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HACKETT: THE FINANCE 2020 AGENDA – GO ALL-IN WITH DIGITAL TRANSFORMATION TO REDUCE COST WHILE DRIVING ENTERPRISE GROWTH

HACKETT

For the first time in 10 years, finance executives predict an uptick in technology spending in 2020, according to new Finance Key Issues research from The Hackett Group, Inc. (NASDAQ: HCKT). By accelerating cloud migration and the adoption of RPA, data visualization and advanced analytics solutions, finance is seeking to optimize cost efficiency while driving enterprise growth. Most finance executives expect to see an increase of 5-10% in the share of the finance operating budget dedicated to technology in 2020, the research found, despite a projected 3.4% decline in the overall budget.

Technology spend as a percentage of the finance budget has been flat or declining since 2009, but finance is prepared to make incremental investment to advance its digital transformation agenda. Our research shows that executives are setting aggressive year-over-year targets for digital technology adoption. At the end of 2019, our study respondents projected that in 2020 they would see a rise of 26% in the adoption of data visualization tools, 24% in RPA implementations, 20% in migration to next-gen cloud-based core finance applications, and an 18% increase in the adoption of advanced analytics solutions.

The research recommended that finance must go digital, faster, in order to support companies’ two biggest objectives for this year: Optimize the cost structure to become more agile in preparation for economic volatility and continue to invest in product and services innovation to maintain competitive advantage. For finance functions, that also means addressing internal cost inefficiencies and working with the business to identify and execute on revenue growth opportunities.

This research is available on a complimentary basis, with registration, at this link: http://go.poweredbyhackett.com/20keyfin1912sm. Note – The full research piece includes 10 charts containing nearly 60 complete metrics.

According to Jim O’Connor, North American Practice Leader, The Hackett Group, “Finance has an aggressive agenda for 2020, with analytics and technological advancement as the top two transformation priorities. Finance executives realize that in the intensely competitive digital economy companies cannot arbitrarily cut cost at the expense of sustainability. It is finance’s job to ensure intelligent cost reduction through smart automation and the use of analytics to help management decide where to cut and where to invest.  

According to Nilly Essaides, Senior Research Director, Finance & EPM, The Hackett Group, “Without advanced analytics, management cannot make fully informed decisions, or make them quickly. So, there’s a tremendous need for finance to improve its data and analytics competencies, adopt new tools, and enhance the business value it provides directly.”

Finance’s transformation progress, however, faces several critical hurdles. The biggest is overcommitment, followed by skills deficiencies, capacity constraints, and technology and process complexity.

Because finance is asked to juggle multiple projects, the function must find ways to prioritize. Our research identified six critical development areas, defined as those with the largest gaps between the importance of its objectives and finance’s ability to deliver on business expectations. They are: redeploying capacity to value-added work; improving performance measurement; improving agility; aligning skills and talent with business needs; improving analytical capability; and leveraging new technologies. It’s imperative that finance organizations narrow these gaps, allowing them deliver value beyond lowering cost and transition into their new role as provider of actionable insight to support tactical and strategic management decisions.

The study found that finance must take a holistic approach to addressing its critical development areas across all elements of its service delivery model. Finance must be clear how services will be delivered, and  must focus on improving human capital, according to Essaides. “The low prioritization finance has placed on human capital, including upskilling and reskilling of staff, is one of the most concerning elements of this year’s findings. It’s towards the bottom of the ranking of service delivery model elements and isn’t even on the top 10 list of finance key issues for 2020. This suggests that not only does finance need to address the skills needed for the future, but it must also clearly design how services will be executed along with defining both new and old roles within finance to deliver on business expectations.  Finance must focus its attention in these areas, because without the right service delivery model, the right roles, people, and skills, even the best technologies will likely fail to produce the results.”

Many finance organizations are still in the early stages of digital transformation, and continue to rely heavily on legacy financial applications, the study found. However, such legacy systems have the lowest rate of meeting business expectations. Finance organizations are hoping to improve realization of business objectives of their technology investment through strong growth in adoption of next-generation cloud-based systems and RPA. 

“Our data shows, for example, strong growth in the adoption of cloud-based core finance applications,” said Essaides.  “And the encouraging news is that more than 70% of the finance function that have adopted cloud-based solution have been able to realize or exceed their business expectations.”

Looking ahead, The Hackett Group recommends that finance keep a keen focus on optimizing service delivery and addressing the skills gap that it is facing in order to support not only finance but also the enterprise.  Driving cost efficiency and supporting growth strategies are the top priorities in 2020 for the enterprise.  Finance has an opportunity to become more of a strategic advisor to support the enterprise growth strategies while also generating the expected cost efficiency improvements.  This will require finance to prioritize building the right analytic capabilities, the right technology for efficiency improvement, and aligning skills and talents with business requirements.

