Strategic Treasury

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Managing Risk in the New Financial Climate In last month’s edition of TMI, we introduced the 3rd BNP Paribas’ Cash Management University, which takes place on October 8 – 9 2009 in Paris, France. This year, the event will focus on two of treasurers’ most important priorities: liquidity and risk. In the second article in this series, we preview another of the workshops that will take place during the event, looking at treasurers’ approach to risk management, and how this may have changed over the past year

Managing Risk in the New Financial Climate

BNP Paribas Cash Management University Preview

In last month’s edition of TMI, we introduced the 3rd BNP Paribas’ Cash Management University, which takes place on October 8 – 9 2009 in Paris, France. This year, the event will focus on two of treasurers’ most important priorities: liquidity and risk. In the second article in this series, we preview another of the workshops that will take place during the event, looking at treasurers’ approach to risk management, and how this may have changed over the past year.

Introduction

Managing risk has always been a priority for corporate treasurers, many of whom have invested significantly in people, processes and systems to help identify, monitor and manage risk effectively. The past year has witnessed changing attitudes, however, as many long-held assumptions about the markets and financial counterparties have been swept away.

During benign market conditions, with relatively low levels of volatility, treasurers have often adopted a fairly procedural approach to risk management. More recently, a variety of different factors have collided, leaving many firms with policies and risk management techniques that no longer reflect reality. Unprecedented market volatility, extreme events, rating downgrades and a liquidity drought have all forced treasurers to review their attitudes not only to market risk and operational risk, but also to focus more on counterparty risk and liquidity risk than they have done in the recent past.

Counterparty risk

With increasing recognition that no bank is ‘too big to fail’, counterparty risk is one of the primary issues which treasurers have sought to address. As Marcel Kellerhals, Group Treasurer, Panalpina Management Ltd, illustrates,

“Like many companies, we are focusing more on counterparty risk, and monitoring the amount of cash we place with each bank. In the past, we used credit ratings as our criteria for setting credit limits; however, as these are inevitably retrospective in their analysis, we now track changes to CDS (credit default swap) prices for our counterparties.”

In addition to investment counterparties, treasurers have also been re-evaluating their cash management banking relationships. On the one hand, companies are seeking to rationalise their banking relationships in order to gain greater visibility and control over cash; on the other, however, they need to ensure that there are alternative cash management arrangements in place. Marcel Kellerhals continues,

“We use one primary bank for cash management globally, but we have recently started to put in place back up structures so that we could route payments through another bank if necessary.”

A fundamental issue over recent months has been a lack of trust between counterparties, one of the outcomes of which has been reduced lending and higher rates.

Liquidity risk

Until 2007 or 2008, many companies did not experience difficulties in sourcing cheap, plentiful funding, so managing liquidity risk was, in many cases, a secondary discipline to other types of risk management. Today, with financing becoming more elusive and expensive, treasurers need to optimise structures for centralising and mobilising cash to unlock trapped cash, leverage surpluses to finance intercompany deficits and meet payment obligations. As Marc Daniel Roux-Lindtner, Head of Emerging Markets Development, BNP Paribas Cash Management explains,

“In a changing world, reliable cash management services are a real asset. Companies need access to sufficient liquidity to meet their financial obligations, which requires full visibility over cash flow and risk, especially during a period of extreme market volatility. Consequently, we see many treasurers seeking real-time consolidated positions across the business and optimised cash management structures.

For example, as Marc Daniel continues,

“There is an increasing trend amongst companies to move to a centralised treasury structure, which brings better control over processes, reduces operational risk and enhances visibility over the business.”

However, while cash management structures, technology and reporting are an essential part of the risk management picture, a fundamental issue over recent months has been a lack of trust between counterparties, one of the outcomes of which has been reduced lending and higher rates. Although on the one hand, companies are looking to diversify their risk, on the other, it is vitally important to maintain a close and active dialogue with sponsor banks so that both have a detailed understanding of the risk constraints and business opportunities of the other.

FX risk

As with investment counterparties, treasurers are monitoring their exposure to FX counterparties more actively. In Panalpina’s case, the company has put in place a prime brokerage arrangement, which eliminates the risk to FX counterparties with the exception of the bank acting as prime broker. This has proved a successful mechanism and treasury has not needed to modify its approach. However, as Marcel Kellerhals explains,

“We have been looking at our higher yielding currencies, such as Romanian leu, Russian ruble, Peruvian nuevo sol and Brazilian real, and reviewed whether we continue to hedge 100% or reduce this, as we are paying high interest costs to do so. This is only an issue at corporate level, as subsidiaries continue to hedge directly with Group Treasury.”

Such a strategy would have a bigger impact on companies that seek hedge accounting treatment, which Panalpina does not, but with significant volatility and wide margins remaining, the cost of hedging is becoming more of a focus for treasurers.

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