Role of the treasury in risk and governance.
Corporate treasurers have a key role to play in managing risk and
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 (
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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
Meanwhile, volatility in exchange rates and commodity prices has
contributed to a more risk-aware mind-set,
1. The act of drawing a line under; underscoring.
2. Emphasis or stress, as in instruction or argument.
the importance of
measuring and managing exposures as accurately as possible.
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
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
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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
of American companies are required to confirm in their financial
statements that they can
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
1. Mathematics A quantity into which all the denominators of a set of fractions may be divided without a remainder.
2. A commonly shared theme or trait.
: 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
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 [pounds sterling] 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
tr.v. col·lat·ed, col·lat·ing, col·lates
1. To examine and compare carefully in order to note points of disagreement.
2. To assemble in proper numerical or logical sequence.
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
n. the amounts of money due or owed to a business or professional by customers or clients. Generally, accounts receivable refers to the total amount due and is considered in calculating the value of a business or the business’ problems in paying
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.
By Ben Stollard, vice president of sales Northern Europe at Kyriba