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Developing a Fit-for-Purpose Treasury Policy

The existence of a treasury policy is not a given in every organisation, and neither is a regular update where one is in place. David Mathewson, Regional Director & Treasury Advisor, VUCA Treasury, makes the case for designing and optimising treasury policy in today’s challenging environment.

While there is no hard and fast rule that says a treasury policy must be in place, the protection that a well-formed policy can offer a business surely makes having one a necessity, especially in today’s somewhat irregular trading environment. But some companies clearly disagree. “I still see quite a few corporates that don’t have a treasury policy. I find that quite remarkable,” states Mathewson of his frontline experience.

A business turning over £1bn, in the highly volatile retail sector, is offered by Mathewson as a case in point. The reason for not having one was simple: “we don’t have any exposures”, he was told. “I was dumfounded. Although they were importing, they were being invoiced in sterling. But that meant their suppliers were probably taking the FX risk, converting their sterling receipts back into their home currency. And that influences pricing, which clearly is an exposure for that buyer.”

Making the assumption that all corporates, regardless of size, have a formal treasury policy is evidently wrong. However, notes Mathewson, there may be some informal level of agreement on certain processes within treasury, or the CFO may hand down ad hoc proposals on how risk should be managed. But that is a risky tactic, as it exposes individuals, the treasury function, and the business itself, to randomness and instability, warns Mathewson.

Points of failure

However, where policy has been formalised into a recognisable document, while there are some firms that will have everything performing optimally, there are many more where this is not so, declares Mathewson. Indeed, problems will almost certainly arise if that document has not seen the light of day since it was written. “And even if it’s occasionally referenced, it still looks very much like it was created as a tick-box exercise.”

Beyond simply not using it, other common points of failure include the setting of a policy that is too rigid, such that it fails to provide the tactical flexibility to respond to prevailing conditions or sudden changes, and having a policy in place, yet not reviewing it with sufficient regularity. “We suggest not only that treasury frequently reviews its policy –  at least every 12 months, preferably more often – to ensure it’s still fit for purpose within current market conditions, but also that treasury can obtain the right approvals, preferably from the board, to allow policy to be adjusted as required,” advises Mathewson.

Indeed, on occasions where a Black Swan event emerges, such as Covid, or the global final financial crisis in 2008, he explains that a policy that hasn’t taken into account the likelihood of such (albeit rare) events, means that when they do happen, there is no approved response mechanism. This can ultimately prove costly or even commercially fatal. The same demand applies to the establishing of appropriate controls to mitigate the financial impacts of significant industry- and business-specific disruptions. 

Exposure control

When developing a treasury policy, it’s vital to be able to understand all exposures – both direct and indirect – says Mathewson. In the everyday moments of a business, the need to buy USD, for example, may create an FX exposure. An outstanding loan creates an interest rate exposure.

Of course, these are commonplace financial exposures. But exposure to commodities needs policy guidance too, and the need for controls may not be obvious to the business, warns Mathewson. A business with a fleet of lorries used for delivering its goods, for example, generates an immediate exposure to fuel prices. Should that be hedged? If so, how?

The process of policy development demands that the team undertaking it understands the company inside out, urges Mathewson. With multiple exposures, the information will likely be drawn from different departments, which should be pressed to disclose their active budgeted rates, he says. “If manufacturing buys a certain commodity, treasury needs to know the price it has budgeted to purchase that commodity. That will be the rate treasury works with to manage that risk, so it needs to be accurate.”

These metrics will be managed alongside more general inputs such as assumed FX and interest rates, and even expected price paid for fuel at the pump for fleet vehicles. These may be budget inputs that either treasury or finance can calculate and allocate, or it may be that the relevant function is asked to provide correct data.

Once treasury understands its exposures, it must calculate company sensitivity to them, and through cost-benefit analysis and sensitivity analysis, the degree to which they impact the bottom line. It then requires a view on how to manage each exposure; hedging is not always appropriate. Indeed, the board may be comfortable leaving certain exposures unhedged, whereas others may require mitigation.

The bottom line is that a treasury policy should cover all financial exposures. And for Mathewson, it’s essential at the very least to formally acknowledge, and have a managed response to, every exposure, even if it means, in that moment, doing nothing.

