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Corporate treasurers have a key role to play in managing risk and supporting corporate governance within their organisations.

Different types of risk require different mitigation techniques, but whatever the risk, gaining visibility and control over the company’s exposures is a crucial first step.

A dedicated Treasury Management System (TMS) mitigates operational risk by reducing the risk of error and fraud, while also providing the tools needed to manage other types of risk.

Managing risk is one of the core responsibilities of a corporate treasurer. While this has long been the case, effective risk management has never been a higher priority than it is today.

Since 2008, treasurers have focused on a far wider range of risks than in the past – most notably in the area of counterparty risk.

Meanwhile, volatility in exchange rates and commodity prices has contributed to a more risk-aware mind-set, underlining the importance of measuring and managing exposures as accurately as possible.

Risk concerns
Today’s corporate treasurers are required to manage a multitude of risks, including interest rate risk, commodity price risk, regulatory risk and business continuity risk.

While most corporations will experience all of these to some degree or another, for many the three types of risk that pose the greatest challenge are foreign exchange (FX) risk, counterparty risk and operational risk.

Managing FX risk is a central concern for treasurers of multinational companies. Such companies typically face three different types of FX exposure: transaction exposure, translation exposure and economic exposure.

Transaction exposure relates to transactions carried out in foreign currencies; if the exchange rate moves unfavourably the company may receive less cash than expected.

Translation exposure is the risk that the company’s balance sheet may be affected by currency moves and applies if the company holds assets or liabilities in foreign currencies.

Economic exposure arises if the value of the company’s cash flow is affected by exchange rate moves.

Counterparty risk is another major concern and can be defined as the risk that a counterparty fails to meet its contractual obligations.

The way in which counterparty risk is managed has undergone a significant transformation since 2008.

Companies did, of course, manage counterparty risk before the financial crisis, but in many cases they did so by focusing mainly, if not exclusively, on mitigating the risks associated with the company’s investments.

This changed following the collapse of Lehman Brothers and other institutions at the height of the crisis. Companies came to realise that their counterparty exposures stretched far beyond the area of investments.

Today, treasurers include exposures relating to the company’s suppliers, customers and banks when they look at counterparty risk. If a customer fails to pay, the company loses money.

If an important supplier goes bankrupt, the company’s ability to manufacture, deliver and therefore sell its own products may be disrupted.

If a bank fails, a company may lose its deposits – or if those deposits are covered by government insurance, recovering the funds may be time-consuming and slow.

A third major category is operational risk, which is the risk that losses can arise as a result of errors, or indeed deliberate unauthorised actions, originating from within the company.

The treasury is responsible for ensuring that adequate controls are in place around the flow of cash, which are robust enough to prevent errors and fraudulent activity from taking place.

Failure to manage operational risk appropriately can have severe consequences for individuals, as well as for the company.

For example, under the Sarbanes-Oxley Act, the CFO and CEO of American companies are required to confirm in their financial statements that they can attest to the company’s controls being adequate to protect its workflow and information process.

Visibility and control
Companies face a diverse range of risks, but when it comes to managing them there is a common denominator: the need to obtain visibility and control over the relevant exposures.

Managing counterparty risk has become a significantly greater task since the scope of counterparty risk expanded.

In order to manage it, the treasurer must first identify which counterparties the company is exposed to and the nature of them.

In the past few years, many companies have introduced counterparty limits into the treasury policy, or made their limits stricter.

Such limits may identify the institutions the company may bank with and cap the amount the company is prepared to deposit with a particular bank.

Managing FX risk is an essential part of the treasurer’s role, but how can treasurers do this accurately and effectively?

Treasurers are not FX traders and the ability to predict exchange rate movements is not usually part of their skill set.

Managing FX risk does not involve anticipating market movements; the object of the exercise is to reduce the impact of FX risk on the company’s financial assets.

As with counterparty risk management, treasurers need to have the best possible visibility over the company’s FX exposures in order to understand them fully.

From that understanding the treasurer has the information needed to manage the risks, typically by undertaking a hedging programme.

The actions taken to hedge FX risks can include the use of financial instruments, but can also involve identifying natural hedges within the organisation.

Managing risk with a treasury management system Unlike FX risk and counterparty risk, operational risk arises from within the business rather than as a result of external factors.

It is the treasury’s responsibility to put in place controls around the flow of cash that are robust enough to prevent errors and fraudulent activity from taking place.

Technology plays an important role in mitigating operational risk. Many corporate treasuries continue to rely on spreadsheets, but it is widely acknowledged that this practice brings a significant risk of errors occurring in the company’s financial data.

While spreadsheets offer a cheap and flexible way of managing information, they are also notoriously error prone.

From broken formulae to inaccurate input of data, the use of this type of technology in treasury can, and does, lead to errors – and inaccuracies in the company’s core financial data can have serious and far-reaching implications.

A dedicated TMS is designed to provide and support the controls needed to minimise operational risk.

Processes and formulae are automated wherever possible, thereby significantly reducing the risk of error.

A TMS also enables treasurers to establish controls in order to comply with external requirements, such as Sarbanes-Oxley in the US, or with internal governance requirements.

For example, a TMS mitigates the risk of fraud by employees by enforcing the segregation of duties – in other words, stipulating that the user or users authorised to initiate payments are different to the user or users who approve those payments.

Other limits can also be integrated into the approval process.

For example, treasury staff at a certain level may be authorised to approve low-value payments, but a more senior member of staff may be required to approve a transaction exceeding £10m.

TMSs have a clear role in mitigating operational risk, but they also play an important role in helping treasurers manage other types of risk. In order to manage FX risk, the treasurer needs to have the right processes, information flows and technology, and it is the treasurer’s responsibility to optimise all three of these areas in order to gain as much visibility as possible over the company’s FX exposures.

Likewise, a TMS supports treasurers in managing counterparty risk by providing visibility over the company’s exposures.

For companies that do not have an integrated TMS, it is difficult to manage such risks effectively.

If information is held in a range of disparate systems, the treasurer may be able to see pieces of the picture individually, but they will not be in a position to collate the information into a single dashboard or report that allows them to access, analyse and make decisions on the data quickly and accurately.

The object of risk management is to protect the value of a company’s financial assets, which includes everything from investments and cash to accounts receivable and liabilities.

Without visibility and control, treasurers cannot fulfil their responsibilities, which include protecting a company’s financial assets from undue risk and providing proper corporate governance in managing these risks.

A TMS can help treasurers meet these objectives, thereby enabling treasurers to fulfil their role in supporting corporate governance.

Photo: SuperStock


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