Vít Sigmund discusses the challenges of managing a small treasury department in a rapidly growing company. He explains the CGS approach to foreign exchange risk management and illustrates how managing IT solutions can be difficult as companies grow.

How is the treasury department structured?

As a group, CGS has more than twenty individual entities. Within the holding company, we have a central treasury, which is responsible for cash flow management, financial risk management, financing the group’s activities and managing bank relationships.

In addition, every larger group entity has a treasury or financial department with one or two people whilst the smaller companies have a financial person responsible for local treasury as a part of his overall duties. They are responsible for day-to-day operations, such as making and receiving payments, reporting and liquidity planning. They also administer certain activities, which are more closely related to the individual entity than the group as a whole. For example, each group entity will manage its own letters of credit or leasing activities.

In effect, this means the treasury function within the CGS group is partially centralised.

What are you responsible for as Head of Treasury?

There are three of us in the central treasury, each of whom has a specific responsibility. For example, I am responsible for financing and establishing the finance strategy. One of my colleagues looks after hedging activities and cash flow management. My other colleague is responsible for risk management, including FX, interest rate and central credit risk management. He reports risks to our management, oversees credit risks over the group and also says when we should deal with banks and what type of deals we should use. As a small team, we also have to cover each other from time to time. As head, I oversee all activities and have to take many decisions personally.

I am directly responsible to one person from the board of directors of CGS. This means that urgent treasury problems, which are outside my responsibility, can be resolved very quickly. The CFOs of our group companies are on the same level as me. It shows that our management takes the treasury side really seriously and highlights that financing and risk management activities are well supported.

How are you held accountable?

Our main objective is to provide a good quality of service to the operating companies. In some areas such as cash management, risk management and financing, we operate simply as a service centre.

In other areas such as hedging, we work as a profit centre. For example, although we are responsible for managing foreign exchange exposures in all group entities, we can generate a profit for the group if we hedge these exposures effectively.

For example, when we receive a position from a group entity, we can hedge it or wait with at least part of this exposure. We can also measure this decision against a benchmark. Using this benchmark, we will then be able to record our hedge as a profit or loss. For example, when the Czech Koruna was more volatile, we were able to generate a substantial profit through our hedging strategies. However, this is only appropriate in markets where we understand currency movements, where we have good access to the market and good quality information, too. The Czech Koruna is our main currency and is used for all our main reporting, benchmarking and trading requirements.

How do you manage your cash?

We have four main currencies – Czech Koruna, Euro (which contributes about 70% of our turnover), US Dollar and Sterling. We also have some other currencies (Norwegian Krone, Swedish Krona, Danish Krone, Mexican Peso, Swiss Franc and Brazilian Real), reflecting the other markets where we operate. In these locations, the subsidiaries are only permitted to operate in their own currency. We control any foreign currency transactions on their behalf in central treasury.

Within central treasury, we are responsible for cash flow management. At the moment, we manage three currencies (Czech Koruna, Euro and US Dollar) through cash pooling structures, based in the Czech Republic, with our major banks. Last year, we went through a tendering process to appoint our cash management banks. At the end of this process, we appointed four banks – ABN AMRO, Citibank, Ceska Sporitelna (part of Erste Bank) and CSOB (part of KBC Group). This gives us enough banks to provide competition and also allows us to ensure our cash flow concentration is maximised. Two of them, previously fully local banks, are the best in local cash management; the two international ones support us in international payments and international liquidity management.

From April, we will introduce an international cash pool for our Euro balances. All subsidiaries in Euroland will participate in this pool. This international pool will also be a good tool for managing the financing of these subsidiaries. The international cash pool will be based in London and will connect our MITAS subsidiaries. Our main bank, Citibank, convinced us this was the best location for the pool as there are minimal legal restrictions and tax matters to consider. Citibank’s electronic banking system will also allow us to oversee these accounts effectively.

How do you manage currency risk?

We use a range of instruments – spot, forwards and some vanilla options. We also use some barrier options, because I find they can be cheaper and more efficient in some situations. All foreign exchange deals are done from the centre. We receive email or fax requests from the subsidiaries. These requests are concentrated centrally and dealt internally where possible. We will then transact any balance externally. At present we execute all our deals on the telephone, but I am looking for a more transparent and efficient way to access the market. One potential solution could be Reuters messaging after some adjustment.

