Managing Risk in the New Financial Climate

Published: August 01, 2009

BNP Paribas Cash Management University Preview

In last month’s edition of TMI, we introduced the 3rd BNP Paribas’ Cash Management University, which takes place on October 8 – 9 2009 in Paris, France. This year, the event will focus on two of treasurers’ most important priorities: liquidity and risk. In the second article in this series, we preview another of the workshops that will take place during the event, looking at treasurers’ approach to risk management, and how this may have changed over the past year.

Introduction

Managing risk has always been a priority for corporate treasurers, many of whom have invested significantly in people, processes and systems to help identify, monitor and manage risk effectively. The past year has witnessed changing attitudes, however, as many long-held assumptions about the markets and financial counterparties have been swept away.

During benign market conditions, with relatively low levels of volatility, treasurers have often adopted a fairly procedural approach to risk management. More recently, a variety of different factors have collided, leaving many firms with policies and risk management techniques that no longer reflect reality. Unprecedented market volatility, extreme events, rating downgrades and a liquidity drought have all forced treasurers to review their attitudes not only to market risk and operational risk, but also to focus more on counterparty risk and liquidity risk than they have done in the recent past.

Counterparty risk

With increasing recognition that no bank is ‘too big to fail’, counterparty risk is one of the primary issues which treasurers have sought to address. As Marcel Kellerhals, Group Treasurer, Panalpina Management Ltd, illustrates,

“Like many companies, we are focusing more on counterparty risk, and monitoring the amount of cash we place with each bank. In the past, we used credit ratings as our criteria for setting credit limits; however, as these are inevitably retrospective in their analysis, we now track changes to CDS (credit default swap) prices for our counterparties.”

In addition to investment counterparties, treasurers have also been re-evaluating their cash management banking relationships. On the one hand, companies are seeking to rationalise their banking relationships in order to gain greater visibility and control over cash; on the other, however, they need to ensure that there are alternative cash management arrangements in place. Marcel Kellerhals continues,

“We use one primary bank for cash management globally, but we have recently started to put in place back up structures so that we could route payments through another bank if necessary.”

A fundamental issue over recent months has been a lack of trust between counterparties, one of the outcomes of which has been reduced lending and higher rates.

Liquidity risk

Until 2007 or 2008, many companies did not experience difficulties in sourcing cheap, plentiful funding, so managing liquidity risk was, in many cases, a secondary discipline to other types of risk management. Today, with financing becoming more elusive and expensive, treasurers need to optimise structures for centralising and mobilising cash to unlock trapped cash, leverage surpluses to finance intercompany deficits and meet payment obligations. As Marc Daniel Roux-Lindtner, Head of Emerging Markets Development, BNP Paribas Cash Management explains,

“In a changing world, reliable cash management services are a real asset. Companies need access to sufficient liquidity to meet their financial obligations, which requires full visibility over cash flow and risk, especially during a period of extreme market volatility. Consequently, we see many treasurers seeking real-time consolidated positions across the business and optimised cash management structures.

For example, as Marc Daniel continues,

“There is an increasing trend amongst companies to move to a centralised treasury structure, which brings better control over processes, reduces operational risk and enhances visibility over the business.”

However, while cash management structures, technology and reporting are an essential part of the risk management picture, a fundamental issue over recent months has been a lack of trust between counterparties, one of the outcomes of which has been reduced lending and higher rates. Although on the one hand, companies are looking to diversify their risk, on the other, it is vitally important to maintain a close and active dialogue with sponsor banks so that both have a detailed understanding of the risk constraints and business opportunities of the other.

FX risk

As with investment counterparties, treasurers are monitoring their exposure to FX counterparties more actively. In Panalpina’s case, the company has put in place a prime brokerage arrangement, which eliminates the risk to FX counterparties with the exception of the bank acting as prime broker. This has proved a successful mechanism and treasury has not needed to modify its approach. However, as Marcel Kellerhals explains,

“We have been looking at our higher yielding currencies, such as Romanian leu, Russian ruble, Peruvian nuevo sol and Brazilian real, and reviewed whether we continue to hedge 100% or reduce this, as we are paying high interest costs to do so. This is only an issue at corporate level, as subsidiaries continue to hedge directly with Group Treasury.”

Such a strategy would have a bigger impact on companies that seek hedge accounting treatment, which Panalpina does not, but with significant volatility and wide margins remaining, the cost of hedging is becoming more of a focus for treasurers. [[[PAGE]]]

Operational risk

With a greater focus on counterparty monitoring, market risk and cash management, the need for transparent, comprehensive reporting is now more important than ever. Many companies are taking the opportunity to review how risk management reporting is constructed, looking at the data, processes and analysis on which financial decisions are made. This has benefits in both the quality of decision-making and operational risk. As Verena Michel, Financial Services Solutions Architect, IBM illustrates,

“The requirements of banks and corporates in operational risk management have become increasingly closely aligned, as compliance with internal and external regulations is more important for everyone. In this environment, it is important to identify and implement best practices. For example, we encourage our clients to document their processes, and identify and investigate those which are critical to the business. Then we look at the information flow that facilitates these processes and ensure that risks are mitigated as far as possible.”

Marcel Kellerhals, Panalpina explains how treasury had already optimised operational risk, a process which many firms are doing now,

“Around three years ago, we looked at our financial processes and systems, identified potential risks and found ways to mitigate these, including developing the use of our treasury management system.”

Decision support

In addition to the company’s risk and cash position requiring visibility and accuracy, the next step is to ensure that decision-making is objective, transparent and appropriate to market conditions. Paolo Sironi, Managing Director, CAPITECTS, outlines,

“Corporate treasurers should move beyond tools such as sensitivity analysis and value at risk. What is important to take into account is a consistent estimate of the potential changes over time of the company cash flow position, which depends on market and liquidity conditions in the future as well as internal cash flow requirements and constraints. Therefore, any asset and liability management, or decision support tool, needs to encompass various liquidity horizons, including both market and internal issues.”

Paolo goes on to emphasise that effective risk management and decision support should not be complex, in fact the opposite,

“The liquidity crisis has largely been due to excessive complexity and lack of visibility over the potential impact of balance-sheet risk and effective counterparty exposure to the broader industry. By adopting a more intuitive approach to decision-making, by which I mean using a tool that  uses real data and products in a transparent way, the complexity can be removed from the process, and the treasurer can focus more on portfolio and exposure management.”

Closing thoughts

Risk management is a dynamic and evolving discipline, not a set of policies that can be documented and left in a drawer. Market conditions, shareholders’ risk appetite and evolving business strategy all impact on how treasury monitors and manages risk. Although corporate treasuries have become more risk averse over the past year, this will continue to develop, with some companies starting to seek greater returns and expand their appetite for risk. However much risk a firm is prepared to accept, the right cash and liquidity management structures, internal processing and technology will continue to be critical.

 


 

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Article Last Updated: May 07, 2024

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