification mechanisms.

Authorization

Verifies that the person has permission to perform a trade or other specific action on behalf of the company. Authorization is enforced by data stored in the corporation’s databases and can be granted by using the private key of a digital certificate.

Integrity

Ensures that information is not changed or tampered with by any non-authorized users. Integrity can be assured by storing independent copies of the trading transaction data, such as the buyer’s treasury system, the seller’s trading system and the independent marketplace database.

Privacy

Protects sensitive data from theft or misuse. In the Internet world, cryptography is the mechanism that safeguards data privacy. For corporations with partners or third-party providers, they must have contracts that clearly describe privacy policies and how the corporation’s information is handled.

For online FX to become a regular, viable activity for corporations and their treasury, users and providers must have physical, electronic and procedural safeguards in place — and provide training to ensure everyone involved knows the importance of observing these security measures.

Choosing a Provider

Most treasurers choose a single-bank trading platform because multi-bank platforms are only available to corporations that have trading relationships with many banks — plus these services can be very expensive. According to Jane Guyett, Managing Director, Global Foreign Exchange at Bank of America, “The single-bank platform usually offers a wider range of functions, real-time price quotes, and more products than multi-bank platforms. In addition, if treasurers have a strong relationship with one bank, they can leverage the single-bank platform to enjoy a higher level of service.”

How Letter-Perfect is Online FX Today?

Both STP and online FX are getting better all the time. Yet, there are still some challenges to be worked out. Most STP solutions have not been integrated into treasury applications from beginning data entry through settlement. Many still require the use of two applications: the treasury system to establish FX positions, and the FX trading platform to execute trades. Plus, there is still some inherent risk to data integrity.

“The good news is that more and more corporations are becoming aware of the value of automating treasury management systems,” says Guyett. “At the same time, they are centralizing both FX risk management and transactions to achieve greater control and efficiency. So as treasury automation extends globally, it will be easier for the treasurer to manage FX transactions and risk for all operations.”

As more countries become familiar with the ease and efficiency of online FX, banks with an established presence in these markets will be able to promote international trading in their currencies. This could eventually provide better information on pricing and cultivate the growth of eFX in emerging market currencies.

The Future of Online FX

Once STP becomes better integrated between corporate TMS and online FX platforms, a greater percentage of trading will move online and away from the telephone. The ability to transfer trade information directly into a TMS without any manual ticket writing or human intervention will greatly reduce errors – and ultimately cut expenses for monitoring trade flows and correcting erroneous trade details.

Someday soon, online FX will be a continuous process that allows treasurers to always be logged into their treasury system. Without ever needing to log into any other system or application, treasurers will be able to view positions, generate trade requests, execute, confirm and settle trades automatically, and even authorize payment transmissions — all with the click of a button. And considering how far online FX has progressed and continues to do so, that day won’t be far away.

A letter of credit (L/C) is a tremendous tool for managing international financial risk. And limiting financial risk is an essential part of any successful global transaction. But a new trend toward open account — which is gaining momentum — is helping to streamline supply chain operations and eliminate inefficiencies.

The Good, the Bad and the L/C

In order to determine whether or not the foreign buyer’s debt obligations are likely to be paid on time, a number of questions must be answered. For example, is the foreign customer creditworthy for the shipment, or suffering cash flow problems that might delay payment? What is the foreign customer’s reputation for honesty and dependability? How long has the prospect been with his/her bank? When answers to these and other questions leave doubt, an L/C tends to be the document of choice.

In January 2003, the CFO of a Michigan-based auto parts manufacturer reviewed his capital budget with his firm's Budget Committee. One conspicuous line item identified the cost of retooling the company's parts plant in Asia.

But from February 2002 to September 2003, the value of the U.S. dollar decreased by 17 percent, according the Federal Reserve's Nominal Major Currencies Dollar Index. As a result, the actual cost to retool the Asian parts facility was millions of dollars more than anticipated. This oversimplified scenario illustrates the need for exporters, importers or companies with overseas subsidiaries to factor foreign exchange risk into their budgets.

The Impact of Currency Volatility

Although exchange rates usually move gradually over time, they have been known to fluctuate with extreme volatility. This not only can reduce corporate profits, but can put companies out of business and economies into recession.

