Published: March 01, 2012
Corporate treasury is at a crossroads. The evolution of technology, ongoing financial crises, and emergence of new risks from unexpected places has combined to usher in a new era in the treasury industry. This new era represents the Third Generation of treasury. On the cusp of this Third Generation, treasury organizations around the world have already begun to evolve into a fully integrated financial nerve center of the organization.
The treasury of the future will be an analytic and technology hub that provides end-to-end business intelligence and strategic advice to the company’s board, business units, creditors, customers, suppliers, shareholders, rating agencies and regulators. Treasury Strategies believes this trend is now emerging and will require a decade or more to fully manifest. As this Third Generation of corporate treasury gains momentum, it will become increasingly critical for corporate treasuries (along with their providers) to adopt new approaches and tools, which will be required to fully and successfully execute the role of the financial nerve center.
The First Generation - Prior to 1970, companies borrowed almost exclusively from banks and kept ample compensating balances. Operating services were accommodations—simple and free. Exchange rates were fixed and liquidity was plentiful. The commercial paper market was just developing. Computers were not used in treasury. Calculators had just been invented. Banking was about relationships.
The Second Generation – Everything changed in the early 1970s with the collapse of the Bretton Woods agreement and the elimination of the gold standard in the United States. Exchange rates fluctuated, liquidity and compensating balances dried up, banks began charging for services, and short-term investment markets blossomed. The treasury function changed radically. Financial data became available and was sometimes transformed into information. The first treasury workstations were introduced (by banks) and evolved to become critical elements of corporate treasury management. Early enterprise resource planning systems (ERPs) came to market, but they were not initially widely accessed by the finance function.
The Third Generation – Now in the Third Generation, treasury is increasingly focused on becoming the company’s financial nerve center. Information is no longer sufficient to meet the demands of external stakeholders, including regulatory bodies, investors or counterparties, or the internal demands of board members, business units or senior management. Intelligence – the strategic application of information to generate and monitor liquidity as well as mitigate risks - is required now.
This transformation is not limited to corporations. The providers of financial services, operating services, information services and risk management services are entering a period of massive change. The entire ecosystem is impacted.
Since this transformation is centered on corporate treasury organizations, there are a few natural questions. What are the implications for treasury? What steps can a corporate treasury take in order to achieve the vision of treasury as the financial nerve center?
In our work with corporate clients, and in the market at large, Treasury Strategies sees a massive expansion in the scope of treasury’s influence and its activities. The mission for treasury organizations is changing – clear evidence we are moving into the Third Generation.[[[PAGE]]]
Treasury organizations are now called upon to do much more than the operational activities that dominated the Second Generation. Treasury now answers to a wider array of stakeholders with a growing list of needs. External parties require more communication and a higher degree of business intelligence. Equally important are the internal stakeholders who continue to depend on treasury for operational support and now look for strategic advice as well.
Treasury is also expanding its influence into risk management. For example, hedging commodity risk has long been in the purview of procurement or sourcing. The long-standing practice of having procurement execute commodity hedges is no longer sufficient given that commodity volatility is as high as that of currencies. Because more treasurers are taking control of executing and accounting for commodity hedges, they are able to view financial risk in a comprehensive manner across the entire derivative portfolio. Regulatory action will continue to force this kind of systemic assessment and execution of risk management activities in the organization.
This expanding scope of influence and activities is the first stage of the transition to the Third Generation. As we move in this direction, there are important, strategic decisions to be made. What organizational structure does treasury need in order to fulfill its duties and become the financial nerve center? What types of intelligence does treasury require from other business units? What is the most meaningful information to report to each stakeholder?
To manage it all, treasury must first articulate a vision for what its future state will look like. Only with a clearly articulated vision can treasury position itself as the financial nerve center, thus commanding resources, technology, and a seat at the table to lead strategic initiatives.
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Once a vision of the future is set, treasury must understand the financial goals of the organization and establish a means to measure and evaluate how effectively it is supporting those objectives.
Too many treasury organizations are measuring the wrong activities or fail to carefully evaluate how well they are supporting the organization’s financial goals. As such, many treasurers are looking for ways to quickly highlight how various treasury functions are performing and which activities require more attention.
A Third Generation treasury operation has a set of objectives that support the organizations’ financial goals, as well as metrics to measure treasury’s success in executing many of its activities. However, it can be a challenge to identify which activities should be measured, and more importantly, how to quantify that activity in a meaningful way. Through our work consulting with corporations around the world, Treasury Strategies has identified two key steps to establish effective metrics.
