Where there is business, there will be risk. That is the nature of the beast. But just like businesses, risks are not static, with some rising to the fore whilst others lay dormant in the background. And then an incident erupts somewhere in the world, and those that were dormant are now very active.
Generally speaking, there will be commonalities in the risks that businesses face. The impact that these risks may have on the business is, however, very dependent on the nature of the business, the markets it is active in and a number of other criteria.
In this article, we use the findings from Treasury Today’s 2016 Voice of Corporate Treasury Study to hone in on what the key risks are for treasurers both today and in the future and then take a look at the strategies that can be employed to not only mitigate these risks, but in some instances, turn these into opportunities.
These have not been easy times of late for corporate treasurers. Intense volatility and uncertainty across the commodity and currency markets has become the norm, causing many headaches for practitioners. This challenge has been reflected in our recently published Voice of Corporate Treasury Study, which found that currency volatility and commodity prices currently rank amongst the top five risks for treasurers around the world.
Although the management of market risk is certainly not a new area of focus for corporate treasury, new realities are demanding new approaches. Most notably the need to be proactive in the management of these risks.
The incessant tide of commodity and currency price fluctuations has created a glut of challenges for the corporate treasury department, especially around accounting and forecasting. If these risks are not managed correctly, then these swings can have a significant impact on the treasury operation, creating losses and perhaps even the potential risk of a ratings downgrade and an increased cost of access to capital. The impact can be even more profound on a company’s share price, creating uncertainty in the value of the company and drawing the attention of the boardroom.
But many corporate treasury departments are not in a position to manage these risks sufficiently. “Generally speaking, to manage these risks proactively corporate treasury departments need greater transparency over their asset classes across the business than they currently have,” says Mark O’Toole, Vice President, Commodities and Treasury Solutions at OpenLink. “In doing so they will be in a better position to view their cash and risks in real-time which is crucial.”
Achieving this, as many treasurers will attest to, is very difficult. As they have expanded, companies have seen departments become autonomous units in their own right, adopting their own technology to meet their specific needs. In the finance function alone it is typical for there to be between three and seven different systems in place just to manage day-to-day operations.
When managing risk, treasury will typically extract all this information and enter this into a spreadsheet. “These processes can take a considerable amount of time depending on the complexity of the organisation and the disparity of systems and data,” says O’Toole. “By this point the markets may have changed and treasury will be on the back foot again.”
This is beginning to change, albeit slowly. “The pressures to reduce capital expenditure and increase margins have forced the hand of the treasurer,” says O’Toole. “Gone are the days of running multiple systems to manage day-to-day business operations. Today, it’s all about reducing the number of systems and manpower to operate them, and having the tools to gather detailed insight into activity and gain more predictable outcomes.”
There are numerous players in the market offering holistic risk management solutions that can help corporates achieve this. “The existing base of best-of-breed treasury management system (TMS) and enterprise resource planning (ERP) vendors are continuously developing their products,” says Tobias Westermaier, Manager at Zanders. “On top of that we have seen a recent rise in specialist vendors addressing a specific element of the treasury process.”
Of course, all of these solutions will offer varying levels of functionality so it is important that one is selected which meets the specific needs of the company. But, no matter which solution is selected, it must give treasury access to reliable, complete and consistent data, available on a timely basis. Then, from this base, risk can start being analysed more proactively and holistically, perhaps providing the business a competitive advantage.
Changes in process
Bringing all this siloed and inconsistent data together however, so that it can be viewed through a single window, not only requires a change in technology. It also demands a change in thinking across the company and the need for silos to be eliminated, fostering a cross-functional and holistic approach to risk management.
According to O’Toole, the companies that manage risk best have done this by centralising their processes and appointing a Chief Risk Officer (CRO) who will help drive a concentrated focus on risk across the company. “A CRO, who will have an intimate knowledge of risk fostered over many years, can help create a risk framework, shape the policies and then help all the various business departments understand risk holistically,” says O’Toole. “Typically, risk specialists were once few and far between, often concentrated within the banking sector. However, since the banks have begun deleveraging we have started to see a lot of these risk experts jump to the corporate side.”
The treasury department, with its intimate knowledge of financial risks could be seen as a candidate to take on this role. O’Toole advises however, that whilst this could work theoretically, a CRO typically will dive further into risk than a treasurer typically would, using a raft of complex tools to measure items such as Value-at-Risk (VAR) and potential future exposure. That being said, the treasury should be aligned very closely to the CRO and be a key ally in the management of risk.
With risk centralised at C-suite level, the CRO can work hand-in-hand with other executives within the business to create more sophisticated risk management policies and guidelines than perhaps existed before. Mark van Ommen, Director at Zanders highlights that this is a trend at present: “We are seeing many of our clients creating much more sophisticated policies. They are also looking to leverage outside expertise in order to understand what other companies are doing and the lessons that can be learnt from this.”
However, the creation of policies is one thing; these also need to be closely adhered to for them to be effective. To do this, van Ommen is seeing many corporates building dashboards to track risk performance. “In doing so they are not only tracking traditional key performance indicators (KPIs) but specific key risk indicators, directly related to the risk-bearing capacity of the company.”
Fit for the future
In bringing the processes and technology pieces together, a corporate should end up with a single centralised system that highlights the risk across the entire enterprise in real-time. This will be controlled at a central level by a CRO, but utilised by various departments across the business, all of whom are aware not only of the risk faced by their function, but also that faced by others. And it is from this position that a business can truly begin to proactively manage risk.
“To do this companies can begin looking at stress testing and scenario analysis,” says Zanders’ Westermaier. “In doing so they will be able to see how their business reacts in different scenarios and put in place strategies and processes should these manifest in reality.”
