It took several financial scandals to propel the issuance of deal confirmations by corporate treasuries from standard practice to best practice. Little more than 10 years ago, many corporate treasuries did not generate their own confirmations; their back office teams simply sight-checked the counterparties’ confirmations as and when they were received. This approach lacked robustness and objective control, starting with the absence of a formal record of the deal originated on the corporate treasury side.
Today’s standard approach increasingly involves specialist electronic confirmation services to generate and match confirmations between corporates and counterparty banks. These provide the essential status feedback to both parties so the process may be monitored, and timely intervention made to avoid the costs and risks of deal settlement failure, such as interest charges.
These services accommodate a range of treasury instruments, although e-mailed confirmation letters may still be needed for transactions in less common instrument types.
The set-up of a confirmation management environment is another demanding static data management exercise, with complex rule-driven solutions needed by different counterparties and instrument types. This complexity extends to both electronic and manual confirmation management, but is the price for security and transparency.
The information collection and validation exercise for confirmation management environment – combined with managing other key counterparty data such as standard settlement instructions – can be an unexpectedly demanding component of TMS implementation. However, the resulting benefits include substantially enhanced audit quality.
The underlying treasury control quality gain from automated separation of confirmation issuance and matching from dealing is significant. A locked-down automated process ensures that an accurate confirmation is sent to the deal counterparty once each deal is executed. The electronic matching process compares the corporate’s confirmed deal information with the counterparty’s – and automatically notifies both parties of differences. Similarly, the receipt of a confirmation not matching anything received from the ‘other side’ should trigger investigation and remedial action. The key point is that the matching service provides an automated, independent authentication between the parties of a deal; a powerful control tool for detecting errors and omissions and correcting them before settlement.
A further benefit from this technology is that it provides an early opportunity to detect any rogue trading – provided that the confirmation management process is fully segregated from the dealing process.
Where manual confirmation process must be used, performance of the confirmation issuance process and subsequent completion of visual matching with the counterparty’s incoming confirmation should both be flagged by updates to the deal record the TMS database, to control subsequent workflow and provide event entries for the audit trail.
There is often a legal requirement to confirm inter-company deals; automation of this process again representing treasury operations best practice. TMS communications of inter-company deal confirmations are often web-based.
Successful deal confirmation opens an important control gate in the treasury dealing workflow, enabling subsequent automated operations to proceed with a high level of confidence.
The TMS controls the timely initiation of the deal settlement process, helping minimise the risk of late or inaccurate operations. The automated workflow is often triggered by an update that verifies that successful confirmation matching has been achieved.
Collecting and updating a full set of standard settlement instructions for all counterparties and deal types is a demanding implementation exercise and another prone to underestimation. An ongoing benefit is the establishment of a secure and automated settlement workflow. TMS implementations naturally bring strengthened control functions, as the full instruction set required can be fully validated and then locked-down for secure live operations.
Further useful technology supports in the settlement workflow are the diary and scheduler functions built into TMSs. Users are alerted automatically when settlement interventions by the treasury team are needed. Further, many settlement processes may be started automatically by the TMS in good time for currency cut-off deadlines. Each deal-related cash flow will have a value date, and perhaps an action date attached, and is used by the TMS to initiate payment execution.
Often, treasury deal settlement payments to one counterparty bank account are netted together into single payments by the TMS to minimise bank costs.
It is standard for a payment release operation by an authorised individual to be included in the settlement workflow and there may be additional authorisation and approval interventions included in the automated process.
Overall, technology offers a dependable treasury transaction settlement environment, in which events are kicked-off promptly to minimise the risks and costs of failures. The automated TMS actions are driven by the detail defined in the static and transactional data, and the TMS will also be set up to alert designated team members when intervention is required to complete a settlement action successfully.
The completion of the treasury dealing workflow is the treasury accounting process, to be fully addressed later in this series.
In summary, all TMSs generate cash flow based accounting journals (‘cash accounting’), and also calculate accounting values such as mark-to-market (M2M) revaluations of FX contracts, interest accruals on loans and deposits, and discount accretion on instruments such as bills and commercial paper (‘financial accounting’).
Accounting actions and processes are driven by the pre-defined accounting framework, represented by the Chart of Accounts and accounting rules for the group or corporate entity. The accounting journals are usually exported to the corporate or local enterprise resource planning (ERP) or accounting system, either in detail or summary.
The ease with which the accounting framework can be changed within different TMSs varies, and the degree of flexibility can impact in adjusting treasury accounting to reflect changed accounting needs following actions such as corporate mergers and acquisitions – an important factor to consider in TMS evaluation for acquisitive organisations.
TMSs also vary in their capabilities to support trial balance management, and the related balance sheet and profit/loss reporting needed by some treasuries.
TMSs routinely include a hedge accounting solution as an integral part of treasury accounting, for IFRS 9 compliance. The technology addresses the demands of hedge designation – the facility to link underlying exposures with their hedges – and effectiveness testing. Solutions differ in their scope and transparency of hedge accounting functionality.