For example, on December 20, 1994, an attempted currency adjustment by the Mexican government accelerated out of control. Within two days pressures mounted; currency reserves used to prop up the peso quickly dwindled. As a result, the peso was allowed to float freely. Shortly thereafter, it nose-dived. Like falling dominoes, the ensuing panic spread to Brazil and Argentina, whose currencies also dropped precipitously.

The impact of the 1997 Asian financial crisis was felt worldwide. With front page news of plunging currencies — beginning with the Thai baht and quickly affecting the Malaysian ringgit, the Indonesian rupiah, and the Korean won — the tremendous damage caused by currency fluctuations became evident. Not only did the domino effect put pressure on traditionally strong currencies, but it also resulted in economic recession in several countries.

When budgeting for expenses and revenues from overseas transactions, clearly CFOs must manage and account for minimal, as well as potentially severe, currency fluctuations

Minimize Foreign Exchange Exposure

A purchase contract that is signed on January 1 with a foreign currency payment due on February 1 represents 30 days of foreign exchange exposure. Consequently, a U.S. exporter who sells goods to Germany (priced in euros) runs the risk of collecting euros in 30 days at a depreciated rate when they are converted into dollars.

Should this occur, the exporter will receive lower than expected revenue — which must be accounted for in the budget. On the other hand, a U.S. importer who buys French wine (also priced in euros) will benefit if the euro rises compared to the dollar, making the same case of burgundy less expensive.

Due to fluctuating exchange rates, CFOs should seek to stabilize cash flows and reduce uncertainty in their financial forecasts. In doing so, they must consider the three most important factors that impact currency exchange: foreign exchange exposure, the expected and actual rate of exchange, and the date the exchange actually occurs. In doing so, a variety of interest rate hedges may be used.

Employ Foreign Exchange Contracts

Contracts are one way to hedge against foreign exchange risk and bring certainty into the budget process. Spot contracts deal with the exchange of currency that deal with a contract term of two business days. (This two-day period applies to all currency with the exception of the Canadian dollar.)

For the purposes of establishing an annual budget, a forward contract may be an ideal tool. This locks in the future foreign currency purchase price at the time of agreement. To determine the rate of exchange, two items must be factored in: the current spot rate and the forward rate adjustment, which involves the interest rates of the currencies in question and the time frame between contract date and settlement date.

Overall, currency volatility requires CFOs to account for all risks when deciding which projects to finance and how to fund them. If they use the Net Present Value (NPV) method of evaluating budgets for a foreign project, the parent company could hedge against currency risk, especially if the NPV of the project is greater then the NPV to the company.

Foreign exchange risk can be shown on the projected balance sheet when the firm discounts foreign currency cash flow at the foreign discount rate, and converts it at the current spot rate. Or, the foreign exchange risk can be converted at a future spot rate and discount domestic cash flows at the domestic discount rate. Often, either a higher discount rate can be applied for what is conceived to be a riskier investment or project — or expectations of cash flows from the project can be reduced.

Borrowing in the Global Market?

Borrowing for a project in foreign currency can provide a sound solution, and the cost of borrowing from the global capital market is generally less than the cost of borrowing domestically.

However, host-government regulations or demands may drive up the discount rate used in capital budgeting. Nevertheless, the discount rate should be appropriate for the risk of the cash flow.

Consider Hedging

In addition to adjusting capital budgeting, there are many ways to hedge against exposure to foreign exchange risk. These include:

1. Buying forward
2. Using currency swaps
3. Leading and lagging payables and receivables
4. Manipulating transfer prices
5. Using local debt financing
6. Accelerating dividend payments

Control Risk by Recognizing and Controlling Exposure

In today's dynamic global economy where currency values constantly fluctuate, it is necessary to monitor your exposure and risk-control activities measures. And when deciding which hedges to employ, a reasonable idea of future exchange rate movements is helpful.

But perhaps most importantly, your company should consider monitoring exposure to make adjustments to the annual budget as needed.

When the 10-year Treasury Bond spiked from 3.11 percent to 4.375 percent over a six-week span, it unfortunately sparked the bond sell-off heard around the world. Placid fixed-income investors nervously focused on the plummeting value of their portfolios, and not on the reasons why they invested in bonds in the first place: the relative safety from the short-term ravages of fickle equities markets. The sudden, violent rise in rates took everyone by surprise, and oversupply quickly dwarfed dwindling demand.

