Much has happened over the last two years to change the way that corporates view and manage risk. In this Bank Interview we talk to Colin Devo, Head of Corporate FX and Liquidity Solutions and Andrew Willett, Managing Director, Lloyds Banking Group about how Lloyds has responded to this evolving risk landscape on behalf of its clients. We also discuss current treasury trends and what to look out for in 2011.

What trends are you seeing in the treasury market at the moment?

AW: As a result of the events of the last two years, successful organisations and their boards are now much more aware of the role and importance of the treasury function. This means there is a much greater level of scrutiny over long held risk management policies to re-assess their suitability in the current environment.

This has, in turn, led to increased demand for a deep and thorough analysis of these policies to validate and quantify their contribution to shareholder value. As a trusted risk adviser, Lloyds has continued to invest in developing its capabilities to address our clients’ needs. Specifically, this means broadening our range of expertise, for instance in IFRS accounting and financial risk management areas.

CD: As Andrew has outlined, corporate treasurers are going to be focusing much more on their treasury policy in this volatile environment and this includes, of course, their hedging policies. Are the company’s hedging policies still relevant? And do the stress scenarios that have been used in the past need to be looked at in a new light?

AW: The other big change is a renewed focus on counterparty risk, with a much greater focus than in the recent past on a broader range of metrics when deciding who to deal with than simply price.

CD: This is something that has also been reflected on the cash side: chasing yield is now the second priority, after counterparty risk.

Are there any particular products that your clients are asking for today, and if so, why?

CD: In FX, there’s far more interest in flexible hedging products than we have seen before. We’ve seen much greater volatility in the currency markets this year, and this makes certain derivative structures far more attractive in terms of pricing and their pay-off profile.

On the cash side, we’re in a low rate environment and this is increasing the attractiveness of enhanced-yield products. So yes, counterparty risk is a priority, but there are still clients we’re speaking to who do want to try to enhance yield. They understand that enhanced yield means accepting a small amount of extra risk and are willing to accept it. However, our approach is not just from a yield-enhancement perspective, but also incorporating their FX risk with products such as dual currency deposits, which are increasingly popular as they can provide an element of FX hedging and an increased yield.

AW: As for interest rates and inflation hedging, we definitely have gone ‘back to basics’, with corporates using simpler instruments to meet their risk management needs. However, a more in-depth view would show that there is a greater appreciation that option-based products can offer equal, or greater, value in certain circumstances. This is the case, for example, as corporates balance the cost of moving out along the yield curve against the risk of a significant shock to rates as and when quantitative easing is withdrawn.

This poses challenges around hedge accounting, so we are having regular dialogue with corporates on how they can, for instance, bifurcate the trades to minimise P&L volatility or, if that is not possible, helping them to quantify that volatility to allow for such products to be catered for within their risk management policies and framework. We also help clients in their communications with the market where they decide not to apply hedge accounting to relatively simple solutions against which hedge accounting rules unfairly discriminate.

How would you describe risk appetite at the moment? Have you seen any shift at all?

AW: I think that sovereign debt concerns, notably in Greece, have shown once again just how quickly market liquidity can vanish and how highly volatile rates and FX can be.

CD: While risk appetite is low, risk management has probably never been higher in a treasurer’s mind. Through regular interaction with our clients, we believe risk management is now at the front of mind of other senior managers. For instance, we’re seeing more Finance Directors involved in these decisions than ever before.

How does Lloyds address the needs of its clients?

AW: Relationship banking is the cornerstone of Lloyds’ approach. Our teams in Corporate Banking, Risk Management and Capital Markets are all set up along sector lines. The teams meet regularly to brainstorm themes that might be impacting any particular sector, and we pride ourselves on the deep ‘due diligence’ that we undertake ahead of client meetings to ensure we are talking to clients about their requirements.

A few weeks ago, Lloyds Banking Group was recognised as ‘Bank of the Year’ for the sixth year in a row in the Financial Director’s Excellence Awards for the ongoing support it has given business customers throughout the downturn. What’s important is that this is voted for by customers – more than 1,000 UK Financial Directors.

Other good examples of how we address the needs of our clients include the series of events we held for corporates across the country timed to coincide with the UK election, addressing the economic challenges the next government will face, and a seminar highlighting the potential impact of the proposed OTC derivative regulation. By being proactive in this way, we’re helping customers to understand what is affecting them and how they can overcome these hurdles.

CD: We also offer tailored services to fit the needs of specific clients. For instance, we were working with a FTSE 100 retailer where the treasury looks after all the different subsidiaries, and they wanted us to produce a presentation to educate and explain to their buyers what the FX risks were, and how the market movements on a daily basis were actually impacting them. This was posted on their intranet site and as a result of our presentation, their buyers are now able to better negotiate prices with their suppliers.

