Where are the risks? RUNNING

RUNNING CORPORATE TREASURYin an Environmentof Elevated Risks

Where are the risks?

What are the challenges for treasury intensive organizations?

How do you move forward?

An eBook written & produced by

Important TermsThroughout this ebook you will see

terms such as “treasury intensive,” “payment intensive,” and “risk intensive” which we’ll take a moment to describe up front.

The broadest category, treasury intensive, refers to an organization that has either high volumes or a high-level of exposures in various domains (payments, debt, investments, FX, commodity, counterparty, country-level). This is the macro-level category that distinguishes one type of organization from others.

This type of organization has particular demands that require a significantly different level of response than organizations who operate at standard levels of activity and risk.

Within this top level category we may identify more specific areas of treasury intensity, such as payment intensive (which covers organizations that produce or process millions of payments per month) and risk intensive (which would cover commodity intensive organizations, those with a high level of FX exposures, etc.).

The overall intent is to highlight areas of significant needs and differences between organizations. In addition to individual organizations, certain industries may have common treasury intensive characteristics as well.

Executive Summary

The risk environment faced by organizations is diverse and significant. Some companies face a disproportionate level of exposure to these risks due to the very nature of their business. Treasury intensive organizations face an even greater level of expectations from executive management. These elevated and continually increasing expectations must be addressed.

Significant challenges make the financial risk management task difficult. Data typically sits in numerous systems and different formats and it must be aggregated and normalized before analysis can start. Concerns about fraud and operational control demand ongoing automation and improvements. And, regulations can add significant complexity even when they offer additional options for managing those risks through financial instruments.

The financial crisis raised the general awareness level of risk, and since then it has remained at an elevated level. Increased awareness brought with it added expectations of treasury to more effectively manage the organization’s risks. Treasury organizations have a long history of being thinly staffed. And, while some organizations have added some staff to support risk management activities, these have been minor.

According to Strategic Treasurer’s annual Cash Forecasting and Visibility Survey, organizations have planned to spend heavily on treasury technology at extremely elevated levels over the past three years.

In fact, the number of those planning on spending significantly on treasury has been over 30% of total survey respondents. This investment reflects an environment of increasing requirements and significant opportunity if the investment is made.

The investments being made must address challenges brought about not only by exposure data housed in numerous systems. It must also support the entire risk management process for treasury and commodity procurement. This has financial benefits at both the operating and trade level.

Even if treasury and commodity procurement work in perfect synchrony, they can lose the overall war if they do not bring and keep executive management to a level of understanding on risk management. This requires the right tools to perform various functions, from: exposure aggregation and pre-trade analytics to post trade hedge accounting and reporting. In increasing measure, organizations are using risk visualization tools that help executive management and others better understand their exposures, possible outcomes and how the organization manages their risk.

The recognition of risk is elevated as are the expectations. Fortunately, there is progress on investment levels and the tools that can help an organization succeed. This is particularly true for treasury intensive organizations and thoughtful treasury and procurement groups will leverage these resources effectively.

2© 2016 Strategic Treasurer. All rights reserved.

What’sInside?This e-Book explains key elements

of the overall risk landscape facing treasury organizations.

It provides a particular focus on treasury intensive organizations. It highlights some of the biggest

challenges and opportunities and provides some key concepts

that will help you bring your organization forward to a better

risk management position.

01 REALIZING THE ENVIRONMENT OF RISK w Global Volatility w Commodity Price Volatility & Embedded Currency Exposure Risk w FX Volatility w Treasury & Risk Intensive Organizations

02 INCREASED CHALLENGES AND EXPECTATIONS w Disparate Systems and Data Sources w Controls and Fraud Potential w Increased Expectations by the Board and Senior Management w Additional Regulations w M&A Activity

03 OPPORTUNITIES w Increased Willingness to Spend w Increased Staffing Levels w Technological Advances w Centralized Data and Process Standardization w Reduced Operating Expense

04 BRINGING THE ORGANIZATION ALONG w Process, Not an Event w Risk Visualization w Making the Business Case

05 CASE STUDIES w Large Retailer w Large Airline w Manufacturer 3© 2016 Strategic Treasurer. All rights reserved.

01

4

Global Volatility

Commodity Price Volatility & Currency Exposure Risk

FX Volatility

Treasury & Risk Intensive Organizations

Realizing the Environment of Risk

© 2016 Strategic Treasurer. All rights reserved.