Return To Near Normalcy

The good news is now that the efficiency of the bond market has scared away the hiccups, things have stabilized. Institutional portfolio managers and individual investors alike have caught their collective breaths. And after the dust settled, bond yields still were hovering at or near 45-year lows.

Issuers, Underwriters, Distributors and Investors Make the Fixed Income Game Efficient

Corporations still need to manage cash flow, and finance operations and capital improvements. State and local governments, schools, and the health care industry continue to borrow at a record pace.

Investment bankers are advising their corporate clients to manage interest rate risk using a variety of hedging strategies, such as interest rate swaps, caps, floors and collars. This helps companies match their debt service flows with their outlook on rates, and improve management of their balance sheet, as well as gives them access to alternate interest rate structures.

For the investor, bonds continue to inhabit their accustomed place in a diversified portfolio, providing stability and income. True, if the economy recovers and rates rise over the next few years, today’s investment grade bonds are overvalued. Consider this, however: investors include bonds in their portfolio to guard against exactly what has happened over the last three years — a weakened economy and an uncertain equities market. So what is the difference now? Investors are realizing it may be just as important to diversify among their fixed income portfolio as it is with equities.

Scandals Erode Investor Confidence

According to Susan Janson, Managing Director, Investment Banking Group, Comerica Securities, many underwriters, including herself, believe that scandal-ridden big corporate America has actually had more to do with decreased demand in the fixed income market than the specter of rising interest rates.

"The impact of corporate accounting scandals has had a greater impact on yield and price than issuance " said Janson, referring to the recent cascade of high-profile accounting scandals. "That said, demand still continues to be there. We've seen only a slight pullback even as investors, just entering the market now, are demanding higher yields."

Build with Ladders, Insulate with Savings Bonds

So, where should investors go with their fixed-income allocation? Staggering or laddering maturities every one or two years over the life of an investor’s portfolio has become one proven way to control interest rate risk. Janson believes that current ladder purchases which include maturities in the two- to five-year range can be used to pick up yield over today's short term rates, but generally the wisdom of laddering lies in establishing continual maturities to hedge spikes or valleys in the interest rate environment.

Try a Little Junk?

Some experts also like high-yield corporate bonds, especially if the economy continues to show signs of a true recovery. These "junk bonds" are paying 8 percent or higher, but carry with them a proportionally high degree of risk. For sophisticated investors with well-diversified portfolios, these types of securities may make some sense.

Oversupply Makes Some Munis Attractive

With supply outpacing demand, the municipal bond market is offering relatively high yields these days. One look at 2003 shows that this year's issuance is likely to exceed 2002's record numbers, according to some analysts.

The marvel of the efficient market is that although certain states may experience extreme credit pressures, the market recognizes the ongoing need of those states and their municipalities to continue to borrow. The result is continued demand at a price.

“When we look at underwriting a municipal bond, we consider the entire package to determine whether our customers have an appetite for certain credit exposures and at what yield,” said Janson. Municipal buyers tend to be conservative investors.

“Consider the overall strength of the municipal market”, said Janson. “Municipal GOs are second in quality only to U.S. governments."

What about the Great Rate Spike of 2003?

Janson dismisses the "bond trouble" hype. "What happened was a logical repositioning after the market found itself in an overbought position, not a mass withdrawal,” she explained. “The demand is still there, especially with conservative investors."

Settling foreign exchange (FX) trades has always been complicated and risky. For example, trades may involve volatile currencies, fluctuating exchange rates, different time zones, and the time lag between paying in one currency and receiving in the other, known as “temporal” risk.

Fortunately, a new system introduced 2002, is taking much of the risk, expense and difficulty out of foreign exchange settlement. This system is called Continuous Linked Settlement (CLS).

The Need for CLS

Global FX transactions have been increasing year after year, currently reaching an average of nearly $2 trillion daily. Although transaction volumes have been steadily rising, they have been settled in the same manner for 300 years.

Until the arrival of CLS, each side of a trade transaction was paid separately. And time-zone differences increased the risk of default. The most momentous and expensive FX trade default, which became the rallying cry for settlement reform, occurred in 1974. The German Bank, Bankhaus Herstatt, failed and was closed before U.S. dollar counterparties could be paid.

