The conference room where I presented at this year’s AFP
conference with Louis Edwards, assistant treasurer, global risk management at
Novelis, was filled with industry professionals eager to hear how one treasury
peer took risk management to another level.
Having worked in partnership
with Novelis over the past seven years at Reval, I was happy to join Louis in
his presentation, which demonstrated his skilful approach to the continuous
development of Novelis as a more risk-aware organisation. While he shared
concepts that can apply to any risk, he specifically covered the complexities of
commodity risk management and the lessons learned. However, to really understand
the evolution of how risk management became an integral part of Novelis’
business Louis took the audience through some important changes that occurred in
the company’s history and the role that risk management played in it.
Novelis purchases aluminum cans and ingots and converts
them into rolled sheets, which are then sold to manufacturers, who make car
bodies, cans and all sort of other aluminum objects. The company does this all
over the world.
Novelis was established in 2005 as a spin-off of the
rolled product division of Alcan, a vertically-integrated aluminum producer.
During the Alcan days, Novelis was a value-add to a large aluminum miner,
refiner and provider, whose sole risk management focus was on the price at which
refined aluminum could be sold. Once spun off, Novelis had to buy much of its
aluminum, which then created both a cost and revenue risk focus. This changed
the risk management culture completely, as aluminum purchases were now central
to the business and presented many risk management challenges.
Novelis was acquired by Hindalco, which in recent years has grown to become one
of the top five aluminum majors worldwide and the largest vertically integrated
aluminum company in India. Now part of Hindalco’s portfolio investment, Novelis
was required to increase its focus on risk management even further.
Evolution of a Best Practice Risk Management Function
In the six years
since the Hindalco acquisition, Novelis evolved its risk management approach by
more deeply understanding its exposures, minimising earnings volatility by hedge
accounting, complying with new regulations, and, more recently, by proactively
scoring its counterparties performance, evaluating the best time to trade
derivatives for a global organisation and instilling a corporate risk management
culture with its risk management playbook. Below is a brief recap of the key
steps Novelis took to continuously improve their approach to risk management:
- Bringing the capped contracts under control.
- Gaining an
understanding of how the inventory lifecycle impacted on earnings.
- Mitigating earnings volatility from derivative unrealised gains and losses
by applying hedge accounting.
- Applying hedge accounting across all asset
- Adopting Financial Accounting Standard (FAS 157) – now
Accounting Standards Codification (ASC) Topic 820 – Fair Value Measurements and
- Scoring counterparties and negotiating improved terms
- Improving trade execution by region based on
favorable trading times.
- Publishing a risk management playbook for
Novelis’ hedge accounting and regulatory reporting
required a scalable, sophisticated system that could handle large volumes of
trades and hedge designations, support large market data sets of exchange and
custom commodity curves, and credit default swap curves. The system also needed
to support complex valuations of derivatives and exposures, and calculate
regression statistics (R-Squared, slope, p and t statistics), and it needed to
be able to report on these metrics at the summary and hedge program level.
Reval gave Novelis the ability to do all of this quickly and
efficiently, and enabled quarterly reporting to be completed very quickly. More
importantly, it enabled the company to be more proactive in continuously
improving its risk management practices, illustrated by counterparty scorecards,
a risk management playbook and a global trading analysis review.
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This year promises to further the regulatory compliance burden imposed on financial institutions. How are firms in the sector responding to the challenge?
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