Let’s Talk about Risk

by Paul Taylor, Head of Sales, Global Transaction Services EMEA, Bank of America Merrill Lynch 

Treasurers are focusing on risk management more closely than ever and are using more sophisticated tools and techniques to manage their exposures. At the same time, the relationship between banks and corporations has fundamentally shifted, with treasurers expecting their banks to take on an increasingly advisory role.

Risk management has always been an important aspect of corporate treasury – but in the last few years this topic has become more central than ever. For today’s treasurer, risk management influences every decision, interaction and bank conversation. At the same time, this focus on risk is fundamentally changing the relationship between treasurers and banks.

While this has been precipitated by the financial crisis, the focus on risk management has continued to gain momentum in the last couple of years. Some corporations have withdrawn from certain markets, while others have had to redefine where and how they are able to place their cash.

Treasurers are focusing on a number of different types of risk, and these are often interconnected: market risk, which arises as a result of a particular event in the market, can lead to other types of exposure such as foreign exchange (FX) risk, interest rate risk, liquidity risk, counterparty risk and credit risk. Other key risk topics include commodity, compliance, reputational, operational and business risks.

Meanwhile, there is concern that measures taken across industries to address these risks could lead to adverse unintended consequences. For example, if corporations are no longer able to access particular facilities from banks because they no longer fit certain criteria, this can have a sizeable knock-on effect upon the business.

Identifying and measuring risk

While there are many risks to manage, companies are also becoming better at addressing them. The ability of the market to predict risk exposures – whether those relate to sovereign defaults, counterparty default or fluctuations in interest rates – continues to evolve. Recently, we have seen interest rate cuts by the European Central Bank (ECB) and Riksbank, the Swedish central bank. However, these events were widely anticipated and have therefore had significantly less impact on corporate behaviour than they would have before.

Treasurers have become more adept at predicting the risk impact of different market events

At the same time, treasurers have become more adept at predicting the risk impact of different market events. In 2008 this was unchartered territory – but by the time of the euro crisis in 2011-2012, treasurers were able to react more calmly and take steps to protect their businesses, thereby avoiding the run on the market that had taken place in 2008.

This ability to address risk exposures more effectively has been driven both by treasurers’ growing experience in this area and by the availability of more sophisticated tools and techniques. When reviewing bank counterparty risk, treasurers once looked predominantly at external credit ratings – but today they are also looking at banks’ share prices, credit default swap (CDS) levels and tier one capital ratios, which are all longer-term indicators of the market’s confidence in a financial institution.

Keenly focused on working with banks which will continue to support them in the longer term, treasurers are looking for validation from the markets that a particular financial institution is believed to be sustainable. These topics are increasingly featured in requests for proposal and conversations between banks and their corporate clients.

This coincides with a widespread and significant improvement in the quality of treasury management tools and portals, as well as the continued evolution of structures such as in-house banks, payment factories and shared service centres. While these developments have been driven by improvements in technology, such tools are also being seen as more valuable because of the function they can fulfil in helping treasurers to manage their risk exposures.

Portals like Bank of America Merrill Lynch’s CashPro® Online platform, for example, can give treasurers 100% real-time visibility on their cash positions across multiple accounts, even if those accounts are not all held with the same bank. Companies are able to access a global view of their cash positions and to produce reports on their positions in a flexible way. Cash management tools which allow treasurers to move cash between different pooling structures and hedge FX positions more proactively and immediately have been invaluable in helping treasurers mitigate their risks more effectively.

For example, at a treasury conference six years ago, the treasurer of an IT company commented that – at any point in time – he had, at best, 60% visibility over his actual cash position. Six years down the line, the tools that exist and the way that they are being deployed have changed this situation dramatically. A combination of improvements in the information available and improvements in the treasurer’s ability to manage cash and risk exposures mean that treasurers are better informed and better able to respond to market developments.

Sharing best practices

More than ever, effective risk management is being supported by the sharing of information and best practices. On the one hand, the market offers more forward guidance than it did in the past: central banks are far more vocal and explicit regarding their future expectations than they were a few years ago. On the other, the treasury community has become more open about sharing information and experiences.

Conferences, forums and round tables have been a staple for companies, but whereas previously these would have focused on topics of interest and recent innovations, these types of discussion are now more about how treasurers are managing specific challenges and what sort of tools, techniques and early warning indicators they are employing. While risk management can be a competitive differentiator, it is not an area in which any company wants to be a distant outlier – so the sharing of this type of information is becoming increasingly widespread.[[[PAGE]]]

At the same time, global banks may be well positioned to educate clients about the approach being taken by other corporations and the prevailing trends. They are better equipped to share best practices across industries and regions. Corporate treasurers are beginning to differentiate between their banks based on the quality of this advice.

When talking to their banks, treasurers are asking for input on areas such as managing counterparty risk, regulatory change, and the ability to hedge FX positions with increased flexibility. Where credit risk is concerned, there has been a surge of syndication activity since the end of last year, which, in turn, has created a new wave of interest in refinancing. Issues such as the future direction of interest rates, and the resulting impact on corporate liquidity, continue to arise in conversations with clients.

Shifting relationships

At the same time, banks and corporations have become better at sharing information and better at protecting themselves and each other. Banks are no longer simply purveyors of services: they are also regarded as trusted advisors and are increasingly helping corporations to understand the solutions available to them.

In order to win business in this environment, banks must be able to give confidence, show market understanding, predict trends, provide advice and deliver solutions. They have to demonstrate to corporate clients that they are able to help companies protect themselves and support them as they grow their businesses.

The role of the bank is not the same as it used to be – and nor are corporate expectations of the bank. The risk management element of the dialogue between a corporate treasurer and their bank, once non-existent, has now become a key part of the conversation.

Going forward, this trend is only likely to intensify: the role of the corporate treasurer is ever more focused on managing risk, while still allowing the company to achieve what it needs to from a strategic perspective – and the interaction between the corporate treasurer and the bank will increasingly be shaped by the management of risk.

Continuous improvement

Treasurers are continuing to improve their ability to respond to risk and have become more selective about where they keep their currencies. They have changed the way in which they deploy cash, and the way in which deployment of cash increases the risk exposure to any one currency or institution or sovereign market. Today’s treasurers are better prepared to handle the full spectrum of risk exposures – and are working more closely with their banks to do so.