How CLS Works

With the real-time CLS system, both sides of a trade are settled simultaneously on a payment vs. payment (PVP) basis regardless of time zones. If both sides of an FX trade do not settle simultaneously, the trade doesn’t settle at all. However, when both sides settle at the same time, CLS provides real-time payment rather than intra-day settlement, virtually eliminating temporal risk.

The CLS service is provided by CLS Bank International, which is owned by nearly 70 of the world’s largest financial groups throughout the U.S., Europe and Asia Pacific. CLS currently deals in the Australian, Canadian and U.S. dollar; the euro; the Japanese yen; the British pound; and Swiss franc.

Direct access to CLS is available only to settlement members, who must have invested in CLS and be a shareholder of the CLS Group. CLS links the clearing systems of seven central banks for five of the overlapping business hours each day (three hours in Asia Pacific) of the participating settlement members. During this time:

• Settlement members submit settlement instructions directly to CLS Bank for processing.
• Settlement members pay in the net funds at the relevant central bank.
• CLS Bank continuously receives funds from members, settles instructions and pays out funds to members until all instructions are settled.
• Trades that can’t settle immediately are returned to the queue and are continually revisited until they settle.
• If there are no problems, all funds are disbursed back to settlement members.
• If the strict settlement criteria are not met for each side of a trade, it’s not settled and no funds are exchanged.

Using CLS As a Non-Member

It’s possible to enjoy the advantages of CLS as a third party, sponsored by a CLS Bank member who acts on your behalf. As a third-party user, you can expand your FX business and trade capacity, manage global liquidity more efficiently, leverage multi-currency accounts, and reduce your payment volume and cash-clearing costs — without the costly investment in CLS or the demands of a 24-hour operation.

In a third-party arrangement, the CLS Bank member is responsible for paying the time-sensitive funds, which are consolidated in CLS. The third party then reimburses the member later in the settlement day or settles accounts according to a bilateral agreement. It’s easy to participate as a third party. All you need is a standard web browser with regular SWIFT connectivity to send trade instructions or check the status of your trades.

Choosing a CLS Provider

Many banks, investment funds, non-banking financial institutions, and corporations are offering the CLS service to their customers. A large number of these are third parties themselves, who participate indirectly as customers of settlement members. If you’re considering participating in CLS as a third party, you’ll want to ensure that your provider has a global presence, expertise in processing payments and managing liquidity in all currencies, and 24-hour real-time systems in place to handle all the processing, reporting, customer service and other issues involved in CLS.

From February 2002 to July 2003, the U.S. dollar fell by more than 18 percent against major currencies, according to the U.S. Federal Reserve. This elated U.S. exporters, whose products have became less expensive and more competitive abroad. On the other hand, the weaker dollar hurt importers, who must pay more for foreign goods.

Whether you deal in U.S. dollars or foreign currencies, you need to protect yourself against adverse fluctuations.

How Currency Shifts Affect Business

When the U.S. dollar fluctuates in value against other major currencies, global trade flows, as well as a company’s level of international competitiveness, are impacted. For example, in the seven-year climb leading up to February 2002, the value of the U.S. dollar rose by 40 percent. This pushed the cost of U.S. goods and services beyond the reach of many overseas buyers, resulting in fewer U.S. exports. The exceptionally strong dollar forced U.S. producers to increase productivity or cut costs in order to remain internationally competitive.

A weak or declining dollar, however, has the opposite effect. As the value of the dollar decreased from its recent high in February 2002 through July 1, 2003, the cost of U.S. exports in terms of many foreign currencies became 17 percent less expensive. This allowed foreign buyers to obtain more for their money — making U.S. goods and services more attractive. As a result, U.S. exports should increase.

But, U.S. companies interested in purchasing foreign assets will receive less for their money. However, U.S. firms already invested abroad will generate larger profits when converting their foreign currencies to dollars.

The Nearly Impossible Task of Managing Currencies

Today, new sophisticated technology allows investors to transmit tremendous amounts of capital to all corners of the globe with unprecedented speed. This is affecting assumptions about financial controls. The belief that national governments or central banks — in both developing and developed countries — can still manage their capital outflows or currency fluctuations to the same degree as in the past is dangerous and has resulted in extensive economic instability.

This is exemplified by the Asian financial crisis that began in 1997, Mexico’s peso crisis that began in 1994 and, to a lesser extent, Great Britain’s and Italy’s withdrawal from the European Exchange Rate Mechanism in September 1992.

