Today’s Risk Management Challenges for Corporate Treasury
by Hennie de Klerk, CEO, TreasuryOne (Pty) Ltd
What comprises best practice risk management in today’s corporate treasury? And how are the industry and its suppliers rising to new challenges for policy, process and technology?
This article analyses a range of risk classes that are generally managed in today’s corporate treasury operations, and examines how a demanding set of evolving challenges is being met in practice.
There are two essential requirements for effective treasury risk management: having a documented treasury policy that clearly defines which risks are to be managed, and how they are to be managed; and having access to technology of sufficient power and flexibility to apply and monitor the policy in daily operations.
The management of different kinds of market risk has been the primary concern for corporate treasuries ever since treasury departments were first organised as a distinct section of the finance operation of the largest multinational corporations. And since the financial crisis first struck in 2008, more and more companies have determined that a necessary part of protecting working capital, profits, earnings and financial asset values involves investing in deeper and more powerful resources to manage the market risks relating to liquidity, foreign exchange and interest rate risk exposures.
Technology is central to market risk management, supporting the databases, information imports, calculations and reporting that are needed for effective market risk management. Treasuries today are seeking flexible solutions that address risks according to policy requirements, company structure and specific business patterns.
- Liquidity risk is based upon achieving complete and accurate cash visibility, which depends on utilising effective and timely bank communications to obtain current balance and transaction statements from domestic and international cash management banks, including intra-day updates. Modern treasury technology combines the bank positions with the future committed cash flows of open treasury FX and interest rate deals, and with payable and receivable flows that can be extracted from ERP and accounting systems to provide an accurate projection of multi-currency cash positions out to several weeks or even months. Such reporting means that treasury is no longer flying blind with respect to future liquidity needs, and is therefore much better placed to anticipate and manage future funding requirements. The most sophisticated treasuries look further ahead, by importing operating subsidiaries current forecasts of future income and expenditure, to build a more precise view of future liquidity. Treasuries that effectively manage liquidity risk are better placed to minimise external borrowings by funding shortfalls in one place with any available surpluses in others, through inter-company lending operations. They improve the organisation’s performance through efficient funding, and can minimise the expense of external funding. Effective liquidity risk management helps to protects companies’ abilities to maintain the required level of commercial activity when credit and profitability are squeezed.
- FX risk management is a familiar activity for all South African companies with significant overseas exposures, and especially for those dependent on the profitability of export operations. The volatility of the FX market seems to be a standard fact of life, and treasurers and finance departments continue to invest in technology to support FX exposure capture and analysis, and the related hedging operations. More and more companies are looking to support their core business expertise by seeking expert outsourcing services for FX risk analysis, hedging strategy design, and for optimal market execution.
- Interest rate risk management is important for leveraged companies, and for cash rich organisations looking to maximise interest income from financial investments. Forthcoming risk exposures, and maturities of existing borrowings and investments, are areas of interest rate risk that need effective technology to generate the necessary reporting, and for the execution and administration of the resultant market operations.
FX and interest rate risk management share common ground through periodic mark-to-market revaluations, where applicable. Best practice now requires the use of independent market rates, often automatically sourced from specialist suppliers to ensure objectivity. Risk management and accounting effectively converge with the calculation and posting of unrealised FX gains and losses.
Additionally, IFRS 13 compliance now requires the application of CVA (‘credit valuation adjustment’) in the calculation of derivative valuations. Effectively, this means that derivatives must be priced taking into account the counterparty’s probability of default – which links naturally into discussion of counterparty risk management which follows.