Global Volatility

One doesn’t need to look far to realize that we operate on a planet full of various risks. From a range of natural disasters that can impact global supply chains to man-caused strife, each element can create heavy volatility.

Unexpected combinations of these events could create situations that challenge even the largest organizations, banks, and governments. From deadly terrorism to aggressive actions by various countries, the risk levels can scale far more rapidly than treasurers would like. These can impact the supply chain, cost, and even availability of certain materials and commodities. Furthermore, given the global nature of the economy, many activities influence the foreign exchange (FX) markets and the cost of doing business.

Since 2008 senior management and board members have increasingly recognized that this level of volatility represents significant risk that must be better analyzed and managed. Finance and audit committees now frequently ask about risk exposures and seek to understand the risk mitigation plans and hedging strategies

of an organization. When they ask questions about a potential exposure or risk they uncovered after reading the Wall Street Journal, Financial Times, or during a board management briefing, they often want a very well-formulated response in hours or days, not weeks or months.

Global tension and regional conflict keeps the world and finance on alert. Terrorist organizations seek not just death but destabilization of countries and regions and add additional layers of risk and the attendant costs associated with reducing those risks – all set against global economic headwinds.

Following any type of financial crisis, regulations and rules seem to propagate like rabbits. No matter how well intentioned, these require another layer of analysis due to unintended consequences and the impact on organizational systems and processes.


Market and Credit Risk Impacts: Finance, Operations, Treasury

Counterparty Risk Impacts: Mid-Office, Compliance, Payments, Settlements, Treasury

Liquidity and Settlement Risk Impacts: Settlements, Receivables, Accounting, Treasury

Commodity Price Volatility & Embedded Currency Exposure Risk

Historically, the magnitude of commodity price volatility overshadows FX and interest rate (IR) volatility. Nonetheless, the volatility of FX rates by itself is extremely significant for an increasing number of organizations as their global footprint continues to grow.

Notably, for many organizations that use commodities in their supply chain their total volatility is usually magnified since there are two main sources that can give rise to significant volatility.

First, the overall commodity price can fluctuate dramatically, sometimes wildly. Second, for some organizations an embedded volatility risk for the currency exposure can exacerbate the total level of volatility. For example, you could be buying a physical commodity in Euros but reporting in US Dollars. You now have to manage several risks including the price of the physical commodity, the FX risk associated with that commodity, and potentially, logistical and counterparty risk. Both exposures move in lockstep in an unfavorable direction, as the commodity price jumps significantly while

at the same time you need to execute an FX transaction to settle the deal and the currency you are short strengthens at the same time.

Combinations of exposures and risk are often part of the current day treasury management and even procurement world. Those that must bring risk levels in line with the organization’s risk appetite learn that these risk combinations need to be addressed in tandem, not as discrete or separate potentialities.

More recently, forward-thinking treasurers have sought to break down the barriers between commodity procurement and treasury in order to gain greater visibility into exposures and to take a more proactive role in commodity hedging.


FX Volatility

Ongoing uncertainty about the strength of the global economy and unpredictable monetary policy will drive increased currency risk for the foreseeable future.

In the last twelve months alone the surprise decision of the Swiss National Bank to unpeg the Swiss Franc sent its value falling, and this year’s surprise “Brexit” sent the British Pound tumbling, while the value of the Euro decreased. These events highlight the sheer volatility of today’s currency markets. How well hedged were you? Did you identify all your hidden FX exposure? How quickly did you manage to report on it? Did you create stress tests and scenarios to mitigate this type of risk?