Showing authority

Another policy impact area for treasury is cash management. Many businesses will have a cash surplus. When Mathewson asks a client what its policy instructs treasury to do with that cash, without policy guidance, it transpires that often it is just left in a current account.

Of course, this may or may not be the most effective use of that cash. If not, then the cash is being underused. But if a higher yield is sought through its investment, then key components such as the credit appetite of the company must be incorporated into every decision. “If, rather than being clearly directed by treasury policy, an individual or a function is making ad hoc and detached financial decisions, it creates an untenable risk,” Mathewson cautions.

From a company perspective, the worst-case scenario stemming from no, or poor, policy implementation is financial loss. Whether through inactivity, chasing yield, over-hedging or speculating with some of the more arcane derivatives offered by FIs, those losses could be material. From a personal perspective, such an error of judgment, unsupported by formal policy, could result in termination of employment.

But there’s more to policy than simply providing internal operational guidance, suggests Mathewson. In essence, a policy should be a focused expression of proper governance just as not having a formal policy may indicate to external stakeholders that proper governance is not being exercised. “A key external stakeholder – an investor, for example – can be shown that an exposure has been acknowledged, and that it is being dealt with either through active management or by simply acknowledging and proving that it has minimal impact on the bottom line.”

Controls with freedom

“While it’s really important to have a treasury policy that’s tight, it also has to provide flexibility,” states Mathewson. Whereas at first glance this may seem contradictory, in practice it is more a matter of finding the right balance. “You can’t be too rigid; you have to give some ownership and flexibility to treasury within the policy. But it does still have to retain a degree of control such that decisions cannot be made that don’t reflect the strategy of the company and the board.”

In fact, Mathewson firmly believes that adherence to company strategy should be a core priority of any policy. As a matter of major importance, that policy document must reflect high-level elements such as the business ownership structure. Indeed, the stakeholders within a private versus shareholder, or non-profit versus profit set-up will have different drivers, and these must be recognised.

It’s also necessary to incorporate the varying demands of where the company is in its life cycle – is it trying to grow, consolidate or seek new ownership, for example? Again, this must be acknowledged within policy guidance.

Among other important components to recognise within a treasury policy are the covenants agreed with FIs. These cannot be breached, and it is essential that the policy puts in place rules that protect them.

The company’s credit appetite should always feed into policy expectations. This may also steer its view on counterparty credit, with the policy offering guidance on, for example, the categorisations of company that it wishes to deal with, especially on the supply side. Mathewson suggests that information may be sought through the rating agencies to help build a quantitative viewpoint, adding that although not all companies are rated, and thus it may be a challenge for treasury to allocate its own suitable rating, “it is nonetheless a worthwhile exercise”.

Increasingly, sustainability guidelines are being incorporated within treasury policies, reveals Mathewson. This, too, is an extension of the strategy set out by the company and its board. It will direct aspects such as treasury investments of surplus cash, green bond issuance, support for sustainability-linked loans and SCF programmes. And, of course, the evolving set of sustainability disclosure rules (such as the EU’s Corporate Sustainability Reporting Directive) must be adhered to, a demand that in itself underscores the need to maintain a dynamic approach to policy management.

Own it, now

The design and maintenance of a treasury policy will ultimately reside in the domain of the finance or treasury teams. “They will own the document, and set the rules of engagement,” declares Mathewson. But the process of designing, developing, and maintaining a treasury policy from scratch is demanding. It may therefore be beneficial to consult an independent adviser, at least to oversee the work.

However, while a firm such as VUCA Treasury can manage the entire policy process, Mathewson acknowledges that the deepest understanding of the business will (or should) come from within, especially when it comes to collating and analysing its exposures. “We can then ask questions, probe policy content and aims, and provide a structure and oversight, both prior to submission for board sign-off, and on an ongoing basis.”

A fit-for-purpose treasury policy will provide a framework for minimising financial risk. For a treasurer, that is good news. But such a policy also supports the wider strategic goals of the business by setting clear objectives and rules of engagement. It defines the roles and responsibilities of treasury, and also presents a clear indication of strong governance to external parties. Those firms currently operating without a treasury policy, or those that have left theirs to gather dust, should perhaps reconsider these upsides, sooner rather than later.