Risk management and compliance: two growing treasury challenges

A global study of how corporate treasurers approach risk management and regulatory compliance suggests a sharp increase over the past year in the number of companies that have adopted a formal risk policy.

Baking and payment technologies provider FIS interviewed more than 100 treasury and finance professionals to ascertain the most significant challenges and critical risk factors. Forty-two per cent of the participating companies were headquartered in North America, 24% in Asia, including Australasia and 20% in Europe. All major industries were represented, with just over one in five of the participating companies in manufacturing.

The report, entitled ‘Treasury Risk Management and Regulations Market Study 2016: Tough Questions for Treasurers’, comments: “Slow growth and high volatility have been the watchwords of the global economy over the past two years – and far longer in some regions.

“Central banks and regulators have responded to economic conditions in different ways. While new regulations are intended to protect the financial sector, these often add greater complexity for treasurers, as they plan their liquidity and risk management strategies. Understanding the changing regulatory environment, establishing visibility over current and future exposures, and limiting the impact of volatility has been central to treasury strategy.”

Among the main findings of the 2016 study:

• Documenting risk parameters: Eighty-one percent of participating companies have a formal risk policy, representing an increase of 15% since 2015.
• Risk management challenges: Managing credit risk (both to commercial and bank counterparties – 56% and 54% respectively), market risk (65%) and liquidity risk (49%) all continue to pose challenges for treasurers – a trend in line with the 2015 survey findings. These are exacerbated by regulatory changes that challenge treasurers’ existing treasury and risk management strategies.
• Effective risk management: Twenty-six per cent perceive their risk management approach is ‘very effective’, although the figure increases to 43% of those using a treasury management system (TMS) with risk management capabilities, 69% of those using a specialised risk management information system (RMIS) that is not integrated with their TMS, and 71% of those using a specialised RMIS that is integrated with their TMS.

• Less effective risk management: Forty-four percent of treasurers are concerned that their risk management performance is mediocre or poor. This particularly applies to those using spreadsheets and enterprise resource planning (ERP) systems for risk management. Given the potential impact of financial risk on business performance, there is a strong imperative to focus and invest in risk management, whether in skills, technology or a combination.

• Counterparty credit risk: Ninety-two per cent of treasurers use external credit ratings to categorise their banks from a risk standpoint, but many supplement this with a more dynamic, proactive approach to monitoring credit quality. Sixty-eight per cent consider country/region risk, while 58% include industry in their risk evaluation, reflecting the market impact of wider economic and geopolitical risks, and vulnerabilities that affect all players within an industry. Capital structure has also become more important – cited by 62% – as treasurers recognise the importance of a bank’s liquidity, security, and funding.

• Event risk: Treasurers are being forced to enhance their monitoring and modelling tools to anticipate the short and longer term impact of major political and economic changes such as Brexit and the recent US presidential election. Similarly, volatile geopolitical and economic trends that are playing out globally should be prompting treasurers to strengthen their risk management policy framework, infrastructure and skills.

• Cybersecurity threats: Currently, only 17% of survey participants anticipate that addressing cyber threats will be a significant priority for the year ahead, while a further 35% expect that cybersecurity will have a moderate impact on their risk management strategies. Cybersecurity breaches are becoming more frequent and severe, with few – if any – organisations unaffected. Treasurers should respond by reviewing and strengthening controls and education within their departments, and work with IT departments and technology vendors to protect the confidentiality and integrity of business-critical, sensitive treasury data.

Managing risk: effectiveness and challenges

The survey asked participants to assess the effectiveness of their risk management approach. Just over one in four (26%) believes they are very effective (comparable with 2015) and 31% rate theirs as somewhat effective (20% in 2015).

Also in line with last year’s results are treasurers’ continuing concerns with managing credit risk – both to commercial and bank counterparties, market risk and liquidity risk.

• Market risk (65% indicated moderate to severe difficulty)

Market risk includes the “traditional” risks managed by treasury: interest rate risk, FX risk and commodity risk. While treasurers have become better equipped to manage individual risk areas, many find it challenging to manage the full spectrum of market risk. Among the biggest challenges that treasurers are experiencing is the impact of market volatility, particularly in the currency and commodity markets, but interest rates are also a key area of concern given negative rates in Europe (including effectively negative rates in the UK) and unprecedented low rates in the US.

• Credit risk – commercial counterparties (56% indicated moderate to severe difficulty)

Managing credit risk to commercial counterparties is often a bigger challenge for companies headquartered outside North America, as US companies typically have a higher concentration of domestic customers for whom credit information is more readily available. According to most sources, over 10% of companies in the UK export internationally against less than 1% of US-headquartered companies.

Survey results reveal that US companies with a predominantly domestic customer base also find it difficult to manage their credit risk. This particularly applies to those using ERP tools or manual methods such as spreadsheets as opposed to specialised credit and collections technology. Specialised automation and workflow technology enables companies to integrate credit and collection systems with one or more ERPs, or instances of ERPs, enabling credit and collection processes to be standardised across the enterprise irrespective of the organisational model and/or ERP environment.

Credit and collections teams can integrate online credit applications with a scoring tool for faster decisions. They can automatically track payment behaviour and external risk data to identify high risk accounts, schedule automatic reviews, get proactive risk alerts, create custom score cards, automatically score the entire portfolio monthly and adjust collections.

• Bank counterparty risk (54% indicated moderate to severe difficulty)

Managing bank counterparty risk has become more challenging in recent years, not least due to the number of credit rating downgrades. This has resulted in fewer banks that meet treasurers’ criteria, and it can be difficult to establish sufficient credit limits. Some companies have reviewed their bank credit criteria accordingly, while in many countries, treasurers need to work with local banks that may be unrated, whether for regulatory reasons or to access a local branch network. Bank exits from sensitive markets in regions such as the Caribbean, East Asia Pacific, Eastern Europe and Central Asia which are more susceptible to, and less equipped to combat financial crime, further limit the choice of banks for multinational corporations operating in these countries.

• Liquidity risk (49% indicated moderate to severe difficulty)

With base rates in negative territory in Europe in absolute terms (and in effective terms in the UK), and at historically low levels elsewhere in the world, and with the impact of regulations such as changes to prime money market funds (MMFs) in the US, there is increased demand for high quality, liquid assets. Consequently, treasurers find it increasingly difficult to identify suitable repositories for cash that allow them to meet their liquidity requirements.

A related challenge is the difficulty of centralising and repatriating cash held internationally. This is relatively straightforward in regions such as Europe, but in parts of Asia, Africa and Latin America, the challenges are greater due to currency and capital controls, and restrictions on both domestic and cross-border cash pooling. In China, for example, which has become a key trading location for companies across a wide range of industries, opportunities to repatriate renminbi (RMB) have been limited in the past, and while these have expanded over the past 12 months, various controls still apply. Basel III is also creating liquidity management challenges as techniques such as notional pooling are likely to become less accessible for some corporations, prompting a review in regional and global liquidity management.

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