As you can see from some historical FX rate graphs, modest movements can give way to more dramatic movements from time to time. Some of these are sudden and dramatic. And, in most cases unexpected.

Even without dramatic FX movements, as you can see from the historical graphs, calm is followed by the occasional sudden and dramatic movement.


Treasury & Risk Intensive Organizations(Commodity, FX, Counterparty, Payments, Debt, Investments)

All organizations are not alike in terms of the level of treasury and risk intensity. This has a substantial impact on how they will manage these risks or areas of concentrated requirements.

Some organizations have massive commodity impacts (e.g. an energy firm or a food and beverage company). Others may make payments that are several

orders of magnitude larger (volume and value) than one in another industry (e.g. an insurance company).

Still other firms may face larger counterparty risks due to their investment portfolio. Treasury

and risk intensive organizations necessarily approach these matters differently. The

need for better information about the

level and certainty of their exposures, the frequency of current market data, and the ability to handle significant volumes of activities drives the organization structure, risk processes and underlying systems.

Just like the type of travel one must do determines the proper mode and tools for transportation, so too, the type of risk and treasury intensity determines the methods and tools for risk management.

However, organizations are starting to realize that having a top-down risk management policy and methodology that’s well understood, measurable, and helps mitigate downside risk is absolutely essential in today’s economy to help better protect margins.


Treasury Intensive

Organizations having high volumes or high levels of exposure across various domains (includes both categories below).

Payment Intensive Risk Intensive

Organizations producing or processing millions of payments per month.

Organizations with high levels of exposure due to commodity, FX, counterparties, etc.

Big quote about realizing the growing

risk environment.“Unexpected events

create unpreventable situations.”

02

10

Disparate Systems & Data Sources

Controls & Fraud Potential

Increased Expectations: Board & Senior Management

Additional Regulations

M&A Activity

Increased Challenges & Expectations


Increased Challenges & Expectations

The level of volatility we see in global markets for both commodity and FX creates a range of challenges. The financial crisis has led to a sustained and increased awareness of this volatility and an increased expectation that the organization will be better able to effectively manage this volatility. Other elements that drive this view of increased challenges facing treasury and procurement include:

Disparate Systems & Data SourcesMergers and acquisitions layer on additional

systems. This places data in different locations and formats. The use of numerous and separately managed spreadsheets contributes to this diaspora of data.

Controls & Fraud PotentialThe increased returns criminals are receiving

has caused the modern day calculus to show that crime does pay. Protecting against external and internal threats challenges processes, controls and monitoring activity.

Increased Expectations by the Board & Senior Management

Additional information, analysis and protection are now expected more accurately and at a faster pace. And, the review process is no longer a rubber stamp but one with some intelligent and piercing questions and follow up.

Additional RegulationsThe financial crisis created a global demand for

action. Legislators and regulators have been busy creating unprecedented levels of new regulations that have been cascading into the marketplace. Keeping up with these requirements demands that a significant portion of an organization’s investment remain compliant (GAAP, IFRS 9, Dodd Frank, MiFiid II). These may or may not be fully aligned with organizational plans to manage financial risks and often exacerbates the fight over limited investment dollars in the organization.

M&A ActivityWith increasing M&A activity, companies

look to grow and integrate their organizations by standardizing processes and leveraging enterprise technology that will also grow as their requirements grow. While ERP systems provide a valuable component of this, they cannot provide the enterprise risk and credit management required in today’s economy.

11 © 2016 Strategic Treasurer. All rights reserved.


risk environment.“New awareness of

volatility brings new risk expectations.”

03

13

Increased Willingness to Spend

Increased Staffing Levels

Technological Advances

Centralized Data & Process Standardization

Reduced Operating Expense

Opportunities


The above-mentioned challenges are not easy to address. However, they do provide some clear opportunities and positive news. Here are some of them:

Increased Willingness to Spend

For the past few years we have seen elevated levels for organizations and their intent to spend significantly on technology. The chart shows some of these categories and level of spend. We believe these heightened plan-to-spend-significantly levels are the result of the situations and expectations laid out earlier. Investment is, finally, following the requirements.

