A Word from the Red Carpet on Managing Risk
By Helen Sanders, Editor
While treasury and Hollywood often seem to be worlds apart, it was Helen Mirren who said, “Fear sometimes stops you from doing stupid things. But it can also stop you from doing creative or exciting or experimental things”, a comment that is as relevant to a treasurer’s day job as walking the red carpet. As one of the world’s greatest actors, you take risks on the script you pick, the director you work with and most importantly of all, your choice of red carpet footwear. Taking informed risks on the first two of these is how you move from rep theatre in a small market town to the West End, Broadway or Hollywood. Taking a risk on the third and hobbling through a première or breaking an ankle is avoidable and leads to all the wrong sort of headlines.
So risk is neither unfamiliar nor always undesirable: however, in each instance, it needs to be treated appropriately: take, mitigate or manage. A company will always take the specific risks related to their business, whatever their industry, as this is where growth and competitive advantage can accrue. It will mitigate risks such as operational risk, where there is no upside. Most market risks, including FX, fall into a third category, where, like the risk of vertiginous heels, risks can create serial pain, but also serial gain, so they need to be managed correctly to limit downside risk without eliminating upside potential.
The scale of the challenge
Managing foreign exchange (FX) risk is core to treasury’s responsibilities, but the scale of risk and therefore potential impact on earnings, continues to increase as corporations extend their international reach whilst buffeted by high levels of market volatility. Although the nature of FX risk remains universal, corporate skills and attitudes, together with the market and regulatory environment, have changed significantly over recent years. As Dipak Khot, Thought Leadership, Corporate Risk Solutions, UK & CEEMEA, HSBC describes,
“Historically, risk management looked quite different to the way it appears today. In the past, treasury management was largely confined within local boundaries, with each external or overseas unit responsible for managing its own market risk. Secondly, the treasury and risk policy was often static, and not reviewed regularly. This policy was largely focused on market risks that the treasurer understood best, such as FX, interest rate and commodity risk, and mostly these tended to be managed in isolation rather than under one umbrella. Even within FX, risks arising from different currencies were managed separately rather than as a basket risk. Amongst our clients, for instance, only a few, more sophisticated corporate treasuries managed a wider set of risks such as credit, inflation, correlation etc., and expertise in these areas was relatively limited in some organisations.”
“However, we are now in an environment where high levels of volatility are the norm rather than the exception. Furthermore, we have seen in the recent months that world geopolitical events have become more important in driving market volatility than the fundamental economic indicators that were used in the past. Over time, treasurers have learnt to accept ‘black swan’ events as something of a norm rather than an exception, and have therefore moved towards more flexible solutions to allow them to hedge risk appropriately. Similarly, tail risk hedging (i.e., hedging against events that have a low probability) is now an accepted reality among corporates, far more than in the past.”
Changing attitudes to FX risk management
“While treasury and risk functions are at different stages of maturity, treasurers have also developed a different mindset in terms of how they assess and manage their specific risks: Firstly, the corporate view and management of risk is now moving towards global. Secondly, treasurers recognise the importance of a more dynamic risk management and execution policy that can be adapted to changing market conditions, availability of innovative solutions, and evolving business and regulatory requirements. Thirdly, they are taking a more integrated approach to different risks with more regularity than in the past.”
Dipak Khot, Thought Leadership, Corporate Risk Solutions, UK & CEEMEA, HSBC
The regulatory environment has also changed. While in the recent past , treasury’s activities have been heavily influenced by accounting requirements, such as obtaining hedge accounting treatment for derivatives, with IFRS9 coming into effect, treasurers are able to focus more on the risk requirements of their business, allowing for more economic rather than simply accounting hedging.