The preceding article outlined how the dealing process can be integrated with risk management functions such as the ‘what-if?’ evaluation of possible deals, yield curve stressing, mark-to-market (M2M) revaluation and counterparty limit management. Some higher end TMSs further integrate the dealing workflow with more advanced risk management disciplines such as value at risk (VaR) and Money at Risk derivation and Monte Carlo simulation.
The power and sophistication of different vendor offerings in this area varies. Most treasury dealers appreciate intuitive TMS risk management functionality that combines seamlessly with deal execution logic, and includes functional scope to support the demands of treasury risk policy.
So far, the treasury hedging, dealing and investment workflow has been treated generically. This section reviews the specific instruments encountered in corporate treasury FX, interest rate and commodity hedging operations in global corporate treasuries.
For present purposes, ‘support’ by a TMS is defined to include initial deal capture, confirmation, settlement, treasury accounting and basic risk management functions.
Instruments may be dealt externally in the financial markets, or on an inter-company/in-house bank (IHB) basis.
TMSs routinely support FX spot, forward and swap dealing, fulfilling most corporates’ needs for FX hedging, to mitigate transaction and translation exposures.
Option support has remained at the vanilla end of the spectrum, plus coverage of barrier and average rate options – reflecting the most common corporate usage pattern for FX options.
A minority of systems support hedging with FX futures. TMS futures functionality such as margin calculation and call management can be limited compared with mission-specific futures dealing solutions, and demand for this feature is limited outside very large or specialist corporations. Generally, management of futures margins is restricted to a few of the available TMS solutions.
Interest rate dealing, investing and hedging
Support for vanilla deposits and loans – including borrowing facility draw-downs – is common to all TMS offerings. Systems accommodate both borrower and lender perspectives, as in deposits placed and deposits taken, as a support for inter-company dealing and in-house banking. Most support money market fund (MMF) investments and redemptions, some support investment in primary and, to varying extents, secondary money market instruments such as certificates of deposit (CDs), bankers’ acceptances (BAs), bills of exchange and commercial paper, and this includes the value-adding support for discount and coupon interest accrual calculations and accounting.
TMSs effectively treat repurchase agreements (repos) as money market instruments – as opposed to contracts reflecting (from the corporate investor perspective) the purchase and sale of securities. The TMS perspective effectively treats a repo as a collateralised investment. TMSs often do not deal well with the collateral management aspect of the transaction; this is the expert province of investment management and banking systems. TMSs can typically retain notes of collateral pledged against a repo deal, but rarely track its location and value or manage any relevant interest flows.
Related derivatives typically supported by TMSs include interest rate swaps and cross-currency interest rate swaps, caps, floors and collars and forward rate agreements (FRAs). Some solutions additionally support swaptions and interest rate futures.
Some TMSs support commodity hedging operations, a facility often added to a TMS as an enhancement or afterthought, through modification of the FX hedging logic to fit the terminology and conventions of certain commodities markets. The most generally covered commodities are metals and oil, with complex commodities such as grains and electricity less regularly handled.
TMS commodity hedging solutions are designed to support standard commodity hedging operations in a corporate treasury, being less suited to physical commodity dealing.
Those evaluating commodity hedging TMS alternatives will review instrument coverage (such as average rate commodity swaps), and the value of integrated TMS modules such as cash management and hedge accounting with commodity hedging. It’s a complex area where the terminology and objectives of different businesses often overlap.
Other instruments – trade finance
Most TMSs offer some functionality to support trade finance operations with letters of credit (L/Cs) and guarantees, both taken from banks and given to subsidiaries and business projects. TMS trade finance solutions generally support instrument tracking and related cash management; but lack in depth specialist support for the instruments.
System selection considerations
TMS history is long enough for all solutions to include coverage of all ‘standard’ treasury hedging and investment instruments, and also incorporate processing functionality for all stages of the treasury dealing workflow. Differentiation between competing solutions probably won’t be found in these areas, as today’s TMS evaluation projects rarely reveal many important differences between competing systems based on dealing and hedging functionality alone. The calculations will be accurate against industry benchmarks, and the processes will be secure – otherwise the systems would not survive as reputable alternatives.
Selection decisions will be probably be based on other system and service features, such as intuitiveness, ease of reporting, workflow management power and flexibility, cost/benefit performance, and also integration capabilities with complementary third party systems, such as with banks and ERPs, dealing portals, confirmation matching services and market rate sources.
Buyers and influencers often look for value-added intuitive features amongst competing systems, including the availability of relevant risk management information, and the presentation of decision support tools such as real time yield comparisons between time deposits and the equivalent FX swap. The dealing and hedging solution must also be reviewed against the backdrop of cash management and general finance priorities.
Technology enables treasury dealing and hedging to be performed efficiently, in transparent real time environments that maximise visibility and risk decision-taking support. Treasurers can extend their professional offerings to other parts of the organisation, to optimise risk mitigation operations, borrowing efficiency and investment returns.
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