Treasurers often have to face unforeseen market events such as the recent heightened concerns regarding sovereign issuers including those in the Eurozone. Consequently, corporates are left facing a market where implied volatility, a measure of how expensive option contracts are, is high and where the ‘skew’ in the options market has made buying protection against sterling or euro depreciation expensive. Net US dollar buyers for instance, are faced with the dilemma of hedging at historically unattractive rates, or adopting a ‘wait and see’ approach in the hope the markets return to long-term averages. The temptation to wait and see is exacerbated by many economists’ view that markets will ‘mean revert’ to more favourable levels.

As a result we are talking to our clients about trades that they have entered into before the market fallout that may currently yield large positive mark to markets in their favour. We are able to use this positive position to restructure existing trades and extend the tenor of their hedging programmes at better rates than the current market.

We are also seeing clients who have unhedged exposures but are not willing to lock in at unfavourable prevailing market rates. The desire to achieve budget rates higher than current market rates supersedes the desire to achieve hedge accounting and as such ‘out-performance trades’ that make use of leverage, knock-in and knock-out features have grown in popularity.

Finally, corporates may have entered into hedges that use leverage, knock-in and knock-out features prior to the market fallout, and we look to see if there is value in restructuring these trades to either alleviate the pressure on barrier levels or to take advantage of current market conditions and restructure at more favourable rates.

In what way does your offering set you apart from your competitors in the risk management space?

CD: Service is a key differentiator for us, and how we approach the customer. We look to work with the clients to identify and evaluate the financial risks they’re exposed to. We also look to comprehend the underlying business, and we try to develop our ideas and strategies, whether FX or rates, around the company’s culture, their values and their visions for hedging. The resources we have got behind us, such as our IFRS consultants, our economic research and our derivatives structuring teams – all contribute to an overall trusted risk advisory position which clients really appreciate. We also offer an array of tactical market indicators for interest rates and foreign exchange which our clients can use to help determine hedging strategies within their tactical scope.

AW: Trust permeates everything we do in relation to our clients: in the Greenwich Quality Index we recently got a series of very high scores across a wide range of metrics, and I think that shows real traction with our clients based on a very co-ordinated relationship banking approach.

How can Lloyds help its clients to manage risk in a holistic manner?

AW: Our typical approach to a corporate client involves a significant amount of analysis around capital structure, peer analysis, sector analysis and so forth. We also like to provide analysis that is ‘product neutral’, which ensures that any proposals we make are focused on the value add for the client rather than championing any particular product range, or any particular team within the bank itself. The most important thing is that we meet, and many times exceed, the client’s requirements.

CD: I think the other side of this is the people, and those who we’ve hired in the last two years: we’ve had two organisations come together and really, we’ve got the best of both worlds. To have that kind of intellectual capital within our offering, I think does differentiate us with the wealth of experience that these people bring with them.

What plans do you have for expansion over the next 24 months?

AW: In 2009 we were busy delivering the integration of Lloyds TSB and HBOS to form the new Lloyds Banking Group and, as Colin said, we’ve got great people in the business now from across the two organisations. Everybody is really energised and is incredibly enthusiastic about applying our trusted risk adviser approach to a wider universe of clients.

CD: We’re going to continue to listen to our customers. Being a banking partner through the cycle is at the core of our relationship banking approach. It’s essential always to work hard to understand your clients and how you can help them deliver solutions they really want. We will therefore focus on continuing to build out our emerging market offering, building out our e-capabilities using market-leading technology and complementing this with investment in other areas such as capital markets. Our view is that you can always improve on what you’re offering with people and products and that will also be a focus going forward.

What do you believe will be the hot treasury topics in 2011?

CD: Starting with FX, we’ve seen sterling depreciate significantly this year, and our chief economist, Trevor Williams is forecasting continued weakness into next year but as volatility has been on the rise recently, bouts of strength are to be expected.

This means corporates are going to have to get used to a weaker sterling and adapt their budgets and their hedging policies accordingly. Moving to more dynamic hedging strategies could yield benefits and so could a willingness to restructure existing hedges when appropriate. With this in mind, we intend to remain in regular dialogue with our customers in order to ensure we can provide the advice and assistance needed.

AW: Diversification of funding sources will remain a priority – and Lloyds is well positioned here with its strong debt and equity capital markets capabilities. I also believe that the strength of the two-way relationship between bank and corporate will continue to be pre-eminent.