Increased Staffing Levels

Treasury groups are notoriously understaffed and are either being asked to do more with less or to do everything with nothing. There has been some relief, however slight, on the staffing front. While the majority of organizations are maintaining static resource levels in treasury, for those organizations that have changed staff levels, more organizations are adding than reducing. The chart below this text shows this multi-year trend. In our view this reflects an increased awareness of the requirements placed upon treasury to protect the organization.


Technological Advances

The development of better systems through the use of improved tools and combined with superior connections for data and transaction management at better price points means that smaller organizations can secure substantially better technology tools now than much larger organizations could afford with larger budgets five and ten years ago. It is a good time to acquire good technology.

Centralized Data and Process Standardization

Complete and timely data is a foundational requirement for good decisions. With the recognition of increased expectations and the types of exposures organizations have, disparate systems create an entire sub-economy of trying to standardize and cleanse these data sets before any analysis can occur.

Rationalizing the number of systems used that capture exposure and risk data has become more critical. This recognition can help an organization make the business case to concentrate that data while standardizing a number of processes that surround the risk management process.


Reduced Operating Expense

Expense management pressures have not subsided. Given the increased demand for technology and services, organizations have an opportunity keep expenses minimized within this new framework.

w Rationalization of systems across multiple departments (e.g. commodity procurement, treasury, trading, etc.) is one key method for reduced expense. An insightful quote that is attributed to many is “Optimizing part of the process sub-optimizes the whole”. By reducing the number of systems that various areas use to accomplish part of the same core process, companies can achieve cost efficiencies for system support and process management.

w Visibility over global commodity exposures allows treasury to execute fewer, larger hedges (many to one). Having a more accurate view of your risk exposures allows for better and more accurate analysis. And, it typically reduces the costs for hedging and settlement.



risk environment.“Optimizing part of the process sub-optimizes

the whole.”

04

18

Process, Not an Event

Risk Visualization

Making the Business Case

Bringing the Organization Along


P erhaps, in an ideal world senior management and the entire board would be experts at finance. That would make communication much easier. Expectations can change as time elapses between the review of the risk management framework and hedging

policy to some time later. What became a clear understanding of “we hedge to bring our exposures in line with our risk appetite and will bear the associated costs” has been forgotten and the CEO is now saying “we would have done better if we hadn’t hedged”.

To ensure ongoing cohesiveness of the risk management mindset, we will highlight three concepts:

Process, Not An Event

Enterprise risk management (ERM) is an integrated, forward-looking, and process oriented approach to managing all key business risks and opportunities - not just financial ones - with the intent of maximizing value for the enterprise as a whole.

Risk is not just a number, but it requires a holistic view across the organization to help better explain where the risk occurs, what it means, its likelihood of happening again, what can we do about it, and expected P&L.

Risk Visualization

Concepts can be, as concepts often are ...conceptual... and not as concrete. This is usually true for treasury, but it is almost always true for senior management. Their eyes can glaze over when you talk about VAR and CFAR. Communicating the exposures and the potential impacts goes far better when you have a clear visual to use as a starting point.

Showing what the cash flow impact can be 5% of the time – or one out of twenty periods – can be eye opening and mind engaging. Following that up with a normal-person language discussion of risk (this 5% is based upon historical numbers, that doesn’t mean that is what we’ll actually see


in the future or that it is 19 periods away from the last one we saw) will increase their real understanding and appreciation for what needs to be done.

Visualization helps in about a dozen ways, but here are two high-impact benefits visualization can bring:

w Gain real-time visibility into all your commodity exposures in order to effectively hedge and risk manage them.

w Understand the currency exposures embedded in your physical commodity exposures and how your program alters these and at what cost.

