Turning Exposure Management into a Competitive Advantage

 

By Eric Cohen, Principal, Financial & Treasury Management, PwC US, (Lead author), Robert Pierson, Manager, Financial & Treasury Management, PwC US and Tom Lawson, Manager, Treasury Advisory, PwC New Zealand (Contributing authors)

Three principles to consider when implementing an exposure management programme to manage financial risk effectively while also positioning your organisation for growth. 

The top threats CEOs are concerned about include both uncertain economic growth and exchange rate volatility, according to PwC’s 20th CEO survey. CFOs play a critical role in helping organisations address these challenges, from identifying growth opportunities to effectively managing financial risk. So what can the CFO and finance function do to manage financial risk better while also positioning their organisation for growth?

CFOs and treasurers alike are increasingly focusing on exposure management, particularly because shifting dynamics between financial markets in today’s integrated global economy are consistently impacting companies’ financial performance. Thus, leading CFOs and treasurers are working to establish tools, processes and solutions to identify, manage and expand visibility into the company’s underlying exposure profile. Upon implementing the solutions, the enhanced tools and processes provide their organisations with a better understanding and more meaningful analysis of how financial markets impact their businesses, as well as an improved ability to explain results to investors.

 

Fig 1 - How concerned are you about the following economic, policy, social, environmental and business threats to your organisation’s growth prospects?

 

Exposure management is the framework and operational process of identifying, analysing and reporting financial market risks for foreign exchange, interest rate, commodity price risks and, to a lesser extent, funding and liquidity risks. Such risks are embedded across the organisation and typically managed in silos, such as balance sheet hedging of currency exposure or a cash flow interest rate hedging programme. While many elements of downstream risk management are well known and widely systemised, the complexity of each company’s operations often makes the inception of the exposure management life cycle and underlying execution of the process more challenging, esoteric and labour intensive. 

Unsurprisingly, reviewing and overhauling the exposure management process from beginning to end is often equally daunting and intensive. However, if undertaken correctly – with a strong strategic view of the objectives and a clear focus on the three key principles presented in this article – the end result can be extremely valuable and the execution less daunting. When taken into consideration, these three principles aim to balance operational processes with IT initiatives by centering on standardising data, strengthening analytics and, finally, aligning systems. 

 

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Principle 1: Capture and standardise exposure data 

The exposure identification and capture process is often the most fundamental challenge that companies face. The decentralised nature of regional commercial teams and the lingering impact of mergers and acquisitions or operations across different industries result in fragmented methods and variability across business units when trying to normalise data sets and inconsistent information into a universally accepted, consistent operating model. These challenges also naturally occur across different asset classes with a variety of delegated authorities and different objectives being sought from the associated risk management. 

Overhauling the exposure capture process begins with a detailed gap analysis across the business to understand how financial market risks are currently being identified, managed and reported. Key questions that arise: 

• Are the strategic objectives of risk management well aligned across asset classes? If not, is there a strong reason why this is the case?
  
  
• What has driven the decision to review the exposure management process and what is the expected cost-benefit of broadening to other asset classes (e.g., also including commodities alongside an FX-related review)?
  
  
• Is the information distributed meaningful and does it clearly explain the risks, impacts, and variability to your financials? 

More technical and operationally-focused questions will include: 

• Are all market risks being captured in a timely fashion? 
  
  
• Are all parts of your business identifying the same market risk in the same manner? 
  
  
• Are the same definitions being used across business units? 

It’s important at this stage to recognise the different characteristics and requirements of different financial market risks and to prioritise the risks which are creating the biggest challenge. Foreign exchange exposures are often the primary culprit here, given they can be harder to forecast, arise at short notice, and are more frequent and more material to profitability than, say, interest rate exposures. Nevertheless, financial market movements impact both FX and interest rates simultaneously due to the inter-relationships between the two markets; that impact to earnings and financial reporting can be significantly material depending on the nature of the business, risk management strategies aside. Accordingly, understanding the materiality, as well as the timeline and effort for gathering the exposures, is an important part of the decision-making process. 

It’s also important to point out that businesses do not need to be actively hedging on an enterprise-wide or portfolio basis to include more than one asset class within the overhaul. A fundamental rationale is to raise the awareness of how financial market risks are impacting the business, so that this knowledge can then be carried forward into future risk management decisions and/or monitored on an ongoing basis. If a lot of time and effort is going into making operational and systems changes for one asset class (e.g., foreign currencies) what’s the marginal cost of adding others?

Separately, broader business functions outside of treasury can be embedded within the new process to streamline data management and increase data quality. These can include tax, hedge accounting and FP&A elements, reducing the extent to which data is repackaged and redistributed around the company in different forms. For this to play out effectively, redesigning the exposure capture process requires strong integration and collaboration with key stakeholders across the business. Awareness and governance play an important role in this regard, to help ensure the standardised approach is well understood and targeted outcomes are achieved. 

Once the new process has been embedded, the next challenge is consolidating and analysing the data and identifying the desired output. Are exposures well covered within the existing reporting framework? Companies often struggle to do this effectively when there is a complex or time-consuming exposure management process. Also, in large organisations, there can be a breakdown between different teams managing the financial market risks, the cost of goods sold and the liquidity of assets, resulting in reduced visibility and less meaningful output to senior leadership for managing the total financial market risk profile. 

Principle 2: Strengthen analytics by leveraging standardised data

If companies are able to increase the standardisation and automation of data during the exposure capture process, the first major benefit will likely be increased data analytics and visibility into the changes and impacts across the financial spectrum. 

