ERM: What is Treasury’s Responsibility?

By Bob Stark June 2, 2015

The financial challenges that the Great Recession imposed on many organisations pushed the treasury team front and center of corporate enterprise risk management initiatives. While the biggest mandate for treasury post-2008 has been for treasury to deliver strategic value for the organisation as a whole, the need for treasury to establish controls and mitigate risk across the enterprise is also paramount.

When it comes to ERM, it is best for treasurers to begin with risks that are within their team’s immediate responsibilities, starting with effective management of cash and liquidity.

Liquidity risk

Managing cash and liquidity is a great place to start, simply because it is so often a limiting factor for an organisation’s growth. Treasurers must know expected funding requirements with certainty so that cash deployment is optimized. Risking an overdraft is clearly unacceptable, yet having excess cash sitting in bank accounts is no longer accepted as good treasury practice either. It’s a difficult balancing act that necessitates that cash forecasts must be accurate.

Accurate cash forecasts depend on three variables:

  • Collaborating with internal stakeholders – it is key to know who owns and understands the information necessary for forecasting.
  • Consolidating data sources – this will entail automation, interfacing with ERP, and implementing modeling to confirm historic and future data patterns.
  • Measurement – implementing a feedback loop that analyzes, measures, and communicates forecast variances will offer opportunities to improve weak forecast inputs. A forecast without detailed measurement is a waste of time.

Financial Risk

While treasurers are often tasked with both interest rate and currency management, it is foreign exchange that presents a bigger issue for treasurers today. Cash forecasting can improve exposure management by identifying with more confidence expected cash exposures in a basket of currencies. Similar exercises can be done to identify balance sheet exposures. Certainty in both areas allows treasurers to confidently improve hedge performance, by taking positions that cover a greater percentage of exposures and also allow hedges to put in place over longer durations. While shareholders may forgive a bad quarter due to FX losses, they are unlikely to offer sympathies for back to back occurrences. Similarly, while gains from foreign exchange may appear positive on the surface, investors and analysts clearly know that an unhedged gain could very easily have been a loss, so goodwill won’t have been built because treasury gambled successfully with shareholders’ money.

Operational risk

Operational risk used to be an afterthought for many organisations that recognized implementing proactive monitoring, multi-layered controls, and corporate governance was a good idea but not necessarily top of the priority list. Fraud and cybercrime have changed this thinking, as criminal gangs implement well researched and perfectly executed spear phishing schemes targeting treasury and finance teams at specific organisations. Although the actual amounts defrauded may not bankrupt a global multinational, the knock-on impact of loss of shareholder and customer confidence, combined with the possibility of fines and lawsuits are making CFOs and treasurers take notice. While internal fraud is not always as likely to make headlines, it can be just as financially damaging, as these schemes can often go undetected for a long time (the average being 18 months), with millions being skimmed through illegal payments.

Where treasury can have a major benefit on fraud reduction is by implementing security processes (e.g. multi-factor authentication, IP filtering, digital signatures) and improved workflows, so that it isn’t possible to make transfers through unauthorized processes and channels. Treasury should also work with the Chief Risk or Security Officers to establish and enforce standardized policies globally, especially regarding payments,that eliminate the exceptions that fraudsters are eagerly hoping to uncover. In addition to fraud prevention techniques, detection of unauthorized activities through proactive monitoring of data (e.g. bank balances or payment acknowledgements) and workflow changes (e.g. a new bank account signatory) is an absolute must.

The Value Chain

An organisation’s suppliers and customers aren’t always something that treasurers play an active role with. Yet managing risk within the value chain can have a significant impact on a firm’s financial performance. Treasurers play a critical role in ensuring the wheels of the business continue to go round, in the following ways:

  • Supply chain finance:  With large organisations focused on working capital improvement, many CFOs look to extend payables to realize immediate impact (for example Diageo announced in early 2015 that it would extend its standard payment terms from 60 to 90 days). While DPO improvement benefits the buying organisation, the risk of supply chain disruption due to a supplier’s consequent liquidity challenges is a very real concern. Research from the Kauffman Foundation showed than the amount of small businesses that cited late payments as their largest challenge rose seven-fold from 2008 to 2010. This has driven political influence in the UK and the US, most recently with President Obama’s SupplierPay initiative, where larger firms have been told that they have a responsibility to help, rather than hurt, the liquidity of smaller suppliers. Treasurers, who manage both the firm’s cash flow as well as banking relationships, can achieve win-win scenarios where either supplier discounts can be secured by paying early (dynamic discounting) or banks and/or financing partners can pay suppliers early whilst also offering buying organisations the opportunity to pay later (supply chain finance). Neither programme happens without treasury’s experience and expertise steering the ship. Yet, in collaboration with supplier and payables stakeholders, these initiatives can eliminate risk in the supply chain as well as potential growing suppliers into strategic relationships, delivering further dividends.
  • Customer financing: Customer financing schemes can be thought of as supply chain finance in reverse. Treasurers can either offer financing using their own balance sheet or leverage their creditworthiness to partner with financers who wish to offer reasonable terms to the firm’s customers. Treasurers thus have an immediate effect on sales performance, as existing customers may spend more and new customers may be introduced. From an ERM perspective, the revenue chain is better protected from potential sales losses from customers unable to justify significant upfront cash outlays. This type of programme – like its supply chain finance cousin – is most effective in emerging markets such as China, India, and Brazil that feature high inflation and consequently higher interest rates than a European or American firm can offer directly or through partnership. In many verticals, including heavy manufacturing, customer financing is closely tied to treasury or in fact reports directly to the treasurer.
  • Counterparty Risk:  While many treasurers consider diversifying banking and trading activities across multiple financial institutions as the extent of their counterparty risk responsibilities, treasurers have more to offer. Business intelligence – analyzing ‘big data’ – can not only identify business exposures to suppliers and customers but also quantify the total risk based on a marriage of external data (e.g. credit ratings, CDS spreads) and internal cash flow forecasts by counterparty. This can establish a counterparty control centre that delivers analysis in a visual dashboard, offering important insight in an easily digestible format for treasurers, CFOs, and CEOs to deliberate.

Enterprise Risk Management presents many challenges for organisations, yet also offers opportunities for treasurers to become more strategic. ERM is a corporate-wide responsibility, yet in many ways it is a chance for treasurers to proactively contribute. Effective use of technology and visual dashboarding can enable treasurers to seize the opportunity afforded them and truly make a difference.

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