The Hackett Group’s 2020 Finance Key Issues research, “Balancing Cost Reduction with Adding Value,” is based on results gathered from nearly 200 executives in finance, HR, IT, and procurement at a global set of midsized and large enterprises.

 

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ACCELERATION OF DIGITAL TRANSFORMATION PUSHING ORGANISATIONS TOWARDS A MORE DATA-DRIVEN APPROACH

  • 84% of businesses have seen more demand for data due to Covid-19, but nearly a third say data quality remains a fundamental barrier

 

New research from Experian reveals how the acceleration of digital transformation, through the Covid-19 pandemic, has led to greater demand for data insights to inform decision making and strategy.

The annual Global Data Management report, which surveyed 700 data practitioners and data-driven business leaders globally, found that changing customer behaviour has intensified businesses’ need for high-quality data. Eighty-four percent have seen more demand for data insights in their organisations due to Covid-19. In fact, 72% say that the rapid push to digital transformation is making their businesses more reliant on data.

Beyond underscoring its business value, the pandemic has also exposed data’s potential to be used for societal good – and business leaders are keen to explore this further. Seventy-eight percent see COVID-19 as a defining moment for organisations to set-up and use data for societal good where they can, while 86% would like to be able to use their data in some way to benefit society.

Increasing collaboration with other organisations to better support those in need, sharing talent and resources to develop and deliver products, or allowing their data practitioners to spend time on voluntary project were all highlighted as a potential approach to achieving this.

However, they will struggle to use data for either business or social good unless they can overcome endemic weaknesses in legacy data management practices. Experian’s report outlines key barriers that organisations must address:

  • Data quality and maturity: On average, organisations believe a third of their data (32%) is inaccurate in some way. It’s unsurprising then that 55% of business leaders lack trust in data assets, and 51% say improving data quality is a ‘significant priority’.
  • Data skills: Embracing the power of data is being stunted by a skills gap – 62% say a lack of basic data literacy skills impacts the value they get from their investment in data and technology, while 55% believe they lack skills/resources to leverage data assets fully.
  • Agility: Sixty-two percent admit a lack of agility in data processes has hurt their response to changing business needs in the wake of COVID-19.

 

Andrew Abraham, Global Managing Director, Data Quality, at Experian, comments on the findings: “The pandemic has been a catalyst for long-awaited digital transformation. Businesses need to move fast to serve customers’ changing needs, and leaders know that data-based decision-making is key to evolving the right way.

“It’s also heartening to see organisations looking beyond the business applications of data, to how they can use it for societal good. However, if businesses are to succeed in either area, they must overcome fundamental barriers to effective data management.”

The paper also provides insight into businesses’ data priorities, as well as expert advice on how organisations can meet digital transformation objectives by making improvements in the following areas:

  • People: With a data literate workforce, a business is armed with talent that can make timely, data-driven decisions. Reassuringly the report reveals that 85% of organisations are hiring data roles in the next six months.
  • Technology: Technology has a critical role to play when it comes to modernising data management practices. Eighty-five percent of business leaders say sourcing more technology for staff is a priority.
  • New ways of working: DataOps: DataOps aims to shorten development cycles, increase deployment frequency, and create more dependable releases of data pipelines, in close alignment with business objectives. This practice helps organisations adapt more quickly to changing conditions.

Getting back to basics: Before new initiatives complicate the issue, go back to basics – people, processes, and tools. To build resilience against future risk, invest in the right areas to recognise return on investment on data management more quickly.

 

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SUSTAINABLE DERIVATIVES: THE “GIVING TREE”

Jennifer Kafcas, Lauren Blaber, Alvino Van Schalkwyk and Harry Polan

 

Momentum continues to gather pace towards building a sustainable economy, especially since the start of the pandemic. As a result, financial markets have seen a considerable increase in the focus on, and deal volume with respect to, sustainability-linked loans and bonds.  It has been a logical progression that the sustainability tree sprouts a new leaf with the development of environmental, social and governance (ESG) linked derivatives.  These products enable, among other things, firms and companies to hedge risks associated with sustainable investments including project risk, interest rate and currency risks.  This will be all the more important given the need to hedge risks from any underlying loan and its related sustainability criteria.

While ISDA has outlined the broad range of derivatives in sustainable finance, furthering the development of this product type (including, among others, sustainability-linked derivatives, ESG-related credit default swaps, exchange-traded derivatives on listed ESG-related equity indices, emissions trading derivatives, renewable energy and renewable fuels derivatives, and catastrophe and weather derivatives), this article focuses on more conventional derivatives transactions, such as interest rate swaps (IRS) and Foreign Exchange (FX) transactions used by market participants to hedge the risk arising from green bonds and loans. Though these transactions are no different conceptually from a product standpoint than any other IRS or FX transaction, it is important to understand the inherent structural and deal term differences.

