Corporate treasuries are dedicated, complicated and highly skilled financial departments. The services delivered are totally interconnected – to such a degree that in order to achieve the primary objective of good corporate governance, the controls, policy and procedures that govern a treasury’s behaviour should be comprehensively documented. These relationships are best explained in the diagram below.

The aim of any treasury (and what Ilizwe’s treasury products deliver) is to: “evaluate, quantify and manage financial risks into definable future cashflows with a high degree of certainty along defined roles of responsibility and accountability.”

Though interdependent, these ‘products’ can also be separated into job descriptions or departments (as in larger treasuries) and outsourced independently.

Diagram

1. Treasury Policy

Treasury policy is a Board approved, clear and unambiguous statement that tables the best practice, rules and parameters, responsibilities and delegated authorities to measure and manage all financial risk. It is the cornerstone of treasury behaviour and adherence to it is unquestionable. Its position at the top of the Ilizwe Treasury Products diagram reflects the policy’s importance in governing all of the related departments.

Ilizwe will work within the parameters of an existing treasury policy or will create a policy after the completion of a thorough financial risk assessment of your company. (See point two).

A treasury policy should normally include:

  • A mission statement – purpose and scope of the policy
  • A recognition and definition of all the financial risks involved e.g. currency, interest rate or even tax (transaction and economic risk)
  • A means of measurement of the risks
  • A basic framework that covers the minimum requirements of risk management (philosophy of risk management, i.e. risk tolerances). This is the meat of the document and should not be too constrictive as to prevent upside participation
  • A detailed structure of delegated authorities and responsibilities to manage the risks
  • A list of approved financial products, transaction size and maturity limits, counterparties and benchmarks
  • Accounting and disclosure policies and procedures
  • And most importantly, a management reporting framework

The policy is a dynamic document and should be revisited on an annual basis after the Enterprise Wide Risk Analysis (EWRA) assessment has taken place. Changes to the policy can be made at ad hoc Board meetings but any changes must be communicated to and understood by all persons affected (again, see point 2).

As the above behaviour and reporting policy is Board approved, it is easy to outsource its results as they are contractual and failure to comply is dismissible without consequence. The measurement and benchmarking of the various risks makes performance contractual.

2. Enterprise Wide Risk Analysis (EWRA)

While this definition, quantification and evaluation process actually comes before the creation of a policy, it appears in the second box of the Ilizwe Treasury Products diagram as policy creation is a “once off” that is compiled after a single, in-depth (financial) EWRA.

The EWRA process is however, ongoing and should be addressed on an (semi) annual basis to reflect any changes in the company’s business, market standing, peer performance and banking relationships that may affect financial performance. A full EWRA actually covers the complete company assessment and is covered in our “Business Risk Model” – a document that is available on request.

The team at Ilizwe can cover the most important financial aspects of an EWRA and we identify them as:

  • Operations – staff, IT, efficiency, performance, cycles, controls and forecasting etc.
  • Foreign exchange – changes to import costs versus local sales revenue or export revenue versus local production costing
  • Interest rates – risk that interest rates change – inherent and/or direct costs
  • Commodity prices – risk to product price movement
  • Liquidity – banking facilities, asset and liability management etc.
  • Budgets and planning - forecasting
  • Accounting – systems, hedge accounting, AC133 etc.
  • Reporting – management, regulatory and compliance

Through this process of evaluation and quantification, the following questions will be asked:

  • What risk propensity has been acceptable to the board in the past?
  • Is there a strategic plan (direction) for the company?
  • What reserves are available for contingencies?
  • Who are the clients, competitors and their relevant relationships?

The salient results of this evaluation must be documented and placed in an agenda for a minimum (semi) annual evaluation by those positions delegated in the treasury policy.