For O’Toole this point is especially important. “Take the example of sterling in light of the Brexit referendum result, there is no telling what level it will be trading at over the coming months,” he says. “But by being in a position to proactively manage risk, you will be able to use scenario testing to see what the impact will be on the business and proactively manage that, no matter which way the currency moves.”
Ultimately, corporate treasurers should be a leading voice in the organisation over the coming years, developing and driving long-term strategic plans based on latest developments and thinking about what the future disrupting factors on the business will be. The risk management policies and procedures should reflect this and be integrated with, embedded in and understood by the wider finance organisation and business as a whole.
Deeply entwined with market risk is geopolitical risk. Indeed, as the world awoke on the morning of Friday 24th June, the British, European and even global political landscape had changed. The (arguably) shock decision made by the British people to leave the EU had opened up a Pandora’s Box of what ifs and maybes.
Brexit immediately sent shockwaves through financial markets across the globe. The pound fell to a 31-year low against the dollar, the world’s major stock markets plunged in volatile trading and bond yields soared in safe-haven government debt.
In the months since then we have seen further financial impact, including a number of investors rushing to pull money out of commercial property, the Bank of England adjusting capital ratios to free up more funding to individuals and businesses and the pound and stock markets continuing to show high levels of volatility. All the while, in the wake of the decision a political vacuum had appeared in British politics, at a time when the Isle was calling out for strong leadership.
Yet, for the corporate treasurer, this was just one of many incidents that have occurred in recent months and years that have required careful attention. Indeed, few would disagree that the world has entered a new stage of political and economic uncertainty, leaving the fortunes of businesses on a knife edge and putting corporate treasurers at the sharp end.
Understanding geopolitical risk
Geopolitical risk is somewhat of a ‘catchall’ phrase that seeks to encompass all risks that are generated as a result of political decisions. These risks may appear in a variety of guises and can impact either individual businesses, specific sectors or the economy as a whole. Some prominent examples of actions that can create geopolitical risk include: war and conflict; changes in governments; regulatory changes; changes in the tax code; currency revaluations; trade tariffs; labour laws; environment regulation; and changes in government spending.
Yet, in some respects, even this definition is unhelpful because incidents such as terrorism, which is not necessarily committed by state actors, also falls under the purview of geopolitical risk. Geopolitical risk may therefore just be one of those ‘you know it when you see it’ issues.
But just because geopolitical risk is hard to define, it doesn’t mean that it is not vital to understand. “The impact of geopolitical risk on corporates is vast,” says Charlotte Ingham, a Principal Political Risk Analyst at risk and strategic consulting firm Verisk Maplecroft. “This risk can be operational in nature, in terms of the physical security of their facilities and staff or the potential disruption to their logistics, or legal, if you look at things like corruption risk and the potential ramifications of violating the US Foreign Practices Act or the UK Bribery Act, as well as financial.”
Beyond the operational and financial consequences, political risk can damage a corporate’s image as well. “There are big potential reputational risks for corporates with operations in countries which have poor records on democratic governance, political violence, or human rights,” adds Ingham.
A changing world
So what are the key geopolitical risks that corporates and their treasury departments need to keep at least one eye on over the coming few years? Unfortunately, no business has access to a crystal ball. The past, therefore, has to be used as an indicator for the future. And there are a handful of megatrends that currently exist in the geopolitical space that are having a large impact on business operations and will continue to do so in the short term at least.
“More than five years since it began, we are very much living in a post-Arab Spring world,” explains Ingham. “While the obvious consequences of this are the greatly increased levels of political violence in Egypt and Libya – to say nothing of Syria – its consequences are being felt far beyond the MENA region.”
Indeed, as we have witnessed there has been a massive outflow of refugees and the significant rise in political violence in Europe and the US due to an increase in the frequency and intensity of terrorist attacks. “These changing conditions not only have implications for the security environment for business, but also for the policy environment,” she adds. “If you look at the extent to which security and immigration have been key themes highlighted in the debate around Brexit, and the way in which increased migration has exacerbated political polarisation elsewhere in Europe, you can see how this issue is creating increased uncertainty for companies operating across Europe.”
Yet, whilst organisations have evidently been impacted by these events, the actions of businesses themselves has also increased their exposure to new geopolitical risks. As Ingham explains: “At the same time as all these events have been unfolding, we’ve seen companies venture further out from home markets and rely on increasingly diffuse supply chains. As a consequence, they face an increasingly complex interplay of political risks.”
For the corporate treasury department regulatory risk is always front of mind given the impact changes in financial regulation can have on its operations. And, globally speaking, the regulatory environment is only increasing in complexity. Indeed, data from Thomson Reuters highlights that in 2015 there were roughly 50,000 regulatory changes made by 600 different regulators around the world. That is 150 regulatory changes every single day. Of course, it is extremely unlikely that all of these impacted the corporate treasury function directly, or even the organisation more broadly. But they may impact another party in the ecosystem, which may then have a knock-on effect.
It is highly likely that this trend will continue. Indeed, Verisk Maplecroft’s Regulatory Risk Index, highlights that 45% of countries are host to extreme or high risk regulatory environment. “The quality, stability and predictability of the regulatory environment is the most significant challenge facing business,” she adds. “Onerous regulation increases both the time and cost of doing business, while ill-defined, poorly targeted and unevenly enforced legislation creates significant uncertainty around compliance requirements.”
One notable example, from a cast of many, where the corporate treasury was directly impacted comes from a move taken this year by the Chinese regulators to limit the cross-border flow of currency through sweeping arrangements. The ‘window guidance,’ (an uncodified regulatory change) put a halt to the cross-border RMB flow, leaving many treasury teams scrambling for answers around what this meant and how it would impact their global cash management operations.