Overhauling the exposure capturing process can provide a much more real-time view of exposures, which could trigger the need for a new risk management framework. The analytics you receive can be more effectively tailored as the quality of your data improves. For example, leading companies are able to produce automated and consolidated dashboards near real-time that provide management with a comprehensive view of company-wide exposure and risk profile including perspectives on hedge performance. By taking a wider perspective on exposures – to include other asset classes – management can also create cross-asset analysis which projects or quantifies the associated impact of one-off and portfolio risk management decisions. A related part of this process can include projecting how different macroeconomic forces are changing asset relationships or generating different outcomes. It can also be applied to the pre-exposure process. For example, for a large industrial manufacturing company, this could mean projecting the potential FX impact during the bid period of a large project or extrapolating the required hedging costs ahead of submitting pricing. 

With more than one business function involved in the new process, the breadth and integration of different reports are also important benefits. As well as considering the most effective tools to make informed hedging and risk management decisions, the company can also look to automate hedge accounting and tax reporting, and produce FP&A reports projecting the expected impact of financial market risks for forthcoming financial statements. Critically, this step can enable consistent reporting across business departments when presenting numbers up to senior leadership and beyond. 

The end decisions around desired analytics will inevitably be driven by the risk profile of the business and be dependent on the existing treasury system infrastructure. However, because exposures are often not adequately included in treasury management operations, overhauling the exposure management process also provides the opportunity to embed new tools that can help drive strategic or operational decisions, or dramatically strengthen the real-time nature of analytics.  

 

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Principle 3: Align systems at key integration points

The final key principle is applying, leveraging and optimising technology. The overwhelming success of mobile technology, APIs, automation and straight-through processing have caused an explosion of fintech solutions targeting many of treasury’s key pain points. However, exposure management has lagged behind because of the criticality of having many integration points for a comprehensive solution – the ERP, the commercial teams, FP&A, the treasury management system - not to mention the unique operations that exist within an organisation.

Performing a comprehensive inventory of what you have, what it can do and more importantly, what it cannot do, is crucial to the ‘Build vs Buy’ trade off. When it comes to delivering the infrastructure and technology to support the exposure management process, companies are inevitably faced with considering the following trade-off in value:

• The value of building your own is customisation, ownership and flexibility. 
  
  
• The value of buying is often price and effort. 

A key decision point here is the 80/20 rule. Can a system effectively provide you with 80% of your needs for significantly less input and potentially price? Relatedly, what are the easy wins based on your current infrastructure? Are there some simple process changes which can greatly enhance the effectiveness without a significant investment in new inputs?

Taking the plunge

Whether it is organic growth, M&A activity, adapting to technological change or an over-reliance on spreadsheets, many CFOs and treasurers are concerned that the exposure management process needs updating. The key to recognising the need for change starts with asking whether or not you feel comfortable explaining your existing exposure management and risk profile in front of the board. 

As this article has demonstrated, there are countless solution possibilities, provided that companies can create a robust process that captures accurate data and have the infrastructure to convert that data into insight. Fortunately, the cost of such computing strength has dramatically reduced in the past five years, and the increase in smart technologies has brought us to a tipping point for treasury technologies. 

Exposure management is never a ‘one-size-fits-all’. The solution each company requires is likely to depend, crucially, on the nature of the business, the intricacies of its operating model, the ‘easy wins’ for value-adding opportunities and the priorities of senior leadership and the board. It also depends on how integrated other parts of the end-to-end treasury process are, such as trade execution, reporting and settlement. 

Well-designed exposure management processes lay the foundation for effective treasury risk management as well as sharing the information across the financial organisation. For instance, risk managers are able to make more informed and timely decisions and efficiently identify the potential source of any last minute surprises. If executed effectively, treasury can fundamentally reshape the exposure management process, increase efficiency and unlock significantly stronger analytics that provide the CFO and treasurer with more reliable and timely insights. This, in turn, can create a significant competitive advantage for the organisation and position it for future growth.

 

Eric Cohen  Principal, Financial & Treasury Management, PwC US Eric is a Principal in PwC US’s Advisory Practice, specialising in financial management, treasury and risk management consulting. He plays a leadership role within PwC in driving treasury services within our Industrial Products sector.  He also is focused on leading our Treasury M&A consulting services.  Before joining PwC, he spent eight years in the financial sector in a variety of front-, middle- and back-office positions in banking and capital markets.  Eric has a Certified Treasury Professional credential from the Association for Finance Professionals and an MBA degree in Finance from New York University.

   

Robert Pierson  Manager, Financial & Treasury Management, PwC US Robert is a Manager in PwC US’s Risk Advisory Practice specialising in treasury risk management consulting.  Before joining PricewaterhouseCoopers, he held leadership positions in professional services within the treasury software sector for risk and cash management.  Robert is an accomplished risk,  IT and project management professional with leadership experience in designing, developing, and implementing enterprise/system solutions and providing senior executives with ROI-driven recommendations.   He has a BBA. degree in Management Information Science from Loyola University in Baltimore, Maryland.

 

Tom Lawson Manager, Treasury Advisory,  PwC New Zealand Tom is an Associate Director in the Treasury Advisory team at PwC New Zealand, having recently completed a secondment to the US firm where he was a Manager within the Finance and Treasury Management team. Tom has over seven years’ experience working in treasury advisory, helping organisations manage financial market and operational treasury risks. Tom has strong experience analysing and developing treasury risk management frameworks across a wide range of sectors and specialises in managing financial market risks from both a strategic and tactical perspective. He has also worked closely with large multinationals in identifying, capturing and standardising financial market exposures to gain greater visibility for downstream risk management.  Tom has an Honors degree in Economics and a Bachelor’s degrees in Finance from the University of Otago and is a qualified Associate of the Association of Corporate Treasurers (ACT).