Published: October 06, 2014
Increasing sophistication in treasury management technology has led to a major change in the way that corporate treasuries manage their operational and financial risk. At South African Airways (SAA), we strive for continuous improvement across all aspects of our business, including treasury. Because the management of financial and operational risk is a key treasury responsibility, we have invested significantly in effective policies, secure processes and accurate, timely reporting in all risk related areas. This article outlines some of the ways in which we manage operational and financial risk at SAA, leveraging our best-in-class treasury technology infrastructure.
Looking first at operational risk, we have implemented a structured front, middle and back office treasury organisation to enable effective segregation of duties. Our front office dealers take responsibility for execution strategy, dealing and hedging. Our middle office monitors risk, limits and compliance. Back office users manage cash and liquidity, including bank account reconciliation and cash flow forecasting, and manage post-trade activities such as settlement and confirmation.
It is not enough, however, simply to divide responsibilities across different individuals or teams within the treasury department: segregation of duties must also be enforced at a process and systems level. An efficient and secure treasury management system (TMS) is therefore essential to a well-controlled treasury department. We first implemented SunGard’s AvantGard Quantum solution (‘Quantum’) in 2006 based on its ability to support our requirements for straight-through processing (STP) and integrated processing, revaluation, and real-time reporting.
The TMS has played a critical role in delivering an efficient treasury management strategy. For this reason, it is important to conduct periodic treasury management system reviews to ensure that the solution continues to meet an organisation’s evolving functional, technical and usability requirements, and remains at the forefront of treasury innovation. We therefore reviewed the TMS market once again in 2014.
Dealing processes have changed substantially over recent years as a result of both regulatory changes and TMS software improvement. In the past, dealers wrote out three-part deal slips and kept one in front office, gave one to an administrator and sent one to middle office. Today, deal input is a one-step process: dealers either input the deal details directly into the TMS, or this information is imported from an online dealing system. At SAA, our dealers input transactions directly into Quantum From that point, the flow of deals takes place automatically, with check points and controls managed by middle or back office such as approvals, settlement checking and confirmation matching. We have implemented controls in Quantum that allow only authorised middle office and senior management users to approve transactions, while front office users are also prevented from undertaking tasks such as revaluation, settlement, confirmation and uploading rates on which revaluations are based.
Detailed user profiles that allow us to configure in detail the responsibilities of each user are very important in demonstrating financial and process integrity, and are monitored regularly by Middle Office, IT and the auditors. Internal and external auditors review detailed system generated audit reports, which detail all treasury activities. Additionally, they sit with users to check that they are physically prevented from undertaking unauthorised activities, and that these attempts are logged. The management and compliance reports that we are able to produce from Quantum have been essential in helping us meet internal and external audit requirements.[[[PAGE]]]
A valuable benefit of using an integrated TMS is the ability to manage financial, credit as well as operational risk via a single solution. Once a deal has been input into Quantum, middle office users can check the transaction details and ensure that it is within the limit that has been allocated to each counterparty. We have set up a detailed counterparty limit policy in Quantum that we monitor systematically. We have a list of authorised dealing counterparties and allocate limits according to a variety of factors, such as credit ratings. This became more challenging after the global financial crisis as many of our US and European banks were downgraded, although local and regional banking partners were less affected.
We apply risk weightings by instrument and tenor, and include both bank account balances and transactions in our calculations, so that our limit utilisation represents a realistic view of risk of each counterparty. As an airline, we operate in a large number of countries and currencies, so we monitor and manage sovereign risk as well as risk to individual counterparties. We aim to minimise balances held in high risk countries. This can prove difficult in countries such as Mozambique and Malawi where there are restrictions on moving cash out of the country. Therefore, we work closely with our banking partners in these countries who have been instrumental in finding viable ways to repatriate cash and reduce liquidity risk.
In addition to counterparty and sovereign risk, our middle office monitors FX exposure and re-values our FX portfolio on a daily basis through Quantum. While many systems provide re-valuation capabilities, it is important that the methodology used is consistent with that of the external auditors. The treasury systems use a combination of Black Scholes, Black and binomial methods, which gives a result that is within 0.3% of our external auditors’ results. This degree of consistency has been an essential factor in building trust and confidence in our financial calculations. Once we have re-valued the portfolio, we perform various sensitivity analysis as well as stress tests each day, such as measuring the impact of a $1 and a $5 increase or decrease in the fuel price, and a 10 cent and 50 cent up or down change in the USD – ZAR exchange rate.
Although our FX exposure is one of our most significant financial risks, we are also proactive in monitoring interest rate risk. We have a large aircraft loan and lease portfolio, with contracts denominated in both USD and ZAR, all of which are recorded, managed and reported in Quantum. Our Financial Risk Management Policy for interest rates states that we hold a maximum of 75% for fixed interest rates, and a maximum of 50% for floating interest rates. Currently our portfolio is around 60 fixed and40 floating. We are not currently hedging our interest rate risk given the low interest rate environment in USD in particular. While ZAR rates have increased recently, we will continue to monitor the situation.
For any airline, monitoring and managing fuel purchases is a key activity. For the past nine years, we have used SunGard’s Kiodex Risk Workbench solution. Although fuel can also be managed in Quantum, we wanted to take advantage of the commodity-specific functionality that the Risk Workbench offers. We rely on the system’s fully-integrated market data, risk measures such as Value-at-Risk and Expected Shortfall, advanced scenario analysis commodity-specific models for the instruments we trade. Kiodex is integrated seamlessly with Quantum and as a cloud-based, managed solution, requiring no IT resources or system maintenance by SAA.
Like Quantum, the Kiodex Risk Workbench offers detailed user definitions, segregation of duties, and detailed compliance, audit and management reporting. The Risk Workbench offers a suite of integrated market data for the products we trade, including jet fuel indices, Brent crude oil and gas oil. We manage our risk to these commodities using call spreads, Asian calls or zero-cost collars, all of which are recorded, managed and revalued using the Kiodex Risk Workbench. We perform sensitivity analysis and stress testing in the same way as for foreign exchange, and these results are included in a daily report that is provided to senior management.
Systems such as Quantum and Kiodex are instrumental in enabling companies like SAA to manage credit, financial and operational risk. These systems should supplement comprehensive treasury policies, best practices, and effective governance. It is important to make sure that all employees are trained in how to use systems properly and to understand the impact of their actions on treasury and the broader business. In addition to skills and knowledge, the right business culture is also essential in promoting integrity, professionalism and a commitment to quality and accuracy.
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