The Risks and Rewards of Accepting Foreign Currencies

The exporter’s ability to offer attractive terms to foreign importers can create a much needed edge over the competition. Accepting a foreign currency for payment is one way to achieve that goal. However, adverse currency fluctuations can eat into the exporter’s profits or cause a loss.

For example, if a U.S. manufacturer ships $100,000 worth of goods to a foreign buyer with payment due in 90 days in the foreign currency, and at the end of 90 days the foreign currency loses 30 percent of its value, the U.S. exporter will lose $30,000. On the other hand, when currencies are increasing in value against the U.S. dollar — as in the case of the euro and Canadian dollar — the risks and rewards are entirely different.

The Rising Euro and Canadian Dollar

On January 1, 1999, when the euro was established, it was worth approximately U.S. $1.16. Over the years, its value dropped to about U.S. $.82, and registered approximately U.S. $1.15 on July 1, 2003. Its increase in value against the U.S. dollar has some analysts thinking the euro could eventually become the world dominant currency. According to the Conference Board, a research organization, 60 percent of world trade is currently denominated in dollars. In the event that the greenback falls from first place, a position it’s held since usurping the British pound after World War I, more global business will be conducted in euros. But regardless of which currency is on top, more and more European companies will request that their suppliers conduct business in euros.

The value of the Canadian dollar, one of the biggest influences on Canada’s economic growth, reached U.S. $.74 on July 1, 2003, up from approximately U.S. $.66 one year prior. Consequently, Canadian exports to the United States, now 12 percent more expensive than they were a year ago, are likely to decline. This means if you are accepting Canadian dollars for payment, you’ll receive 12 percent more value.

Projecting Shifts Is Problematic

Successfully managing foreign currency exposure requires an understanding and assessment of a variety of factors and conditions affecting currency volatility, including the following three important indicators:

1. Macroeconomic fundamentals (economic growth, inflation, unemployment and balances of trade);
2. Political considerations (upcoming elections, policies and the level of confidence in the government); and
3. Social considerations (labor unrest and violence).

Nevertheless, in actively traded markets, the considerations and potential outcomes are infinite. As a result, managing foreign currency exposure often requires more than research-based predictions — it demands a sound hedging strategy.

Spot, Forward and Option Contracts

Through the use of spot, forward and option contracts, exporters can insulate their business, minimize losses and even take advantage of currency fluctuations.

How do these contracts work? Spot contracts convert the buyer’s currency at current rates for settlement within two business days. This simple method allows the exporter to take immediate advantage of favorable rates, but provides no hedge against future rate changes. Forward contracts enable the exporter to lock in a rate of exchange for three days to 12 months. And, option contracts offer the exporter the ability to lock in a rate over a desired period without the obligation to buy in the event of favorable market fluctuations.

Protect Yourself and Reap Rewards

Currency fluctuations, regardless of their direction, will impact your business. And no currency is immune from some level of volatility, including the greenback. Consequently, it is essential to identify the risks, take measures to limit the downside, and reap the rewards of favorable exchange rate movements.

To learn more about currency fluctuations and how best to protect yourself, contact your banker.

With interest rates at their lowest levels in recent history, developing strategies to optimize cash within your corporate treasury is more challenging than ever. Surprisingly, opportunities do exist for both minimizing costs and maximizing capital resources in the current financial environment.

Look Within Your Company First

The first course of action is to obtain accurate, real-time financial information from each department in your company. It is imperative to know where your funds are and how much cash is available or being used at any time of the day. Once this up-to-the-minute financial data is in hand, smarter, better-informed investment and funding decisions can be made.

Lower the Rate of Your Loans and Credit

With today’s rock-bottom interest rates, you can take advantage of more favorable rates to refinance your company’s higher-rate loans and lines of credit. This action could save your company hundreds or even thousand of dollars over the long term – and free up more cash for investments or new debt at lower rates.

Consider Extending Your Credit Terms

Due to the numerous bank consolidations that have taken place over the years, fewer borrowing options are now available. Yet, since short-term funding is becoming more difficult to acquire, many banks are receptive to extending the maturity of loans. As such, it is an option to think about.