Treasury professionals will understand the various risk management programs since they are immersed in this field. Executive management

touch on these subjects at different times and their understanding can vary significantly. Risk visualization provides an excellent

basis to help executive management better understand their exposures, the risk mitigation practices that are put in

place and the net remaining exposure. Engaging senior management in a dynamic conversation is achievable

through more robust risk visualization tools. In particular, organizations that address Value at Risk

(VAR), Cash Flow at Risk (CFAR), Potential Future Exposure (PFE) or a Credit Value Adjustment

(CVA) will find the tools influential in shaping a conversation in which everyone is on the

same page. By providing the group the ability to

see how various activities or events will impact an individual asset or

the entire portfolio, it is easier to understand what has occurred

and what the future possibilities

are for the portfolio of risks. The ability to visually display these elements and options increase the overall understanding.

VaR will show that the overall risk of the business may be less than the sum of the sub-businesses (i.e. non-additive). This may lead to reduced capital requirements particularly around hedging where previously unknown natural hedges may exist.

Showing what the cash flow impact can be 5% of the time – or one out of twenty periods – can be eye opening and mind engaging. Translating that into laymen’s terms (e.g. this 5% is based upon historical numbers, but may not be what we’ll actually see in the future, or that it is 19 periods away from the last one we saw) will increase their real understanding and appreciation for what needs to be done.

Visualization provides many benefits to treasury and the rest of the organization. Examples of how visualization can improve risk analysis and understanding include:

w Comprehensive view of exposures aggregated from various sources. This allows a complete picture at a point in time or over a period. The ability to model and compare various risk management techniques or instruments to understand which is the best course of action for effectiveness and total cost.

w Illustrating to non-financial executives how their organization’s exposures can create unacceptable losses or liquidity concerns.

w Providing a view of how the risk management process kept the organization’s remaining risk in compliance with the risk appetite and risk management policy.

Instead of doing a financial projection on a “best estimate” basis, your company may perform stress testing where one can determine how a financial instrument or portfolio would perform under various conditions. This may model various periods of great volatility. The analyst can is in



certain crashes, using scenario analysis. Having a relatively streamlined way of running various scenarios provides a more thoroughgoing and rigorous basis that treasury can use to meet the new risk management expectations. Various scenarios can be created that can be modeled to see the impact on: cash flow, risk profile, prepayments, etc. Examples can range from single elements changing to more complex models adjusting numerous elements simultaneously:

w What is the impact on our cash flow for our debt if our interest rate basis increase by 200 basis points?

w How will prices changes natural gas and crude prices from -20% to +20% impact our income over the next quarter for all options?

w If the currency we are long moves negative against USD by 15% and oil prices increase by $15/barrel, what will that do to our cashflow?

w How much does our financial position need to weaken, before our counterparties will no longer support our hedging program and we will have to seek another approach to reducing our exposures?

Making The Business Case

A strategic business case is not equivalent to a cost benefit analysis (CBA) since the financial model is part of the overall case. The strategic rationale for the risk management framework processes and investment in technology is paramount and should be first. Getting buy-in on the overall value and purpose of risk management will make the financial case less likely to be hi-jacked over numbers and assumptions.

When making the financial case to mitigate risk it is very helpful to reference historical events and what that would mean from a financial standpoint (principal loss, cash flow impact, liquidity issue). Anticipating and being able

to address well-meaning or not-well-meaning questions to your financial elements and overall assumptions is vital. The ‘that’s not likely to happen’ comment can be more easily challenged beforehand with useful historical market data and reasoned humility about how it is not our business model to predict FX or commodity rates into the future – it is to mitigate the risks.

Using some great visuals to help make the case personally when possible and in a larger group when available, help move the discussion to facts about risks rather than opinions and musings by non-risk oriented staff.

Conclusion

The recognition of the level of volatility that we see at play in the broader environment has changed how many organizations address financial risk. The increased recognition of this volatility has created a corresponding increase in the expectations that treasury and procurement will manage these risks more appropriately and effectively.

For treasury organizations, this increase in awareness and expectations on the part of executive management and the board is driving significant additional investment in technology and provided much of the impetus behind some multi-year staff increases in treasury.

