Financial Certainty in a world of uncertainty
The 2012 AFP Risk Management Survey asked CFOs, corporate treasurers and other senior finance executives about risks that worry them now, those most likely to cause uncertainty in the next three years, and actions they are taking to mitigate those risks
Here is my view on the major points:
Financial Uncertainty Risk. Over 70% of respondents identified this as the primary area of concern. Financial uncertainty risk is made up of:
Liquidity risk, the ability to turn assets you hold into cash rapidly and the ability to get that cash back quickly when necessary. In determining an organisation’s liquidity risk, it is necessary to determine exactly how much liquidity the organisation requires. Most importantly, it is an understanding of the organisation’s real-time cash position that is required. This understanding will come from knowing the current balance in real-time, knowing what transactions that are in that balance are certain (irrevocable) and knowing what transactions are due into the account before the close of business. This calls for a real-time reconciliation between the organisation’s predicted transactions (typically from the ERP system) and the actual transactions (typically from the correspondent bank). Most organisations not only lack the real-time information from their service provider (and see Roy McPherson’s blog on dirty data (LINK) but also lack the ability to reconcile this data in real-time. No wonder that most respondents are uncertain of their liquidity position when the Nostro reconciliation tools they use are merely a rear view mirror on what happened yesterday. The corporate treasurer and CFO need high quality data, delivered in real-time, fully reconciled against all other sources if they are to have the financial certainty they need to manage liquidity risk when liquidity is scarce.
Credit/Counterparty risk. My colleague, Chris Errington wrote extensively on this (LINK) but in summary the need to reduce credit risk concentration is driving the corporate treasurer to expand multi-banking relationships. Of course there are other reasons to expand relationships as well: the internationalisation of business and the desire to grab higher returns were additional factors for us. There is a minor issue of determining “who is not related to who” so we can be certain that we really are spreading our risk across counterparts that aren’t legally or systemically correlated (What chance that LEI’s will help the corporate? – (LINK). Having gone multi-bank and/or spread our funds across multiple investment houses our next issue is one of due-diligence. Do I really trust these people with my money? Following on from MF Global and earlier client money abuses the increasingly astute CFO or Corporate Treasurer will want to ask tough questions concerning how their money is managed and more importantly how it is segregated. The middle and bank offices of organisations that hold and invest our money need to show that they have the right controls, reporting and reconciliation capabilities to be trusted. It is critical that the corporate treasurer performs the necessary due diligence, not simply at the outset of initiating a relationship, but as part of their ongoing operations and ongoing visibility into investment organisations will become increasingly important. Investment houses that want to retain their corporate clients will need to invest to respond to these increased real-time reconciliation and reporting demands.
Foreign Exchange and FX risk. It’s a small world as they say (unless you’re asked to paint it) and many corporates are trading globally, generating P&L in multiple currencies and thereby generating currency exposure. Corporate treasurers are now much more sophisticated in the way they manage this exposure (out of necessity?) and take a variety of FX derivative trades to manage this exposure. By way of anecdote, I recently blogged about the issues we have as a corporate when we purchase FX options. This week we executed on one of our options, translating a USD position at one institution to a GBP position at another. We executed verbally for next day settlement and the next day the Sterling duly arrived, however our USD position remained long. Two days later it was still long! On the face of it and particularly if interest rates were better this would be a good position to be in – earning interest in both the US and UK on the same funds. In reality, our banks have unwittingly granted us a significant line of credit for which we (and they) have no authorisiation in place, bringing with it increased credit risk and risk of fraud. We’re a relatively straight-forward corporate executing rather vanilla FX options but our visibility of our liquidity position became blurred as a result of inadequacies of the processing infrastructures of our major banking partners.
Regulatory Risks. Just under 30% of the respondents highlighted regulatory risks as generating the greatest concern. Over the last year I have spent a lot of time with the middle and back offices of organisations that are seeking to comply with Dodd-Frank in the US and EMIR in the EU. Dodd-Frank and EMIR will both impose margining requirements that will further exacerbate the organisations liquidity position. This will almost certainly cause a number of organisations to exit the market. Ironically, in the weeks prior to the MF Global collapse they had successfully argued for a lowering in the CTFC’s net capital requirements for members. Liquidity risks aside, the regulatory process itself is causing uncertainty. When exactly will Dodd Frank be mandated? What is the fine detail (see http://www.sec.gov/spotlight/dodd-frank/dfactivity-upcoming.shtml for what is still to be determined)? Organisations are holding back on the investments required and what should be tackled in an enterprise-wide risk focussed set of initiatives will be heroically fixed by the middle office expert with an access database and a roll of tape.
When we launched Clareti Transaction Control for Real-Time Financial Certainty at SIBOS 2011, we did it for a reason. It is pleasing that the AFP Risk Management Survey confirm our views on this subject straight from the shop floor – it’s also a little alarming that recent lessons learnt are yet to be properly addressed by regulators, banks or corporates.