Find Just the Right Balance

Be aware that when you extend your debt from short-term to long-term, the cost of capital increases. To achieve the right balance, there should be some short-term debt in place to handle immediate cash shortages and to take advantage of even lower rates. However, finding short-term sources of funding may be difficult because traditional sources are diminishing.

Another strategy to consider is exchanging a portion of your debt from a fixed rate to a floating or variable rate. This allows you to lower your average credit cost since today’s variable rates are substantially lower than fixed rates. Interest rate exposures also may be managed more effectively this way. However, to protect yourself against rising rates and inflation, use caution with an interest rate swap.

In order to know for certain what half of your costs will be no matter how the market fluctuates, keep at least 50 percent of your debt portfolio set at a fixed rate.

Be Prepared for What’s Ahead

Although it’s hard to predict your company’s future financial needs, don’t get caught short-handed. This was a hard lesson taught by the Asian financial crisis of the late 1990s, when credit was scarce and costly even for companies with good credit ratings. As such, even if funding isn’t needed right now, there’s never a better time than the present to plan for your future credit needs.

For one thing, rates may never be this low ever again. That’s why locking in a favorable rate and having long-term credit ready whenever your business experiences cash deficits is a sound idea. It just makes smart business sense to arrange for new money when the market is right, rather than when new money is needed. This action will provide more control over cash flow and capital costs.

Invest Wisely

Perhaps the greatest challenge in a low rate market environment is finding an investment that offers your company security, liquidity and stability. Liquidity funds, available exclusively to corporations, banks and other institutions, deserve consideration for investing idle cash balances. Plus, liquidity funds offer a number of benefits that make them especially attractive in a low-rate economy. Liquidity funds are:

• Conservative investments with an objective of preserving capital.
• Rated AAA by Standard & Poor, which indicates they are solid, secure investments.
• Designed for temporary or medium-term cash investment, seasonal operating cash, automated cash sweeps, and the cash component of investment portfolios.
• Often available for same-day settlement. That means cash can be obtained on the next business day – an important advantage in the fast-changing market.
• Available at late cut-off times, which allows for the assessment of actual cash needs throughout the morning and investment later in the day, rather than having to estimate to meet early cut-off times.

Since January 1, 1994, when the North American Free Trade Agreement (NAFTA) was implemented, Mexico has become one of the world’s most attractive emerging markets. Now, several Latin American countries are on the free trade path with the U.S. in hopes of obtaining similar payoffs.

Mexico Expands Free Trade Agreements

Mexico has negotiated free trade agreements (FTAs) with 32 countries and regions, including the European Union (EU), European Free Trade Area, Israel, and 10 countries in Latin America. Currently, Mexico is negotiating additional accords with other Latin American and Asian nations. Although problems persist, the free trade model has proven successful. But will these agreements compete with NAFTA?

The Mexico-EU FTA, for example, provides EU goods with “rough NAFTA parity from 2003 onwards,” according to the U.S. and Foreign Commercial Service. This could negate many of the advantages U.S. and Canadian companies currently enjoy under NAFTA.

NAFTA at Nine

On January 1, 1994, when NAFTA began, Mexico embarked on a progressive, scheduled reduction of tariffs on U.S. and Canadian goods. Now, Mexican tariffs average only 2 percent, and more than 80 percent of U.S. goods enter Mexico duty free. Consequently, since NAFTA’s implementation, U.S.-Mexican merchandise trade has almost tripled, rising from $81 billion in 1993 to $233 billion in 2001. Due to slower global growth, however, this figure represents a decline from $247 billion in 2000.

Nevertheless, greater bilateral trade promoted by NAFTA has contributed to Mexico surpassing Japan in 1999 to become the United States’ second largest trading partner. U.S. exports to and imports from Mexico of commercial services, which excludes military and government services, were $14 billion and $11 billion, respectively, in 2000 (latest available data).

Increased Trade Is the Minor Benefit

But increased trade in goods and services only represents a portion of NAFTA’s benefits. Since U.S. gross domestic product (GDP) was 20 times larger than Mexico’s prior to the implementation of the agreement, and U.S. tariffs on Mexican goods already averaged a low 2 percent, the free trade agreement would not have a large impact on the U.S. economy.

“NAFTA was more about foreign policy than about the domestic economy,” says Dan Griswold, associate director of the Center for Trade Policy Studies at the Washington, DC-based CATO Institute. “Its biggest payoff for the United States has been to institutionalize our southern neighbor’s turn away from centralized protectionism and toward decentralized, democratic capitalism. By that measure, NAFTA has been a spectacular success.”

