Treasury Today Country Profiles in association with Citi

Gaining a full view of risk

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It has never been more important for treasurers to have a full view of risk across the business. But how can treasurers achieve this, and how can technology help them manage their risks more effectively?

Managing risk has long been a core responsibility of the corporate treasurer – and recent events have only made risk a greater concern. From interest rate risk to cyber risk, treasurers are required to understand the implications of many different types of risk on the company’s financial position and, where necessary, take appropriate action to mitigate those risks.

In many cases, this is an area where improvements are needed. “In a recent study FIS performed of treasury professionals, approximately half of respondents described their risk management strategies as either mediocre or poor,” comments Steve Wiley, VP Treasury Solutions at FIS. “New regulations, recent fluctuations in foreign exchange prices and highly publicised hacks have put all areas of risk, including cyber risk, higher on the treasurer’s radar than ever before.”

In today’s challenging environment, risk management is arguably second only to cash management where the treasurer’s goals are concerned. PwC’s 2017 Global Treasury Benchmark Survey placed financial risk management third on the treasurer’s agenda after cash flow forecasting and cash management optimisation, while currency risk was found to be the second most important of the CFO’s priorities for treasury. Altogether, the survey found that risk management represented 15% of the activity split for central treasury staff.

In practice, treasurers often manage a broad range of risks. Vivian Peng, Vice President & Asia Treasurer at Flextronics, points out that the traditional financial risks managed by treasurers include liquidity, forex and credit risk, but that other risks may be identified such as counterparty risk, industry risk and geographical risks, depending on the features of individual companies.

With so many risks to manage, how important is it for treasurers to gain a full view of risk across the business – and how can this be achieved in practice?

Evolving risk management environment

From political upheaval to high-profile cyber-attacks, the events of 2016 underlined the importance of expecting the unexpected. The UK’s Brexit vote has had a significant and lasting effect on exchange rates, while attacks such as the Bangladesh Bank heist demonstrated the potential scale of cyber-attacks as fraudsters become ever more sophisticated in their approach.

Understanding the risk circle

In this climate, it is more important than ever to understand the nature of the risks faced by organisations. Paul Taylor, Head of Global Corporate Sales and Head of EMEA Sales for GTS at Bank of America Merrill Lynch, says that he regards risk management as a circle with four points flowing in a cycle.

“At the 12 o’clock position of the circle, you have geopolitical and macroeconomic events, which as we’ve seen in the last 12 months, can be surprising,” he explains, noting that such events can have a considerable impact on financial markets, politics, consumers and economies. “Moving round the circle, that has created a much greater feeling among clients – whether they are institutions or consumers – of exposure to risk. This awareness is the second point on the circle.”

The third point, Taylor continues, is the need for greater regulatory scrutiny and for market bodies to be appointed. “At one end, that means the regulators – but it also means activist investors, think tanks and quangos which provide scrutiny and oversight and highlight risk in a more detailed way than before.”

Finally, Taylor says that banks represent the fourth point of the circle. “Banks have seen a dramatic shift in terms of how they view risk, how they measure risk and how they react to those risk measures,” he says. “This feeds through into their appetite, their market selection and their client selection – and in turn, this ends up having an impact on economies and geopolitical situations, completing the circle.”

Managing volatility

“As a treasurer, we have to worry about two kinds of volatility: the ones we know about and understand, and the ones we are not aware of,” says Damian Glendinning, the Singapore-based treasurer of Lenovo. “For the first category, once we are aware of the issue, it is usually possible to collect the data on the underlying exposure, and take the necessary risk mitigation actions. These will usually be some form of hedging.

“Of course, it is better if the awareness of the risk does not come from a bad experience: we always try to get out ahead of these problems. The sad fact is that many organisations are only willing to make the necessary investment in gathering the data and enforcing the disciplines after they have learned the lesson the hard – and expensive – way.

