Published: April 01, 2012
There are few treasury-related articles nowadays that do not stress the importance of liquidity and risk for corporate treasurers. Things have changed, however, since the gritty days of 2008-9, and while treasurers face new challenges, not least in Europe, they have become more savvy, better prepared and more able to prioritise the risk management issues that matter most. In this article, we look at trends and priorities in risk management from two perspectives. We are therefore pleased to welcome Justin Brimfield, EVP, Corporate Development, at treasury and risk management solution vendor Reval, and secondly, Marco Tierno, Head of Group Treasury and Short Term Planning at international airline, Alitalia, winner of the 2011 TMI Award for Treasury Team of the Year.
Justin Brimfield, Reval first summarises the quite different situations in which treasurers found themselves during the global financial crisis,
“The global financial crisis of 2008-9 was a wake-up call for organisations globally. Treasurers typically found themselves in one of two camps. The first, smaller group comprised those that had already identified some risk tolerance levels, had established policies in place, and in some cases had systems to capture, analyse and address risk exposures. These companies had only to refine the completeness and timeliness of risk management information.
The vast majority of companies, however, found that they had not sufficiently prioritised risk management in the past, and therefore did not have either their risk tolerances defined or appropriate policies or procedures in place. In some cases, board risk committees either did not exist, or were not engaged with the business. These companies found that they lacked the information they needed to understand their exposures or the skills and tools to analyse the impact.”
Since then, the situation has changed considerably, as he continues,
“Since then, we have witnessed a mindshift amongst organisations globally. Risk management is no longer a minority activity remote from the business, but everyone from board level throughout the organisation now shares a strong sense of risk awareness. Corporations are still at different stages of sophistication and readiness but are working towards setting up the appropriate roles, policies, and systems.”
Consequently, there is now a greater awareness of the value of risk management solutions, either as part of a treasury management system (TMS) or a specialist tool integrated into the overall treasury infrastructure. Justin Brimfield, Reval discusses,
“Although risk management tools such as Reval® have been available since 2000, initially to manage compliance issues, these have evolved to focus on capturing, analysing and mitigating risks, and monitoring the performance of these strategies. The most notable requirement for any corporation is visibility: it is impossible to manage what you cannot see. Consequently, we see a significant focus on capturing timely, accurate and complete risk exposures.”
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In the case of Alitalia, its legacy companies, AirOne and Alitalia, were initially victims of the crisis, and the new company was formed in 2009. Although a new company, the former Alitalia had already made progress towards transformation and modernisation, but the reorganisation acted as a catalyst for delivering a highly efficient, centralised treasury structure. Since then, treasury has undergone a major transformation in its treasury and risk management activities, as outlined in edition 200 of TMI, available online by clicking here.
Taking a fresh and comprehensive approach to treasury policies, processes and systems now leaves treasury able to focus on addressing the business’ liquidity and risk priorities. Marco Tierno, Head of Group Treasury and Short Term Financial Planning, Alitalia emphasises that risk management must go far beyond processes and systems, and become a support function to the business,
“Treasurers’ approach to risk management cannot be distinguished from the needs of the business, which will be very specific to its industry, location and key markets. To successfully manage risk, therefore, treasurers have to fully understand the changing business environment in which the company operates, just as much as remaining up to date with market developments.”
Treasurers therefore need to look at the needs of the business, which requires active communication and engagement, and devise their risk management approach accordingly.
One priority for many companies, including Alitalia, during and immediately after the global financial crisis, has been credit risk. Company boards sought real-time, comprehensive reporting on the group’s exposure to financial counterparties, which was particularly challenging for organisations that had fragmented exposures globally and lacked a robust, central system. Since then, not only have efficient technology and processes become more prevalent amongst corporate treasuries, but exposure to financial counterparties has become less immediate a priority as Justin Brimfield, Reval discusses,
“Initially following the crisis, counterparty risk was the most significant issue. Company boards wanted to understand their exposure to vulnerable organisations. Today, the fire-drill around counterparty credit risk has abated a little as many treasury departments put processes and systems in place to provide this information, and as the market generally deems banks as more stable with more oversight. Now regional risk issues are becoming more prevalent.”
The issue of regional risk is one that we will return to later; however, another point of interest is that although credit risk to bank counterparties may be less immediate a concern, this is not necessarily the case in terms of credit risk to commercial counterparties, as Marco Tierno, Alitalia describes,
“One of our primary risk challenges is credit risk, both commercial and financial, although we have more commercial than financial exposure. Many of our travel agents and clients are small and medium-sized enterprises (SMEs) that continue to be very fragile. We found that our default rate was increasing, so we strengthened our risk policies, tightening the amounts for requesting guarantees.”
To address commercial credit risk effectively requires not only traditional counterparty credit risk management tools, but also considerable visibility and control over receivables management, which is often not treasury’s direct responsibility. Marco Tierno, Alitalia continues,
“We set credit limits in our systems and track utilisation on a weekly basis, and compare this with the amounts of guarantees released. In the event of outstanding invoices or other issues affecting the guarantee, we receive an alert and can therefore block the credit line.”
Treasurers have an important role to play in commercial credit management, alongside credit and account receivables departments. Treasury typically has the processes, systems, reporting and expertise to manage credit risk systematically, and can lend these capabilities and expertise to ensuring that senior management fully understand their exposure to both financial and commercial counterparties.
