The Credit Crisis Legacy: Treasury Risk Mitigation and Management

The role of a treasurer within an organisation can vary considerably from company to company due to a variety of factors – size and scope of the company, industry type, location of the business and subsidiaries, etc. Over time, the role of the treasurer has also expanded or contracted in line with economic forces – from a basic receivables and payables focus to a ‘mission-creep’ situation, where functions that traditionally resided in other business units, such as risk, IT and operations, began finding themselves on the treasury ‘to do’ list.

Then came the credit crisis. When the money markets started to see funds ‘break the buck’ and acronyms such as CDO, CDS and ABS were attracting the attention of corporate boards, treasurers had to focus almost exclusively on shoring up or renegotiating lines of credit and reevaluating investment strategies across the board. The tumultuous market conditions put the treasury department firmly in the corporate spotlight – communication with the board was becoming commonplace and treasurers had an opportunity to demonstrate the added value that their function can bring to the organisation. But with this rise in profile came associated risks – senior management were now expecting much more from treasurers, but in many cases were not prepared to back this expectation with additional resources and staff, creating enterprise risk. And in daily treasury activities, risks were enhanced or even created from scratch – which corporates could have envisaged performing counterparty risk analysis on their banks in case they fell over? Added to the scenario were extreme movements in foreign exchange markets that created severe turbulence for multinationals of all shapes and sizes, while pension funds formed a risk headache in some countries rather than others.

All in all, the portfolio of risk that corporate treasurers are facing now that the credit crisis is receding is vast and complicated. As such, it is no surprise that risk was the conversation topic of choice for many of the treasurers who gathered at the gtnews Global Corporate Treasurers Forum Europe 2010 (GCTFE 2010), at London’s Grosvenor House hotel. This feature gathers the main risk management takeaways from the event.

Enterprise Risk Management – What is the Treasurer’s Role in Risk?

The PricewaterhouseCoopers (PwC) UK Treasury Survey 2010 found that nearly 90% of respondents think the credit crisis has led to their department gaining increased attention from the board. In addition, nearly 80% said they think the treasury function is increasingly thought of as adding value, while even 60% said that business units are showing an increased interest in treasury. All of these are impressive numbers, but unfortunately just over 20% said that the level of budget invested in treasury had been increased to match this new position within the organisation – treasurers are effectively being asked to do more but without more resources. This lopsided position carries inherent risk. It is here that an enterprise risk management (ERM) strategy is required.

Today, audit committees are frequently asking for ERM projects to be demonstrated. These are not like buzzword-projects of the past – such as economic value add (EVA). ERM is based on common sense and looks at all elements of risk. The first step in achieving this is to identify the critical risks for your organisation. A risk register can be hundreds of pages long, so the advice in the workshop was to investigate a framework tool, such as the Committee of Sponsoring Organizations (COSO) framework, which can aid the risk identification process.

Treasurers entering this process need to have a firm understanding of the risk environment in their organisation – are they risk-taking, risk-neutral or risk-averse? Different business areas have different risk profiles and treasurers should only take risks that are acceptable to their shareholders – other risks should be managed away. Corporates must understand the internal environment that they operate in. Once this has been established and the risk framework is in place, the treasurer will be in a position for objective setting, event identification, risk assessment and risk response. All of these processes should be linked to the budget cycle.

At the Global Corporate Treasurers Forum Europe 2010, John McAnulty, group treasurer at Richemont, explained that his company initially identified 10 risks, but then realised that this was too many and so reduced it to four or five critical risks that had the potential to knock the company off course. They then produced a very thin executive summary and action plan. McAnulty admitted that lots of groundwork has to be put in at the start of the ERM project, but that this gets easier. A consolidated risk report was also issued to key internal stakeholders, while standard risk action plan templates have been included by the company in strategic plans and budgets and a risk statement is included in the annual report and accounts., McAnulty explained how the company uses a common risk language to ensure this is clear and transparent to all parties.

So if you don’t already have an ERM strategy, should you? Quite a few companies now identify and spell out key risks in their annual report. Any treasurer thinking about this will get huge support from non-executives at the moment, as risk management is a big topic of conversation for this group. Additionally, audit committees are increasingly looking at this. However, there are likely to be several challenges within the organisation to tackle on the way to establishing an ERM programme, and the following comments may crop up:

  • “This is just another management fad.”
  • “Risk is good.”
  • “We don’t have time for this.”
  • “This is no different from internal audit.”

While this process may take the treasurer outside their comfort zone, the embedded understanding of risk that the treasurer has makes him or her the perfect owner of this project as part of a group management team.