 

Finance-linked sustainable derivatives (OTC)

A number of sustainability-linked derivatives have been issued in recent years, which add an ESG pricing component to conventional IRS and FX hedging instruments. The table below provides examples of recently issued sustainability-linked derivatives. As this is a developing market, the transaction volume has been very low, but uptake is expected to increase over coming years.

 

PartiesDeal Information
BNP Paribas & Siemens Gamesa€174 million FX forward, under which Siemens Gamesa will pay a premium on their forward if they do not meet certain ESG targets. If paid, that premium shall be used to finance local reforestation projects in Spain. The premium shall be calculated using a metric assigned by a third-party sustainable finance specialist.
Société Générale & EnelCross currency swap, by which Enel hedged their euro-dollar exchange rate and interest rate risk under a $1.5 billion sustainability-linked bond. If Enel does not meet certain renewable energy targets, the swap will be re-priced to their detriment.
New World Development (NWD) & DBS Hong KongInterest rate swap linked to the United Nations Sustainable Development Goals, hedging interest rate risk under NWD’s HK$1 billion sustainability-linked loan. If NWD generates at least eight business-to-business opportunities that contribute to the Sustainable Development Goals, DBS will sponsor certain NWD social innovation projects.

 

As evidenced above, ESG-linked derivatives can take on a number of characteristics and structures, including:

  • Derivative pricing. One counterparty having a number of prescribed ESG targets which, if met, will lead to a downwards ratchet in the pricing of the derivative (with such pricing often increasing if the targets are not met).
  • Fixed payments. If ESG targets are not met by the corporate, a fixed payment can be required to the issuing bank, which will be put towards a green project.
  • Triggers linked to a company’s ESG rating. If the ESG rating of the corporate increases, a benefit can be awarded to them (e.g. interest rate discount).
  • Both parties having ESG targets papered into their derivatives contracts. Corporates can receive a discount on the interest rate under the derivative if they meet their ESG targets, with that discount increasing if the issuing bank fails to meet its own ESG targets.
  • Charitable giving requirements. A failure by the corporate to comply with its ESG targets can lead to it being required to make contributions to non-profit organisations, with the bank having to make such contributions if the corporate’s ESG targets are met.

As sustainability-linked products gain traction, a degree of care will be required to ensure ESG targets are finely balanced and verifiable. Verification is essential for market transparency, for ESG products to be considered credible and for lenders and corporates alike to avoid reputational risks. Furthermore, the ability of a corporate to verify reliable compliance with ESG targets could provide a significantly smoother path through their lender’s credit approval process and in turn the lender’s ability to verify will enable it to better monitor the performance matrix set by the underlying loan or bond.

 

Renewable Energy and Renewable Fuels

In addition to the above OTCs, renewable energy hedging transactions (including power hedge transactions) are important for market participants to hedge the risk associated with fluctuations in renewable energy production, and in doing so, encourage more capital to be contributed to renewable energy projects.

Typical documentation with respect to the above type of trades are Power Purchase Agreements (PPAs) which document the purchase of power and associated renewable energy certificates between a renewable energy generator (the seller) and a purchaser of renewable electricity (the buyer). PPAs do not require companies to contribute directly to enhanced ESG standards, however they can help catalyse a shift to clean energy sources as they reduce market price volatility for buyers, and reassure sellers that a buyer will purchase power generated from renewable energy assets, thus encouraging the financing of such projects.  In an ESG-linked transaction, these types of arrangements can be replicated by covering the credit risk element in the intercreditor terms.  As an alternative the market may develop such that in lieu of these structures the underlying risk with respect to market price volatility is documented under an ISDA and secured under the financing and intercreditor documentation. This structure is fast approaching.

 

Expected developments in 2021

Climate change and, therefore, a sustainable economy remain front and centre for governments and regulators worldwide.  In 2020,countries like Japan, China, South Korea, Hong Kong and the UK set net carbon neutrality objectives and most recently the USA, following the inauguration of President Biden, announced plans to spend $2 trillion over four years to aid in the fight against climate change, all following the commitment already set by the EU.

Whilst the need for banks and corporates to develop and consider bespoke products to promote true progress in ESG compliance may hinder any radical uplift in ESG-linked derivatives volumes over the course of 2021, we anticipate that as banks and corporates continue to familiarise themselves with the requirements of such products, integrating ESG elements into derivatives trades will begin to be common practice.

In view of this, derivatives market participants will be eager to continue to drive ESG-linked derivatives volumes and to develop new and innovative ESG products facilitating the mobilisation of capital towards sustainable investments to ensure that they continue to significantly improve ESG standards, and to strengthen their contribution to the green finance drive.

 

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