Visualising Risk in a Turbulent World

Based on a webinar with Mark O’Toole, Vice President,  Treasury Solutions, OpenLink and Craig Jeffery, Managing Partner, Strategic Treasurer. Chaired and edited by Helen Sanders, Editor, TMI

Visualising risk using dashboards that bring together data from across the enterprise, and modelling the impact of different market and hedging scenarios is fast becoming a priority for treasurers. In doing so, they can communicate risk issues and factors that influence risk decisions more clearly, both to senior management and the wider organisation, and inform risk discussion on risk appetite, mitigation, and how risk decisions can drive strategic advantage. This feature summarises some of the discussions that took place during a recent webinar featuring Mark O’Toole, VP, Treasury Solutions, OpenLink and Craig Jeffery, Managing Partner, Strategic Treasurer, and chaired by Helen Sanders, Editor, TMI. A recording of the webinar can be found here.

Greater volatility, heightened expectations

Every week, we see a new natural or geopolitical event that impacts on both the global economy, and corporations’ own cash flow, financial and credit risk positions. This impact may be positive or negative, but most important of all is that the impact is unpredictable, as the effects of the Brexit referendum outcome and the  election of President Trump amongst other recent events have demonstrated. Different regulatory trajectories, with the potential for deregulation in the United States, and greater regulation in Europe, also add risk pressures for treasurers, as does the prevalence of low and negative interest rates. Low rates have redirected the role of treasury from earnings booster, through investment of surplus cash, to earnings stabiliser, through risk mitigation and hedging. Low rates are also putting pressure on margins and the need to manage costs. Managing risk on an enterprise basis can be an essential way to both manage unpredictability, but also protect margins and reduce costs by managing the drivers that impact on profitability and hedging judiciously. Of course, this will remain just as important as interest rates rise in the future.

Although treasurers have different priorities, depending on their industry, business model and risk appetite, the relationship between managing volatility and improving financial performance has become more widely recognised. As Craig Jeffery, Managing Partner, Strategic Treasurer comments,

“Since the global financial crisis of 2008-9, there has been a greater emphasis on risk; subsequently, the demands and expectations on treasurers to manage risk have increased. In the past, treasurers rarely engaged directly with the CEO and the Board, but this is now a regular event.”

At the same time, treasurers are tasked to play a more strategic role within the business, such as by participating in mergers & acquisitions and engaging more proactively with procurement, particularly for the purchase of commodities. The question for many treasurers, therefore, is how to mitigate the effect of volatility on one hand, whilst contributing to the strategic ambitions of the organisation. 

 

Fig 1 – Building an enterprise risk framework Source: OpenLink, 2017

 

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Challenges for treasury-intensive corporations

While all treasurers need a comprehensive view of cash balances, exposures and forecast liquidity needs to fulfil their diverse range of responsibilities, some organisations experience greater intensity in a particular risk area, so they need to respond accordingly. For example, building an efficient, high-capacity payment infrastructure will typically be more important for a company with large payment volumes than an organisation with a small number of large payments to a limited number of suppliers. A company with the majority of its business outside its home market, denominated in local currencies, will prioritise FX risk, while another company buying a large amount of raw materials for manufacturing will have an emphasis on creating certainty in the cost of core commodity inputs. As Mark O’Toole, VP Treasury Solutions, OpenLink explains,

“Supply and demand in commodity-intensive corporations, such as food and beverage, manufacturing, chemicals or agribusiness is often finely balanced. It is often difficult to pass the effect of volatility on to the customer, so protecting profitability, whilst maintaining a robust supply chain, becomes a major challenge, particularly when combined with difficulties in forecasting demand across a global organisation.

To overcome these challenges, treasurers need to work closely with procurement to gain visibility over global risks. This typically becomes easier when treasury and procurement are centralised. Treasurers can then hedge exposures based on an aggregate view of risk, hedge at a lower cost and allocate these (lower) costs back to the business, rather than have individual hedges at each location or division.

In this environment, risk visualisation is becoming an important mechanism to facilitate real-time decision-making in a fast-moving business. Risk dashboards, for example, create an integrated physical-to-financial view of positions and price risk exposure, and demonstrate different possibilities for switching inputs, transport options, procurement or hedging strategies.”

Visualising risk at an enterprise level

As Mark O’Toole, OpenLink notes above, risk visualisation, such as using risk dashboards, offers an intuitive way to illustrate to both internal and external stakeholders the risks to which the business is subject, where they arise, which of these risks have an impact on performance, and to what extent. They also help to inform risk discussions by presenting the results of different outcomes, business and hedging strategies. Mark O’Toole, OpenLink continues,

“Moving beyond risk mitigation, risk visualisation offers strategic benefits as it can help to satisfy analysts and external stakeholders about the reliability of forecasts given different risk and hedging scenarios, which in turn can impact on the credit rating, share price and cost of borrowing.”

