Managing company lifeblood

Perhaps more than any other senior executive, treasurers are faced with a daunting responsibility: maintaining the safety and security of the business’s lifeblood – its cash. Also, in the post-crash era of increased regulatory scrutiny and lower returns, they are expected to combine cautious cash stewardship with the ability to maximise opportunities to drive yields. With so much at stake, financial risk management is central to a treasurer’s role.

Treasurers are coming to terms with the structural change that has taken place in the financial markets where they now have to borrow money in advance of needing it.

“In the past, funding was generally readily available and it was more a question of how we fund rather than can we fund it?” says Matt Cooper, group treasurer at social housing provider Affinity Sutton. “That’s now changed and it is a big difference. But it has demonstrated to the wider business that the treasury function does have greater expertise and knowledge that it can bring to the fore.”

While the perception has grown that corporates are sitting on piles of cash, ready to invest, the reality is treasurers must maintain a safety-first approach

Colin Tyler, chief executive of the Association of Corporate Treasurers, points out that just a few years ago most corporates would simply borrow what they needed on a just-in-time basis since the banks were capable of lending on unsecured, unconditional terms. Those days, Mr Tyler says, have gone.

“If you’re managing a funding strategy, you’ll have an eye on the fact that those patterns you’ve relied on in the past are not going to be there for the future, so you’re going to take more control yourself,” he says. “But organisations that have access to the capital markets will use it. That then means they will be borrowing money in advance of needing it and, therefore, you’ll have some cash at hand.”

Mr Tyler says that, while the perception has grown that corporates both in the UK and beyond are sitting on piles of cash, ready to invest, the reality is treasurers must maintain a safety-first approach.

“It’s a convenient truth to say people are doing nothing with their money, but if you’re borrowing money and it’s costing you, and you’re getting nothing for replacing money on deposit, you’re not going to start putting that cash to good use, because at the moment those funds are there to ensure organisations can meet their liabilities as they fall due,” he says.

So beyond this, what are the key risks and how are treasurers meeting the challenges they present?


For many treasurers, in recent years, their role has evolved away from focusing on simple hedging and funding to a more proactive style of risk management. Take commodity risk management. Any business exposed to commodity prices will have experienced a difficult few years. Price volatility has eaten into margins and challenged treasurers to work hand in hand, not just with general finance colleagues, but also procurement teams to ensure volatility doesn’t have too marked an effect.

To meet this need, treasury management system vendors have developed more intuitive products to help businesses. SAP, for example, offers a commodity procurement tool that bolts on to traditional enterprise resource planning systems, and allows treasurers to automate and integrate purchase of commodities, giving the treasury function greater visibility of what it’s buying, when and for how much.


The foundation of much corporate treasury work is does the institution that funds our business, offers credit and provides services have sufficient strength? Understanding counterparty risk used to involve the treasurer working to a simple formula of SLY – security first, liquidity second, followed by yield. That formula remains a handy mnemonic for treasurers, many of whom now look beyond simple bank risk towards corporate counterparty risk – do trading partners have sufficient coverage for the relationship? – as well as exposure to government and the markets.

One of the most commonly used risk management tools when assessing and managing counterparty risk are credit ratings. Despite the battering the ratings agencies took over the financial crisis, credit ratings still perform a critical role in helping treasurers manage counterparty risk. Many businesses will build their credit risk strategy around a series of tolerances of various ratings, limiting the amount placed with institutions or funds with lower ratings, and placing more with safer, AAA-rated banks and other institutions. Of course, ratings change so the savvy and commercially minded treasurer will be ready to move funds around as counterparties change their risk profile.


For the majority of treasurers, the relationship with banking partners sits at the heart of the matter. And the banks are, for the most part, the most important providers of liquidity. However, new banking rules will put greater pressure and scrutiny on treasurers to manage liquidity risk. Under new Basel III regime, the rules governing how banks manage their liquidity have changed.

