Published: March 01, 2012
As a complex, multinational business, risk management is an essential discipline at Ford, particularly with the significant commodity and FX exposures that go along with being a global automobile manufacturer. TMI asked Ford’s Director of Global Trading and Automotive Risk Management, Dennis A. Tosh, to share his experience implementing a Cash Flow-at-Risk, or CFaR, component to the company’s risk management strategy. His insights and pragmatic views will provide other risk professionals with some sound advice in this Spotlight Q&A.
Our Global Trading and Risk Management department at Ford has a wide remit, covering several key trading activities, including cash investment, hedging, commercial paper pricing and sales. The department is also responsible for risk management for the auto business, including FX, commodities, and credit risk management. We are a capital intensive, cyclical business, so cash flow is one of the most important metrics we use in judging the business, and therefore something that we are very focused on.
Yes, this view is helpful in understanding how we think about risk to begin with, because CFaR is really a major step in our progression in risk management as a whole. So, the first tenet of effective risk management, in my view, starts with an organization being able to accurately measure and understand its exposures. This is the basic blocking and tackling of risk management, but it also requires a real partnership between treasury and operating management. After all, the work undertaken by operating management is what creates the exposures to begin with. So, this is where I think most companies fall short – they think of risk management as only a treasury issue, or only the hedging strategy, or whether you use options or forwards, and the like. But I think that is asking the wrong first question. The right first question, the first step in effective risk management, is actually understanding and measuring your exposures.
Because we have a global footprint as a manufacturer, and because we are a dollar based company, we’re short dollars against a lot of currencies around the world. We do a lot of manufacturing in Europe, for example, so there are cross-border flows between Europe and the US. We have a very successful sales operation in Britain and a large manufacturing operation in Continental Europe, so we are short Euro dollars against Sterling, for example. We’re obviously short all kinds of commodities, but it would be useful to know, for example, if our steel exposure provides an offset or is offset by something else. A CFaR module would enable us to do that.
Well, once we understand those exposures, and figure out what they are on a net basis – because we only hedge net exposures, not gross – we then start thinking about hedging as the tool that helps us buy time, because hedging, after all, is only a temporary solution. All it can really do is buy you time – at least enough for operating management to make changes to the underlying physicals of the business to address the things that gave rise to the exposures to begin with. So unless you understand the underlying physicals, you’re never going to really capture the essence of effective risk management. That is step number two. And once you decide to hedge, I think it is critically important in this brave new world, that you have a very robust, bullet-proof hedge accounting compliance process and system – and our relationship with Reval emphasizes the system side of that.[[[PAGE]]]
Correct. Many years ago we tried to develop an in-house system. The issue of course was that the whole hedge accounting space is an evolving discipline. We concluded that in order to stay ahead of the curve it was best to go with a vended product that is an expert in this field and that serves a large number of clients that look a lot like us so that we can be more strategic in how we approach the issue of accounting compliance, instead of just trying to do it ourselves. That is what brought us to Reval to begin with.
For CFaR, we didn’t want to go out and get yet another system to do this for us and face the whole interface issue. We are moving more towards integrated systems because of the efficiencies that provides in terms of support and maintenance. We build autos for a living; we don't trade derivatives for a living like a bank. So for us, the ability to get a vended system that has good infrastructure behind it, stays ahead of the curve in terms of what the regulations are, and is able to deliver on those is very important. When we thought about how to move the process forward from just compliance to really analysis and improving the discipline, we wanted the best overall solution.
At this stage, we were looking at all exposures as being created equal. We didn’t think about, or have the ability to evaluate, how those exposures interacted with each other. This is another major set of netting to get a better look at, or a better view, of what your exposures actually are, and how they play off against each other. From time to time, we would go to our bank and dealer partners and ask for advice and counsel on this, but unless you really have the in-house capabilities to do that analysis yourself, unless you can see through to the arithmetic, it’s a pretty dangerous tool to actually operationalize. You really need to be in control of your own fate. And that’s what brought us to the desire to develop CFaR capability.