1. Tie treasury’s operational, analytic and strategic activities back to financial goals of the organization, and identify the factors that determine success versus failure for each.
2. Establish the processes and technology needed to execute, monitor, measure and report on these functions.
To establish metrics, treasury must ensure their specific objectives are tied to advancing the overall financial goals of the organization. Then, treasury should determine the critical activities it manages to help achieve those goals, and drill down within each activity to determine parameters to monitor for ongoing performance.
For example, one goal of the financial function might be to ensure sufficient liquidity for the company. Treasury then would identify its corporate finance, investment and cash management functions as necessary to help meet that goal. Within each of those activities, treasury would then define exactly what to measure to determine the extent to which treasury is helping to maximize liquidity.
The activities treasury would manage to support organizational objectives fall into three basic categories:
1. Operational activities – Managing cash, executing and settling financial transactions, i.e., investments, FX and debt. Firms cannot overlook the importance of the operational function in corporate treasury. But too often, companies focus all of their efforts on this type of ‘information’ rather than ‘intelligence’.
2. Portfolio analytics – tracking performance of investments, foreign exchange derivatives, commodities and debt, as well as compliance with corporate and regulatory policies.
3. Strategic initiatives – managing risk or leading efforts to enhance shareholder value in ways beyond traditional treasury.
Organizations often focus their metrics and reporting on operational activities. Analytic and strategic activities are commonly overlooked. It is crucial to report meaningfully across all three categories. Figure 2 illustrates meaningful metrics Treasury Strategies’ clients are adopting to measure and monitor counterparty risk.
Metrics for strategic initiatives are more difficult to track and report. As the Third Generation continues to develop, more and more clients undertake these activities and are asked to report progress. For measuring how well treasury accesses capital markets and provides liquidity, some examples are listed in figure 2.
An equally important approach to evaluating the strategic value of treasury lies in whether treasury is being asked to partner on or lead initiatives outside its traditional sphere of influence. Many of our clients are requesting that treasury support or drive projects such as financial shared service centers, payment factories and working capital improvement projects.[[[PAGE]]]
Technology is an essential ingredient to the Third Generation. As the scope of treasury’s activities grows and its sphere of influence expands, it becomes increasingly evident that treasury must leverage technology tools. In order to provide intelligence across the organization, data integration is essential.
Today’s corporations are finding data is trapped or siloed. Too often, treasury struggles to obtain real-time, accurate data and activity forecasts from business units. The solution is a sophisticated, yet easy to use technology system. The time has arrived for treasury to realize the full power of what an ERP promised – integrated data.
New reporting options (ad hoc, standard reports and digital dashboards), risk analytic functions, sophisticated hedge accounting and integrated market data allow for treasury to monitor its performance and function optimally.
A recent client story is an excellent example to illustrate the concept of a treasury that leverages technology effectively and operates as the financial nerve center of the company. Treasury Strategies worked with a multinational client to define a treasury technology mission statement that laid out the requirements for the overall desired architecture. This vision called upon technology to maximize visibility to risk, automate compliance with policy and controls, and ensure efficient processing, accounting and reporting of treasury transactions. The client also required a scalable, low maintenance platform that would not burden IT resources, and provided a low cost of ownership. The client selected a Software-as-a-Service (SaaS) solution which achieved all its needs.
Finally, streamlined bank connectivity is also part of the executional component of the Third Generation. SWIFT for Corporates, a service whereby corporations can access the global financial network for financial messaging, best represents this paradigm. More and more companies are moving toward the SWIFT platform to connect to banks and financial institutions through a single pipeline, thus eliminating a network of host-to-host legacy connections. SWIFT can support a growing number of services, which now includes reporting for balances, payment execution, trade and securities matching, payment exceptions and investigations messages and bank account administration documentation. More and more organizations are deploying SWIFT when they transform their technology architecture.
So how will your treasury evolve into a financial nerve center? The first step is to establish a vision for the future of your treasury operations. Then, treasury must ensure it understands the organization’s overall objectives and how the financial function can strategically support all of its stakeholders. Treasury must realistically define performance expectations and parameters for each activity it manages, and establish technology tools to both enable and monitor performance.
The global economic and political crises experienced over the past months and years have truly demonstrated the need for strategic treasury planning. Without measurable objectives, strategic vision, integrated data and performance assessment, treasury has no means for supporting the organization and no way of telling whether its actions are advancing toward the financial nerve center. If your organization is stuck in the Second Generation, it is time to start the journey.
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