There are now two new liquidity measures that banks need to meet: the liquidity coverage ratio, which requires banks to maintain a buffer of high-quality assets to cover 30 days of outflows around liabilities; and the net stable funding ratio, which demands that banks hold on to long-term assets for the purpose of funding, and a minimum level of stable liabilities in relation to their liquidity risk profiles. Both these rules will require treasurers to take a more proactive approach to choosing which banks to partner with and how to leverage their exposure to ensure the bank offers the right levels of liquidity at the right price.


Treasurers, of course, are not immune from changes in regulations governing banking and corporate funding. Indeed, they are in the front line. The most important changes have been seen in global banking, where a new compliance regime, introduced in the wake of the financial crisis, is now being felt.

Put simply, Basel III demands banks hold more capital, and as a result this will have several major impacts on how banks interact with and serve their corporate clients. The first is capital. All kinds of transactions will now require more capital from banks. In particular, the new capital adequacy rules may have a punitive effect on banks in terms of the capital they must hold. Consequently, the prices of financial products will be affected, with the creditworthiness of the corporate counterparty determining the size of the impact.

Alongside this, greater oversight and scrutiny of the way banks manage their own risks will also affect the corporate treasurer. Documentation requirements will increase as regulators demand to “look under the hood” of banks’ lending to clients, leading to treasury teams expanding headcount to meet the new demands.




“A significant foreign exchange exposure should never arise unexpectedly,” says Hennie de Clerk, chief executive of TreasuryOne, a consultancy that works with corprorate clients to improve their treasury risk management. With good forward planning on foreign exchange (FX) strategy, a significant part of treasury’s work should be achieved well before a contract is agreed, he says.

“A series of decisions will be made in treasury middle office on the basis of documented policy, view and risk appetite as set at board level. Typically, corporate policy is tolerant of commercial risk, but averse to market risk. Documented workflows for identifying and managing risk will therefore be in place and a formal market view sanctioned,” says Mr de Clerk.

“Boards realise that they are unlikely to be smarter than the markets in which they operate. Consequently, in a volatile context, the corporate’s objective is usually to hedge as close to 100 per cent of market risk as possible.

“Risk needs to be recognised and managed as early as possible. Even during the bidding process for a contract, therefore, policy may require that the value of a potential deal with a foreign currency component be protected. For the purpose of protecting against such contingent exposure, a compound option or “option on an option” may be purchased.

“One of the first questions for treasury is whether natural or organisational hedges can be achieved, reducing cost and settlement risk. The classic example is using the dollar denomination of crude oil to hedge dollar exposures, but similar relationships also exist between oil and Nigerian and Russian currencies. The proposed contract will be scrutinised for embedded derivatives at this stage.

“If exposures to multiple correlated currencies are created or if the currency of the exposure is not traded against the base currency, proxy hedges may also need to be considered, using a correlated currency or commodity, but this introduces another level of risk.

“The choice of instruments and tactics for executing straightforward financial hedges will be determined by high-level policy. Certain instruments may or may not be sanctioned. At a straightforward level, instruments range from currency swaps, forwards or an options-based strategy, such as collaring. For treasury purposes, hedge effectiveness is generally at odds with being in the money.

“Then, the issue of translation or accounting exposure will have to be considered. Are the exposures long or short term? That is, do they extend further than three to five years, and could they affect profit and loss volatility? If so, treasury’s task will be to ensure that the exposure and hedging relationships are documented in accordance with International Financial Reporting Standards Foundation or local accounting principles, and hedge accounting achieved.

“As the contract materialises, treasury dealers and the front office will step in to execute the hedge. Choice of tactics will be determined largely on cost and the capability of sanctioned instruments to match the exposure – rarely 100 per cent achievable with exchange-traded instruments. Trading controls will also be in place to ensure competitive cost is achieved. Treasury policy will dictate the level of counterparty and country risk that can be assumed.

“Finally, treasury back office will be monitoring cash and FX forecasts against actual exposures, taking steps, if necessary, to bring hedges within mandated effectiveness.

Hedge effectiveness will be managed by frequent mark to market of both instruments and the fundamental exposures to which they relate. In addition, counterparty risk management is an ongoing task. Metrics such as credit default swap spreads and ratings will be regularly monitored and, if necessary, treasury will intervene to bring risk levels within acceptable maxima. These fundamentals of treasury risk management should be reported directly to the board.”