“By definition, it is hard to prepare for the risks and the volatilities we are not aware of. This will often take the form of unexpected consequences: the funding crisis and the dramatic spike in overnight interest rates during the global financial crisis is a prime example. It might have been possible to foresee the collapse of a single bank – but no-one expected the chain reaction which ensued.

“For these cases, it is always best to make sure we have something in reserve. It is also very good to challenge your own assumptions. In many cases, our actions are based on an implied assumption that something cannot happen – it very often can.”

Growth brings risks

Another catalyst in the current risk environment comes, perhaps counterintuitively, in the form of growth. Steve Elms, EMEA Sales Head, Corporate and Public Sector and Regional Marketing, Treasury and Trade Solutions at Citi, notes that growth is emerging as a key topic for 2017, with clients increasingly looking for opportunities to expand their businesses. “As they search for growth, this brings them to new markets, new counterparties and new relationships,” he comments. “As such, risk continues to play a role even in the context of a very positive growth story.”

Again, the geopolitical landscape is relevant to this theme. “While growth can be seen as positive, there is also a question mark about the impact of nationalism if this global trend continues,” Elms comments. “My belief is that growth will continue to be a theme, but it does create a few slowing down factors.”

Illustrating this point, Elms cites the long tail risks which have been evident following the shocks of 2016. “Following the UK’s vote to leave the EU and the election results in the US, the volatility created in the market was significant – especially in relation to FX rates,” he says. “Many had hedging programmes in place, but as hedges roll off the real impact of currency devaluation has hit home. Earnings volatility is therefore becoming more of a priority for corporates.”

Know your risks

In this environment, what steps can treasurers take to manage their risks as effectively as possible? First and foremost, treasurers need to have a full view of risk across the business. “It is critically important for treasurers to have transparency into their financial exposures and the risks that could affect them,” says Bob Stark, VP Strategy at Kyriba. “Making decisions without a full view of risk is like only looking in one direction before crossing the street.”

Taylor says that the first step is to be as precise as possible when understanding the risks to the business. He points out that every business and industry segment has its own risk profile, so some businesses will prioritise certain risks above others: “If you are an oil major, for example, you will be considering different risks to a technology company.”

As well as having a clear understanding of the risks which impact the business, Taylor says it is essential to have the tools, mechanisms and technology needed to manage those risks on a real-time basis. At the same time, it is increasingly important for treasurers to take a broad, strategic view of the different risks they face. “Nowadays, treasurers play a much broader and more strategic role in the running of the company and how the company operates,” he says. “In that sense, treasurers are obliged to take into account risk considerations which go much further within the company than just within the finance or treasury function.”

Responsibility for risk management

However, gaining a full view of risk across the business can be challenging, and it is important to note that treasurers may not be directly responsible for managing every risk that affects the business. That said, even risks which do not fall under the treasurer’s remit will still need to be considered. “Treasury are normally involved in financial risks, not business risk,” comments Flextronics’ Peng. “But business risks should be factored into financial results. How treasury could help business to factor business risk into the development of strategy and negotiation with customers would be an interesting topic.”

Taylor notes that almost all forms of risk impact the treasurer, whether directly or indirectly. “A good example of that would be technology risk or cyber-security risk,” he explains. “I’m not sure that in most companies this would fall to the treasurer to manage, but clearly technology and cyber-security risk have a massive bearing on the role of the treasurer.”

Another area where treasurers may see indirect impacts is with geopolitical events such as Brexit in the UK, the change of administration in the US and political upheaval in the Middle East. “I don’t know if any treasurer feels that they directly own any of those elements as far as the overall company’s response is concerned,” says Taylor. “But clearly each one of those is going to have a ripple effect on the company’s finances and its ability to manage its working capital.” As such, Taylor says that even if these areas of risk are not ‘owned’ by the treasurer, the treasurer will still be directly responsible for managing certain elements of them.