How about interest rate risk?

Primarily we have a floating rate loan portfolio. Using options, we hedge a maximum interest rate for five years into the future. By using interest rate options, rather than swaps, we have found we have benefited. When measured against the benchmark of a five-year swap, we have found we have gained more than 1% on our Czech Koruna balances. For example, we were able to benefit from paying lower interest when the Czech National Bank unexpectedly lowered interest rates.

As a treasury, do you have to manage commodity price risk?

The company purchases a lot of natural rubber, mainly from brokers on the Singapore Mercantile Exchange. Managing this process is the responsibility of the department of strategic purchases. We have a Reuters screen, so we provide them with information on the market and also perform some technical analysis of the market.

How do you measure these risks?

We still use position reporting to measure risk. We don’t use Value at Risk or Cash flow at Risk, because we do not have the necessary IT solution and the calculations are too complicated to perform in Excel. In future, if we implement a treasury management system, we may start to use a VaR technique to measure risk.

How do you arrange funding for the group?

Over the last year, we have taken a big step forward in our financing. We have arranged a syndicated structure, which provides for three separate credit lines (one each for CGS, MITAS and RUBENA). Through our main arrangers (ABN AMRO, Citibank and Ceska Sporitelna), we have arranged lines totalling CZK3.6 billion. This arrangement is committed for five years. Under the terms of the loan, the three subsidiaries can raise funds for both investment purposes and to fund general operations on a short-term basis.

This structure has a number of advantages. It minimises liquidity risk. We used it to repay some previous credit lines. Also, by consolidating our bank portfolio, it is now much easier to communicate with the banks. Now we only need to communicate with one agent who manages reporting to the banks.

This syndicated facility represents about 70% of the group’s funding requirement. The remainder is managed through short-term borrowings and credit lines.

How do you manage bank relationships?

When managing bank relationships, our philosophy is to cooperate with three or four banks for a minimum of three years. For example, in last year’s tender for cash management business, we chose the four banks. Within this group, we found we like different products from different banks – one bank manages our international payments, a second our CZK collections and a third our trade finance, such as letters of credit. I also think it is useful to perform a tendering process from time to time.

How do you use technology within the treasury?

At the moment, we have a special tool, called Real System 2000, which we use to manage our foreign exchange risk, foreign exchange positions and foreign currency cash flows. It is a Microsoft Access database, which has been programmed by a small Czech firm and developed to meet our own needs. We spent a lot of time developing this system, so we now have everything we need for foreign exchange dealing. All our trades can be entered into this system, marked to market and measured against a benchmark.

The problem is that this system is not enough for us today. The company is growing rapidly. Last year’s acquisition of Continental’s Agro business almost doubled our incomes. This means we now need to adopt a bigger treasury management system, which will allow us to see the group’s cash flows in much more detail and so we can prepare our hedging activities much more efficiently than at present. At the moment, we are reliant on Excel spreadsheets, with some Visual Basic programmes.

We use electronic banking software, too. Our main system is Citidirect, which is an internet-based electronic banking system. I am really satisfied with it as it allows us to manage our balances abroad. We also use Multicash. All our subsidiaries have interfaces between their own IT solution and the electronic banking systems. Finally, we have a Reuters screen to provide us with market data.

It is necessary to say that all these systems stay outside our corporate IT platforms. In Mitas, we have SAP; in Rubena we have Movex. Unfortunately, we have different IT platforms in every company at the moment and we do not have any central data warehouse. If I get approval for the new central treasury management system, this will improve the links between the local and central treasury IT platforms. I hope it will reduce certain costs within our subsidiaries.

What do you see as your challenges over the next few months?

I want to finalise an ongoing project designed to optimise our credit risk management. We decided with the increase in income, we had to improve credit risk management. Together with our advisors, we are preparing a new system, which starts from credit scoring and uses hedging, bank guarantees and credit insurance to protect against loss.

We also need to improve our IT support within treasury. I want to persuade the company management to invest in a treasury management system. I hope to prepare a proposal during the second quarter of this year. The first step will be to conduct a feasibility study. I will look at a range of systems and take up references. I will also discuss the alternatives with risk colleagues, such as those in the Czech Association of Treasurers, before taking a final decision. I would hope to implement such a system by the end of the year.