A Focused Approach to Risk Management

by Maciej Müldner, Treasurer, Skanska Poland

Skanska globally combines both centralised and decentralised elements in its financial management. Skanska Financial Services (SFS) provides a central in-house bank, but there is also a treasury function for each business unit. In some cases, as in Poland, this comprises a team of 12 individuals, while in other countries the treasury function may be smaller. Treasury in Poland needs to support between 100-300 projects each season, each one of which operates as a separate entity. Around seven members of the team provide daily financial operational support to these projects and the remainder are involved in cash management.

We conduct transactions across a range of financial instruments, including traditional hedging, capital financing, leasing, project finance etc. and perform all associated activities with the exception of accounting. To enable this, we use several modules of a TMS (treasury management system) globally which is integrated with our general ledger. This is used across the business, supporting all our main business lines including hedging, cash management (which also comprises a payments factory), documentary credits (such as guarantees) which are important in the construction sector, and insurance lines.

Approach to risk management

For many years, we have adopted a consistent set of risk management processes globally, termed ‘Operational Risk Assessment’ which is central to the way we work. For each business opportunity, we perform a detailed risk assessment, which includes technical issues, but also others such as human resources, health and safety and environmental impact and financial risks. This comprises a detailed, step-by-step process to assess requirements in terms of hedging, cash flow, guarantees, insurance and counterparty risk. The Operational Risk Assessment approach has now been in place for more than eight years, so it is deeply entrenched in our working practices and project teams have the necessary expertise to conduct the risk analysis. Having assessed a project’s financial risks, treasury then helps the project team to find ways of mitigating them. Ultimately, the project manager is accountable for all aspects of the project, including finance, and treasury provides a vital support function.

Increasing precision in counterparty risk

Since September 2008, there has been an even greater focus on risk management across the Skanska group. We have revisited high-risk projects to assess whether they are subject to any additional risks beyond those we had original determined. In fact, the outcome of this process was positive as the Operational Risk Assessment model was found to be robust.

The only area which we decided to expand our focus was counterparty risk, not in relation to the client, but the risk to suppliers and subcontractors, many of which are smaller companies that we recognised could be hit hardest by the crisis. We have over 6,000 suppliers in Poland alone, so it would be unrealistic to conduct a detailed review of each one’s financial position; however, we look at the primary risks for each project, which could be highly specialist firms, for instance. We assess their finances, including bank opinion, and review the terms of the contract. While it would be prohibitively expensive to provide bank guarantees for all risks, we want to support or find more creative ways to minimise any potential negative impact derived from these suppliers and contractors. [[[PAGE]]]

We aim to adopt a balanced approach, understanding the nature of the risk and putting in place an appropriate financial structure. Often people think that a standard financial product can simply be applied to a business transaction; in contrast, we need to understand the risk and construct a specific risk mitigation strategy. In some cases, this could involve third-party insurance, although this takes time to organise. For some suppliers, we use supplier financing, such as working capital finance through a commercial bank. This works well for some suppliers, particularly small and medium-sized enterprises (SMEs) who want to accelerate their collections, but it is not suitable in every situation. While we have used supplier financing before, we have become more active in recent months as we have seen SMEs hit by the crisis.

Hedging strategy

Our hedging strategy has also changed somewhat since the crisis due to the increased volatility and illiquidity in the market. We have found it difficult to implement some of the techniques we were using in the past to manage longer-term risks. For example, we used to hedge all project cash flows at the start by using long-term swaps, whereas now we have to put in place transactions with a shorter maturity and roll-over. From a currency risk perspective, we remain conservative and hedge 100% of our currency risk immediately, the cost of which is embedded into the overall project cost.

Future approach to risk

The financial crisis has not caused Skanska to change its risk management strategy, but we have made our approach to counterparty risk more precise, particularly our risk to suppliers and contractors. Looking at counterparty risk, we use traditional measurement tools, combining analysis of cash flow, debt/ asset ratio, insurance and business skills. What is important is not necessarily to focus on policies or procedures, but to reflect the actual risks for a specialist business such as Skanska.

As we look ahead, we are reviewing the way in which we quantify our risk. For example, we recognise that Value at Risk (VaR) and cash flow at risk are not the answer, particularly during periods of significant volatility, but we have yet to find an alternative, such as for currency risk. Risk management is not simply an issue in which treasury is involved but needs commitment across the company. There is frequently a gap between finance and the business, and treasury needs to bridge this by ensuring that business managers understand that risk management works in the company’s favour. Recently, we implemented a new strategy to increase accountability for risk management amongst our project managers and we are working closely with SFS to optimise our processes and approach to risk.