 A typical way of using risk dashboards is to demonstrate the impact of stress testing to model different market conditions, and combine these into a scenario analysis. By understanding the potential impact of different scenarios, as well as their probability, senior management are better equipped to determine their risk capacity, and what level of risk mitigation is appropriate given their strategic ambitions. This is best achieved by taking a holistic view of risk across the enterprise, as opposed to considering risk in silos. By doing so, treasurers can base decisions on more realistic market conditions, where multiple market levers move simultaneously, and therefore take into account the effect of risk correlations and offsets. Mark O’Toole, OpenLink continues,

“This type of modelling can give companies a competitive edge by bringing data together and using ‘at risk’ models to establish a path towards growth objectives, and clarify the company’s appetite for risk. For example, a North American oil and gas services company struggling to manage liquidity risk and deliver growth in a highly volatile environment built a strategic cash flow at risk model to help create an optimal hedging and capital raising strategy to cover its future cash flow needs based on a 95% confidence level.”

Historically, early adopters of integrated strategic risk models tended to be financial institutions and industries that are subject to the highest levels of commodity volatility, such as energy companies; however, we are now seeing greater interest from a wider range of industries. Airlines, for example, are becoming proactive in using a visual approach to model fuel prices and demand, and measure the effectiveness of current and potential risk mitigation strategies. Craig Jeffery, Strategic Treasurer emphasises,

 “It is important to note that by taking an enterprise-wide view of risk and modelling various strategies, treasurers can identify not only their hedging priorities, but also where they can afford to reduce or stop hedging if there is a minimal impact on group performance. As a result, risk visualisation can be a powerful way of matching exposures with risk appetite.”

The changing role of treasury

As treasurers expand their breadth of responsibilities within the organisation, and take on a more strategic role, they need to adapt their policies, processes, skills and technology infrastructure accordingly. Mark O’Toole, OpenLink observes,

“For many companies, the treasury technology landscape comprises unintegrated systems and silos across the organisation. This makes it difficult to achieve visibility over the business, make consistent use of data, and create and maintain integration points that are required to produce a forward-looking view. Cloud-based, enterprise treasury and risk platforms remove these silos and bring together functional components of the business to produce single source of truth and a real-time approach to measuring and monitoring risk.”

Craig Jeffery, Strategic Treasurer notes that making use of an integrated, enterprise-wide platform can also make it easier to reconcile diverse perspectives across the organisation,

“Each department typically has a different perspective on the business. Treasury takes a forward-looking view of liquidity and risk, while accounting functions typically have a historic focus. Procurement teams are motivated to ensure that the business has the right resources at the right place and at the right time to support sales. However, these are all inter-related, and rely on the same information.”

 

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Guiding the risk framework

With the right technology in place, treasury can bring together data and various perspectives on this data from across the business, and guide the development of a risk framework (see figure 1). With a complete view of information, presented in an intuitive way, treasury and senior management are then in a position to explore the group’s capacity to bear risk; where in the supply chain these risks originate; how they can be managed or passed on, and how these risks and their mitigation compares with competitors. This typically takes into account a variety of inter-related risks, including: credit; liquidity; reputational; market; operational; compliance/regulatory; financial and capital adequacy risks. 

Mark O’Toole, OpenLink concludes,

“By developing an integrated risk management framework and representing the risks to which the company is exposed visually, treasurers are in position to understand risk levers, prioritise risks that have the greatest impact, and determine the outcome of different hedging and business actions. By doing so, they move from a reactive to proactive view of risk, and can apply the most appropriate tools that enable the company to build a strategic and competitive advantage.”

 

Mark O'Toole Vice President, Commodities and Treasury Solutions, OpenLink Mark O'Toole joined OpenLink in 2006, and helped establish the Commodity Intensive Corporates (CIC) business providing integrated treasury and commodities solutions. He has more than 20 years of experience in fintech across sales, business development, product marketing, product management and implementation in commodities, energy and capital markets. He previously worked at Dow Jones, SunGard Energy (formerly Caminus) and RiskMetrics Group (now MSCI).

 

Craig Jeffery Managing Partner, Strategic Treasurer Craig Jeffery formed Strategic Treasurer LLC in 2004 to provide corporate, educational, and government entities direct access to comprehensive and current assistance with their treasury and financial process needs. His 20+ years of financial and treasury experience as a practitioner and as a consultant have uniquely qualified him to help organisations craft realistic goals and achieve significant benefits quickly. He is primarily responsible for relationship management and ensuring total client satisfaction on all projects.