Treasury and procurement both have the double challenges of ensuring they have a clear and accurate view of their exposures and that executive management understands what the organizational exposure can do in the current environment of risk.

To have a clear and accurate view requires exposure data from various sources be automatically aggregated and normalized. The ongoing rationalization of various systems and processes is also vital. Treasury groups that are effective at bringing their executive management team along view risk management education as a dynamic process rather than an event. And, they leverage risk visualization tools that foster deeper understanding of risk management exposures and risk management techniques. This ensures long-term support of an organization’s risk management framework.

The risk environment and level of expectations are demanding for most treasury organizations which requires ongoing change and adaptation. For these organizations, the requirement to respond with appropriate staffing and current technology that reflects their elevated risk profile is vital, immediate, and compelling.



risk environment.“We hedge to bring our exposures in line with

our risk appetite...”

05

24

Case #1: Large Retailer

Case #2: Large Airline

Case #3: Manufacturer

Case Studies


KeyMetrics

Revenue: w 62B GBP

Functional Areas: w Treasury

w Risk Management

w Commodity Front Office

w FX

w Hedge Accounting

Case 1: Large Retailer

Situation: Exposures/Risk/SystemsA manual, labor intensive hedging program that resulted in hedge redundancy,

accounting issues, time-consuming and error prone due to manual processes.

Action:Single platform for production, planning, forecasting, material requirement

planning, procurement planning, hedging, risk reporting, position management and back office functionality.

Results:A single, centralized global treasury for cash management and commodities

hedging resulting in improved margins and reduced costs.


KeyMetrics

Revenue: w 9.02B USD


w Risk Management


w FX

w Hedge Accounting

Case 2: Large Airline

Situation: Exposures/Risk/SystemsDisparate systems for risk and treasury with limited risk analytics. Alterations

to systems required time and IT resources that weren’t available.

Action:Single platform for Risk, Hedge Accounting and Cash Management where jet

fuel hedging was centralized in treasury.

Results:A single, centralized platform for both treasury and risk. The single integrated

system provided better reporting and analytics than legacy systems combined.


KeyMetrics

Revenue: w 4.6B GBP


w Debt

w Risk Management


w FX

w Money Markets

w Intercompany

Case 3: Manufacturer

Situation: Exposures/Risk/SystemsChallenges faced with managing the increasingly complex trading environment

with uncertainty from pending regulation and reform. Rexam was seeking an integrated solution that would optimize their infrastructure and requirements.

Action:Implemented the OpenLink Corporate Treasury Solution suite to support

global treasury, cash, commodity and risk management activities. This allows all financial risks to be captured and managed centrally across the globe.

Results:Allowed global access to provide more efficient processes for forecasting and

order management requirements. The system provided interfaces to import all subsidiary forecasts, actuals, hedges and invoices. This information was then able to be reporting upon including shock scenario testing.


ABOUT OPENLINK

OpenLink is the market leader in trading and risk management software, uniquely providing a solution for managing commodity price risk and treasury on a single platform. OpenLink serves over 600 clients, including 12 of the world’s largest commodity and energy companies, 9 of the largest financial institutions and 13 of the largest central banks.

OpenLink’s recent awards and recognition include: top provider in the bobsguide Buyer’s Guide to Treasury Management Systems 2015/2016; industry leader in Commodity/Energy Trading and Risk Management by Energy Risk; and leader in financial platforms from Gartner and Chartis.

[email protected]

ABOUT STRATEGIC TREASURER

Strategic Treasurer is a specialized treasury consulting firm founded in 2004. They exist to elevate and enhance the practice of treasury by advising individual clients and informing the market at large. Their advisory services cover: global treasury management, treasury and risk technology, financial risk management and working capital management. They provide outsourced senior treasury services, bank connectivity onboarding, compliance support, security and control assessments. They inform the market through various ebooks, whitepapers, videos, their technology analyst report series, eight annual industry surveys and the Treasury Update Newsletter. In addition, they run the FinTech HotSeat program covering current and emerging developments in treasury technology.

[email protected]

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Where are the risks? RUNNING