Managing FX Swings

One of the areas of risk management that treasury is used to dealing with, but gained additional exposure as a result of the effect the credit crisis had on western markets, is the management of foreign exchange (FX) risk. Given the volatility in the currency markets, it is no surprise that the FX risk management workshop drew the attention of many delegates at Global Corporate Treasurers Forum Europe. Richard Roering, from the consultancy Zanders, illustrated that FX risk falls into the following categories:

Transaction exposure: risk of value changes depending on where the transaction is. Some transaction exposure is not shown in the P&L because it has not yet been recognised, or the contract is anticipated rather than committed to.

Economic exposure: future impact on cash flows as a result of long-term FX rate changes.

Translation exposure: The FX exposure seemingly most likely to be forgotten by many treasury departments. It occurs when a subsidiary has a functional currency other than the reporting currency of the holding. This concept can be split into two further categories: profit translation exposures and asset translation exposures.

FX management objectives are linked to company policy – therefore, common FX objectives include:

  1. Reduce the uncertainty of cash flow (protecting short-term cash flow implies a short hedging horizon).
  2. Protect business at budget rate or better in order to protect it within a defined time horizon.
  3. Reduce long-term P&L volatility. Hedging is typically 1-2 years forward on a rolling basis, with layered hedge ratios.

Current thinking seems divided as to whether multinational corporations (MNCs) should hedge FX profit translation risk. Those in favour argue that translation gains or losses exist only ‘on paper’, while those against counter that translation gains/losses have an impact on the reported profit of the company. So what about in practice? Roehring had three points here:

  1. While they are in the minority, some MNCs can face a risk at the EBITDA level.
  2. Credit ratings are a key determinant in positive hedging decisions
  3. Larger MNCs are more likely to hedge FX profit translation risk.

A group treasurer attending the workshop explained to the other delegates that their company had decided not to hedge its transaction exposure. The reason for this was that the company would have had to involve all of its investors, which would have added complexity. It has an impact on reporting – the company would have had to have shown like-for-like figures, and they wanted to protect this information. The factors involved in weighing up whether to hedge this risk or not requires a full evaluation by corporates.

Pension Risk Looming Large in Certain Countries

Many western countries are facing severe risk issues in the corporate pensions market. In the UK, this is particularly the case with defined benefit (DB) pension schemes, which have total assets of £775bn but total liabilities of £975bn.1 Pension schemes are closing and members of these schemes are ageing, meaning that the funding imbalance here will remain for a long time to come. At Global Corporate Treasurers Forum Europe, Chris Sheppard from professional services group Mercer addressed some of the issues that corporates need to be aware of in their pension risk management strategies.

Because companies and trustees have different interests at stake in a DB pension, it is important that a model for the risk management process of the pension scheme is agreed upon by both parties. Sheppard produced a basic five-point plan to create such a model:

  1. Define the mission. Is this to provide short-term balance sheet control for the sponsor, or long-term self-sufficiency for the scheme?
  2. Quantify the risk budget. What is the sponsor’s tolerance of cost variability, and what is the trustees’ tolerance of funding level deterioration?
  3. Decide how the budget is spent. Will you target rewarded risks and value creation, or unrewarded risks and value protection?
  4. Allocate responsibilities. What are the roles of the company and the trustees in the governing and executive functions of the scheme?
  5. Establish a process. What events will be triggers in your scheme management, and what will be the responses to these triggers? How can you ensure ongoing monitoring?

There are a number of market trends that could have an effect on the five points above. Increasingly, swaps are being used to hedge interest rates and inflation at predetermined trigger levels. Longevity solutions are on the rise as mortality reserving increases. Enhanced transfer value exercises will continue and increase as accounting reserves increase (so that P&L impact reduces). There is an increased use of equity derivative solutions to reduce downside risk. Schemes are being closed to future accrual and the search for lower risk alternatives is continuing apace.

Against the backdrop of these market trends, what action can treasurers take to ensure the best for their organisation? Sheppard made the following suggestions:

  • Understand the risk being taken in your DB schemes.
  • Assess the impact of those risks on the company.
  • Define your company’s tolerance to risk.
  • Set risk reduction triggers appropriate to this tolerance.
  • Ensure that robust risk governance is in place.
  • Establish a process to monitor and take action.
  • Monitor market trends and opportunities.


The risk management portfolio that treasurers are responsible for today is considerably greater than it was a couple of years ago. It is too early to tell if this additional burden will subside as the credit crisis fades, but perhaps from the treasurer’s perspective it would be better if it didn’t. The current elevated role of the treasurer provides an opportunity for those in the role to add value to the business and demonstrate the skills that will take their personal careers one step closer to senior management. By taking control of the various risk management functions mentioned in this article, treasurers can demonstrate their overall corporate finance skill-set, and prove to senior management that the treasury function offers much more than merely a cash management functionality.

1Pension Regulator’s The Purple Book, DB Pensions Universe Risk Profile, 2009.



Related reading