Equipping Treasury to Manage Event Risk

An Executive Interview with Jiro Okochi, Co-founder and CEO, Reval

In this edition of TMI, which coincides with this year’s flagship EuroFinance conference, Jiro Okochi, Co-founder and CEO of treasury and risk management solution provider Reval talks to Helen Sanders, Editor, on how geopolitical events are influencing treasury priorities. In particular, the result of the Brexit referendum which came as a surprise to many commentators, emphasised the need to anticipate and mitigate the impact of unexpected outcomes.

Event risk has become top of mind for treasurers globally, in many cases prompted by the result of the Brexit referendum. What have you seen amongst your clients and prospects?

While the lead-up  and result of the Brexit referendum will continue to be memorable for many reasons, it is a scenario that has yet to play out; however, despite all the commentary on what the immediate as well as longer-term impacts on jobs, lenders and investors might be, there has been very little discussion, even amongst the financial community, on the technology implications for corporate treasurers. Treasurers are not tasked to predict the future, but they do need to anticipate the potential impact of any major risk event, including potential outcomes, rather than trying to manage the effects afterwards. To do this successfully, they need the right technology in place to analyse risk and model different scenarios.

During our conversations with prospective customers, we have often been surprised at the number of treasurers of major corporations that were unable to conduct comprehensive analysis of risk events and scenarios before acquiring our solutions. There seems to be a number of reasons for this.

Firstly, many treasurers with constrained resources already find it challenging to manage day-to-day cash, liquidity and risk management activities; therefore, they do not have time to look beyond this. For these treasurers, the priority should be to ensure that a treasury and risk management solution is in place to be able to automate and streamline day-to-day activities, as well as providing analytic tools.

In other cases, treasurers may have a treasury management system in place, but lack the tools and data to develop risk analytics models. They are therefore typically limited to the capabilities of generic software and spreadsheets, which also create issues with security, integrity and auditability.  Although the use of spreadsheets is widespread and convenient, there are limitations in the range of scenarios that can be captured, combined and stored, and difficulties in integrating the full range of data that is required for sophisticated analytics. As a result, treasurers are often spending too much time on even basic risk analytics and are unable to respond quickly to senior management requests.

What tools should treasurers be using to manage event risk? 

Scenario analysis is an essential risk analytic tool for treasurers. This is offered by many treasury and risk management systems, but not necessarily with the level of functionality that treasurers require. For example, a system may allow a treasurer to assess the risk impact of a change  to a parallel shift to a single curve, but this is not how the real world behaves, where shocks can cause inversions of prices and of course multiple scenarios. In contrast, Reval allows users to store a wide variety of user-defined risk models that can be adapted and interrogated, as well as produced regularly as part of a monthly or quarterly management reporting.

Many treasurers who stress test for scenario analysis may not stress enough. The effect of more severe shocks beyond the ad-hoc scenario is therefore well-suited to evaluating event risk, of which the Brexit referendum is a clear example. Immediately after the referendum result was announced, we saw equity markets plummet and then bounce back again, and GBP fell sharply against USD and EUR. Since then, the UK has a new prime minister, currency rates have remained at around their post-referendum level, interest rates have fallen to 0.25% and considerable uncertainty remains over the form that Brexit will take. Each of these factors has an impact on risk, and even more in combination. Measuring the impact of a 5 or 10% change in currency rates is meaningless if the effect of interest rate changes and other variables are not also factored in, so the ability to perform multi-dimensional risk analysis is essential.

Once treasurers have conducted scenario analysis and stress testing, they can then determine where additional risk measures may be required. As we saw before the Brexit referendum, some companies may choose to buy out-of-the-money options to cushion the business from the impact of event risk. While binary (otherwise known as digital) options are not commonly used for day-to-day hedging, they can be very useful in managing event risk as they do not offer simply a pro-rata payment, but a one-off return in the event of a dramatic fall in the value of a currency, for example.  So it is important to have a treasury system that can handle products that you may not think you need to today.

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What should treasurers who perhaps do not actively manage event risk today be doing?

Given that events that create market shocks will continue to happen, treasurers need to look at various ways to equip their business. Firstly, they need the right skills within their department; secondly, the treasury policy should be flexible enough to allow treasurers to manage extreme event risk. This may also require a hedging expense budget, effectively as a disaster insurance premium, which may require some explanation to treasury committees and company boards. Finally, treasurers need to have the technology both to provide the necessary analytics and reporting, and to record, price and account for the hedging instruments that they may put in place on the back of this analysis. As well as lacking some analytical support, many treasury and risk management systems cannot routinely manage option structures beyond plain vanilla options, so treasurers need to evaluate their existing system, or potential systems, carefully when reviewing their event risk management strategies.

What questions should treasurers be asking of their existing – or potential – technology vendors to understand the degree to which they can manage event risk effectively?

To understand the capabilities of an existing, or new system, treasurers need to explain to their incumbent or potential vendor what risks they are trying to model, and the instruments they may use to mitigate these risks. They can then see how the system supports these requirements, ideally using actual data wherever possible to give a more realistic picture.

Secondly, they should evaluate a system’s stress testing capabilities, particularly to assess how multiple risks can be modelled concurrently, including not only parallel shifts in yield curves, for example, but how to twist and introduce shocks into the curve. 

Thirdly, treasurers should consider how data can be imported into the system to create scenarios, such as market information and historic event information. Just as importantly, how these scenarios, and the data on which they are based, can be stored to avoid the need to keep reinventing analyses.

What other characteristics of an effective treasury and risk management solution would you emphasise?

While risk analytic and reporting tools are essential for every multinational treasury organisation, a key element of risk management is to have visibility over cash and exposures across the enterprise. Cash visibility is a challenge that many treasurers continue to struggle with, particularly when they do not have integrated channels between their treasury and risk management system and their banks. This is not simply a one-off implementation task, but an ongoing process as banking relationships change, companies enter new markets, and bank formats and systems are updated. Maintaining secure, robust and transparent bank connectivity can therefore create a major overhead for treasurers unless they implement a SaaS (software as a service)-based solution. This takes away the time and effort required to integrate with banks and other third parties and implement new and refined functionality.

By using a SaaS solution such as Reval to streamline and control key treasury processes, and minimise overheads to maintain connectivity and integration, treasurers can dedicate more time to risk analysis and mitigation, adding greater value to the enterprise, and participating in decision-making at a more strategic level.