At this point, we had a good handle on knowing what our exposures were, how they were created, and what the underlying physicals were. Once we got the accounting nice and tidy, we could now understand how we want to hedge exposures. We did it on kind of a ‘peanut butter’ basis at first, which is pretty common in the corporate world right now, and then we asked ourselves what the next logical step in terms of the evolution of that process would be.
The next logical step was to think about how these exposures play off of each other in correlations, and that’s where the implementation of a CFaR capability, for us, is very helpful. We use CFaR instead of other methodologies, like Value at Risk, because we want to hedge the economic exposure to the company, which we define as Cash Flow-at-Risk. The risk of actually losing cash and settling an exposure, to us, is the definition of an economic exposure. We don’t hedge translation risk for example, because that can actually create Cash Flow-at-Risk; instead, we hedge the underlying exposure, or CFaR. What the CFaR capability allows us to do is to better understand what that net is, and it allows us be more strategic in looking at the risk that we manage. We ask questions like: Are we hedging part of a natural hedge away by hedging this pairing or this commodity, when the analysis tells us that these things can, to some measure, offset each other? The other reason why this CFaR capability is important to have in-house is, of course, that these natural offsets change. Markets are dynamic, not a snapshot where correlations forever and always remain the same. So you have to constantly be able to evaluate and update that analysis to make sure that you stay current with your understanding of what your exposures are.
We think this is really going to move the needle for us to start thinking about risk far more strategically, to look at exposures and recognize that all exposures are not created equal—some are more important than others. Up until now, we’ve had no way to measure that, and this will not just be a process of looking at how exposures net, but also be a process of working with our investor relations folks, for example, in understanding what kind of exposures are more important to some of our stakeholders than others, to make sure that we’re looking at external input in terms of that process as well.[[[PAGE]]]
I think a best practice encompasses the concept that exposures and hedging is not a treasury issue, it’s a corporate issue. And the purpose of risk management is to empower operating management to deliver a great business plan with very little in the way of surprises that come from movements and markets. That’s why we exist. In order for that process to be effective, there has to be a lot of transparency with operating management. And it’s got to be viewed as a partnership, not just a treasury issue. Years ago, risk management, foreign exchange, was a treasury thing, but now we work together effectively with operating management in a partnership, and part of my job is socializing these concepts with the senior leadership team. Some use the phrase that treasury and risk management now really has a seat at the table, whereas maybe five or ten years ago, with a lot of companies, that wasn’t true, and I think that is an important hallmark of an effective and best practice risk management discipline.
The important lesson is that you constantly have to keep at it. It’s a socialization process. These concepts are complicated, many are not all that intuitive, and they’re not at the forefront in a lot of folks’ day jobs. So you have to really make sure you take the time, in simple, plain, non-technical language, to walk people through and help make sure they understand what the risks are that they’re facing, what you’re doing about them, and what the potential outcomes are. It’s something that requires an ongoing effort. It’s not like you go and explain to somebody what a hedge strategy is and that’s it, you’re done. You have to keep at it, and make sure it’s a dialogue and not an occasional meeting.
We do it in several ways. I go in front of senior management two or three times a year to talk about hedging issues. Everyone hears the story, and we have regular risk forums that are more cross-functional, so I spend a lot of time working with folks in purchasing and product development, socializing these issues. We are now developing a process that allows us to get a sense of how our exposure footprint can change as a result of major product cycle decisions. Typically, the way most companies approach risk management is way after the fact. The decisions have already been made, and then companies are gathering exposures and figuring out how to hedge them. We are trying to move it further upstream so when we contemplate major product or sourcing decisions, we have an understanding of how they impact our exposure footprint before the decisions are actually made. That way, exposure impact can at least be a consideration, and we go into it with our eyes open.
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