In some cases, this responsibility will be shared with other parts of the business. “There are some risks that treasurers manage alone – such as liquidity, currency and interest rate risk,” observes Stark. “There are others that treasurers support in collaboration with other teams – such as the impacts of regulatory change on tax or the impacts of globalisation on the supply chain, and sovereign risk impact to top line financial KPIs of their organisations.” Stark points out that for treasurers who don’t play a role in tax strategy, reducing risk in the supply chain or external influences on business performance, “it is a lost opportunity that will limit their career progression.”

Role of technology

When it comes to managing risk, technology has an important role to play – but this doesn’t negate the need for a clear view of the risks faced by the company. As Stark says, “a treasurer cannot manage risk without technology. Yet nothing can be achieved with technology before treasurers understand the business impacts of managing risk.”

With a clear understanding of the impact of risk on their cash flows, positions and opportunities to borrow and invest, Stark says that treasurers can leverage technology “to improve visibility into risk exposures, make better hedging and risk mitigation decisions, and manage regulatory compliance.” He notes that while a reactive treasurer will use technology to get everything done, “a proactive treasurer will leverage technology to analyse the effectiveness of what they are doing and how they can continue to improve.”

Treasury management solutions can play a key role in helping treasurers understand their risks and manage everything from interest rate hedging to liquidity risk. Functionalities such as business continuity and the ability to enforce segregation of duties can enable businesses to mitigate their operational risks.

“Treasury technology allows treasurers to centralise global foreign exchange exposures, track hedging instruments, automate risk analytics and reporting,” comments FIS’ Wiley. He notes that treasury technology can also protect company assets through access to the strongest levels of cyber-security by specialised treasury technology providers. “Additionally, risk management technology allows for the treasury function to be more effective in decision-making processes related to the hedging of risk, by automating the collation and analysis reporting of data, which deliver more timely, complete and accurate information.”

At the same time, treasurers should be monitoring how new and emerging technology can be used to enhance their risk management practices across different areas of risk. “It’s a new technological environment in addition to being a new risk environment,” comments Elms. Where receivables are concerned, Elms says that the use of machine learning to match invoices is a “significant trend” which can enable corporates to reconcile their receivables processes in a much more automated way. “This brings not only improvements to working capital, but also risk mitigation,” he adds.

Meanwhile, Elms points out that the arrival of PSD2 is helping to drive some developments, such as the use of application programming interfaces (APIs), thereby enabling an event-driven rather than demand-driven flow of information. “So rather than requesting data, information is being pushed to the recipient who will be the consumer of that data,” says Elms. “For example, as a collection comes in, that automatically generates an impact to the balance of that account to be shared on a real-time basis.” Such developments can play an important role in arming treasurers with the information they need to gain a clearer view of risks.

Taylor says that robotics could increasingly play a role in helping treasurers manage their risks more effectively by enabling more processes to become automated. “Anyone can run a spreadsheet and it can produce results, but what do we do when we have to make emergency payments, or when a market event has a knock-on impact to the ability of a company or a market to function?” Taylor asks. “Are there newly automatable processes which would not only enable companies to manage this in an automated way, but which would actually increase the company’s speed of response to those events – and thereby dramatically reduce their risk?”

As banks invest in areas such as big data and robotics to bolster their own processes, they are also looking at ways in which this type of technology can be used to benefit their corporate clients. “We’ve certainly done that in terms of our CashPro or virtual account management platforms, and by rolling out robotics in our retail presence in the United States,” says Taylor. “I think banks can play a big role in that technology – but I think technology itself has a much bigger role to play in supporting the treasurer.”

Conclusion

If the events of 2016 taught treasurers anything, it is that unexpected events can and do happen. “Ironically, the market’s reaction for tail risk is becoming much less,” notes Elms. “People are getting used to the unexpected. Of course we’ll continue to see volatile events – but where day to day events are concerned, we’re moving into a new normal.”

Nevertheless, understanding and managing risks is a higher priority than ever for corporate treasurers. As innovation continues, treasurers should welcome any developments that might enable them to manage risks more effectively – while also leveraging the full range of functionalities offered by existing solutions.

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