The typical Mexican boom-and-bust-cycle, high inflation, large debt, and the election-cycle economic crises seem to be things of the past. This has resulted in a more stable environment, increasing Mexico’s level of global attractiveness in terms of its ability to capture foreign direct investment (FDI).

Foreign Direct Investment Climbs

Although global FDI flows fell by approximately half from 2000 to 2001, Mexico continues to be one of the largest recipients of global FDI among emerging markets.

Under NAFTA, U.S. and Canadian investment is accorded “national treatment,” which grants U.S. and Canadian investors the same rights as Mexican investors. Exceptions exist, especially in the energy sector, but overall, Mexico is relatively open to FDI. In fact, approximately 95 percent of all investment transactions do not require government approval. As a result, from 1994 through 2001, the United States and Canada accounted for 72 percent of Mexican inward FDI, the European Union provided 18 percent, and Japan, 3 percent. During this period, Mexico received an annual average of $12.3 billion. However, from 1989 through 1993, years prior to NAFTA, Mexico only received $3.7 billion annually, according to the Mexican government.

Economic Growth To Accelerate

Mexican gross domestic product (GDP) registered a 0.9 percent increase in 2002, slightly below expectations, according to Country Alert, a Banc of America Securities publication. This reflected a slower-than anticipated U.S. economic recovery, to which Mexico is closely tied. However, Mexico’s GDP is anticipated to exceed 3 percent in 2003 and continue to rise through 2004. According to the World Bank, Mexico’s average annual GDP during the 1990s was 2.7 percent, more than twice its 1980s rate of 1.1 percent.

The Mexican peso remains somewhat volatile as a result of recent jolts of depreciation, according to the Bank of America publication, Global Economic Outlook. On February 18, 2000, the peso was almost 9.4 to the U.S. dollar. By February 18, 2003, its value had declined, requiring 10.8 pesos to the dollar. In addition to various current factors, the peso is under downward pressure amid a contentious political environment as mid-year congressional elections take place. Additionally, the inability to achieve compromise among political parties has resulted in fewer structural reforms than anticipated.

Mexican Global Trade Is Strong

The world’s current population growth rate of 1.16 percent annually has continued to decrease since 1963. Mexico’s rate is also decreasing, but not as rapidly. As a result, its population is anticipated to reach almost 105 million this year, making it the 11th largest population. Consequently, the country’s demand is continuing to accelerate. Thus, Mexican world imports jumped from $44 billion in 1990 to $183 billion in 2000. Due to slower growth, imports decreased slightly to $176 billion in 2001. The country’s exports increased from $41 billion in 1990 to $166 billion in 2001. But due to slower world trade, Mexico’s world exports decreased to $159 billion in 2001, according to the World Trade Organization. On the services side, Mexico’s world exports and imports registered $13 billion and $17 billion, respectively, in 2001.

Mexico’s most promising sectors for trade and inward investment include:

• Automotive parts and supplies,
• Computers, software and services,
• Inter-modal transportation equipment,
• Oil and gas field equipment/services,
• Franchising,
• Security and safety equipment/services,
• Water resources equipment/services,
• Pollution control equipment,
• Plastic materials and resins, and
• Telecommunication equip./services.

More Latin American FTAs Coming

In December 2002, after two years of intensive negotiations, the U.S. and Chile reached an agreement on an FTA. This was welcomed with much enthusiasm by the Washington, DC-based National Association of Manufacturers, who claim U.S. companies have lost $800 million annually due to preferential access granted to Canadian products under the 1997 Canada-Chile FTA. If the new FTA is passed by Congress, more than 85 percent of U.S. and Chilean bilateral trade in consumer and industrial products will become duty-free upon implementation.

In January 2003, U.S. Trade Representative Robert Zoellick announced the launch of U.S.-Central American FTA (CAFTA) negotiations. The participants, Costa Rica, El Salvador, Guatemala, Honduras and Nicaragua, who have more than 20 trade agreements in place with various countries, wish to significantly increase inward FDI. This is a goal a U.S. FTA could make a reality. Many in the U.S. view CAFTA as a stepping stone to the creation of the Free Trade Agreement of the Americas based on the NAFTA model.