With enhanced policies and processes in place to cover the most immediate and critical risks, treasurers are now able to focus on other risk topics, as Justin Brimfield, Reval explains,
“Corporate treasurers are also focusing on a wider range of risks. In addition to FX, interest rate, counterparty, liquidity, credit and operational risk, many commodity consumers are now more actively managing commodity risk. Due to the lack of visibility into their exposures and the financial strength of their suppliers, corporations are choosing to decouple supply risk from price risk. As a result of this decoupling, we are seeing treasury take over the responsibility of managing commodity price risk. Historically, the supplier was responsible for price risk, as it had negotiated a fixed price with the corporation. Now, however, the consumer is taking on the price risk.”
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Marco Tierno, Alitalia outlines the company’s approach to some key areas of risk,
“From an interest rate perspective, we have a net debt position. Most of our debt takes the form of long-term loans, such as airline financing and leases, the majority of which were negotiated at favourable terms before the crisis, so we typically have few needs to hedge our floating rate interest rate risk.
“We cover our USD-EUR exposure, which is particularly important as an airline. While most of our revenues are in EUR, our major expenditure, such as fuel and debt repayments is in USD.
“Finally, we keep track of our fuel costs and, based on our policy and risk strategy, hedge the budget fuel prices through a mix of financial instruments and fare price adjustment (fuel surcharge).”
Not all companies have been able to achieve the same degree of visibility over exposures and control over risk as Alitalia. As Justin Brimfield, Reval says,
“We are now seeing three categories of risk management sophistication amongst corporate treasurers:
Those that have built up a robust skills and technology base are looking at more advanced risk management techniques; for example, amongst corporate treasuries, we are seeing CFAR (cash flow at risk) become more popular, whilst VAR (value at risk) is more prevalent amongst financial institutions.
Those that have recently established risk policies and tolerances are setting up monitors, risk limits and approvals to ensure policy compliance and process efficiency.
Companies that are expanding their geographic footprint but lack the complexity to require a very advanced view of risk still need a robust approach, so treasurers are seeking reliable and cost-effective solutions.”
However, not every company needs to aspire to the upper echelons of risk management sophistication; the key is to support the business, as Marco Tierno summarises,
“Fundamentally, treasury needs to support the business in the management of risk, not the other way around!”
Risk management is often approached with some trepidation by some treasurers, as they fear that they will be expected to work with complex mathematical models and reporting. The reality is that while some organisations benefit from highly sophisticated models, in many more cases the focus should be on understanding the needs of the business, and then capturing, monitoring and managing exposures. Justin Brimfield, Reval emphasises,
“The pre-requisite for managing risk is to achieve full visibility over risk exposures.”
Risk management technology, whether part of a TMS or a separate application, has an important role to play in this respect. By integrating data from across the group, consolidating information and presenting group-wide exposures in a consistent fashion, treasurers have the ability to understand their risks more fully and therefore monitor and manage them more effectively. As Justin Brimfield continues, it is no longer the case that only the largest, most complex organisations can adopt this technology,
“With applications such as Reval made available through a SaaS (software as a service) model, the barriers to adopting risk management solutions have been lowered considerably. Companies of all sizes and levels of complexity are able to leverage robust, cost-effective solutions with minimal implementation and zero effort to maintain the application.”
Implementing the right processes and technology are important elements of a risk management strategy, but inevitably treasurers cannot influence market events, only the effects on their business. This implies a strong element of judgement, such as the potential impacts of ongoing instability in the Eurozone. Treasurers will have different views on the future of the euro, the impact on their business, and the countries most significantly affected, as Marco Tierno, Alitalia exemplifies,
“It is inevitable that many companies located in Europe, particularly southern Europe, will consider the implications of the Eurozone crisis. However, we believe that the euro will remain a major currency, and any change of membership is likely to be a longer-term scenario rather than an immediate event. As we tend to focus our risk management efforts on the next two years or so, we are not factoring the breakup of the euro in our risk management decisions.” [[[PAGE]]]
There are, however, more immediate problems posed by the Eurozone crisis, for example, particularly for companies in southern Europe, as Marco continues,
“In Italy, we are facing the challenge that some companies, such as a Japanese fuel company we work with, will not accept guarantees from Italian banks (except in some cases for a limited period and at a high cost), even those that are large and with a strong international presence, without a cross-guarantee from a non-Italian bank. This situation affects corporates’ ability to do business, and our cost of funding.”
He concludes on a positive note,
“These are difficult times for companies in Italy, and it is very challenging to operate internationally. Banks, suppliers and customers are concerned about the situation in Italy and more widely in southern Europe, which affects our business. However, we believe that the extreme market conditions that we are experiencing now will not last for long and do not represent a ‘new normal’.”
Managing risk is certainly no less important today than it was in 2008-9, but the priorities, fears and possible scenarios differ in many ways. While economies in the world remain fragile, the corporate backdrop is robust, with no decline in the rigour that treasurers are applying to manage their company’s credit and market risks. Indeed, risk management has become less about managing fear, and as much about understanding opportunities. Leveraging the right processes, tools and expertise will be essential to navigating companies through ongoing turmoil. However, these will require constant reinforcement and refinement to ensure that policies, processes, technology and skills remain appropriate to changing market conditions, evolving business requirements and new opportunities.
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