3. Market Research

In the Ilizwe Treasury Products diagram we have deliberately placed market research as a product on its own to stress its importance as a function in the treasury environment. We believe that market research is essential to add value to the treasury process. It covers three main areas:

  • Financial market products – these are normally associated with the banks and relate to hedging, investment or finance products that allow a company to better hedge or enhance earnings without putting the underlying exposure at risk.
  • Financial markets – this relates to the economic fundamental, forecasting, charting, fair value modelling and market sentiment analysis to ascertain market mood or direction so as to position the exposures correctly to maximise economic returns by using the best market product (above) available.
  • Specific market/services or commodity markets – this relates specifically to the business at hand and unless a tradable commodity, not normally a treasury function. However, in all instances this would include consumer requirements and all other specific drivers of the given market sector in which the company is involved.

Ilizwe provides for the above with the following products:

  • Daily communication with various leading banks in SA (local and international), news research etc in the form of an ad hoc daily e-mail to all clients on the state of the markets and the possible move on the day – FX and interest rates
  • A weekly report that provides insight into the movements of the past week, fundamental and charting predictions for the short to medium term.
  • Other incident specific reports
  • A monthly consensus report that views other market participants take on the markets, fair value models, economic forecasts and provides for strategies that would best fit the resultant consensus view. This allows for clients to follow the market – at least achieve the average.

The objective of this research is to outperform the relevant daily, weekly or monthly benchmarks (averages) that are normally ascribed to the various markets.

It is important that the client receive as much, trustworthy information as possible and to NOT subscribe to one particular source. Ilizwe is fortunate to have access to a wide range of bank dealing rooms and as such, the most extended research platform available. Any form of financial market positioning cannot be taken with confidence without a good understanding of the market possibilities going forward.

It is only with good market research that any strategy can be developed which is then used to manage any financial exposures facing a company.

4. Front Office Risk Management

Risk management encompasses the skills gained from the market research, the analytics from the EWRA and the guidance of the board approved policy to create a treasuries final aim: “evaluate, quantify and manage financial risks into definable future cashflows with a high degree of certainty.”

Front office risk management comprises the following categories of exposures which require definition in the policy framework:

  • Transaction risk – this is the risk related to a particular deal (exposure) that can be ‘valued’ on its own, whether it be financing or fx.
  • Economic exposure – this is the exposure of ‘staying alive’ i.e. that fx rate at which producing a good for export is no longer viable and long term losses will be incurred. This relates to long term budgeted exposures.
  • Translation exposure – is an fx exposure that relates to financial reporting in another currency and more specifically the translation of local loans (liabilities), as assets are normally stable.

What is often regarded as the main aim of a treasury is the front office management. This is where the dealing strategy and action occurs after the deliberation of market and policy inputs and the decision made of how to manage the main exposure at hand. This should always be done in conjunction with management unless otherwise delegated in policy. It must be emphasised however, that the day-to-day running of a treasury need not constantly seek direction from management but merely report on it timeously. Risk management is not just about obtaining the best price in the market, but also about market timing and positioning in order to add value by curtailing risk and enhancing rewards through upside participation.

The main exposures are divided into four categories:

4.1. Liquidity Management

Liquidity management is probably the most underrated exposure when it comes to the amount of time and effort spent. This is the management of the company’s cash position in that it must ensure that there is cash available to meet all payments, that all cash is circulated both effectively and efficiently and that surpluses are well invested.

The key to liquidity management is the forecasting (mentioned in Section 2 above) which is required to identify all future cashflows and net them into a meaningful time series.

Some inputs into the forecast include: All accounts receivable (sales) and payable (purchases), payrolls, business unit forecasts and future resource planning (capex). Added to this are current bank balances, facilities available (or required) and treasury ‘what if’s’ that include currency conversions via the different strategies planned for the future fx exposures. All this information is quantified into a “global cash position” from which all decisions and exposure management are then made.

The core to liquidity management is:

  • The optimization of cashflows with regards to asset and liability matching (debtor and creditor netting)
  • The valuation of future fx cashflows and their timing
  • General banking facilities (short term) management
  • Long term debt facilities (paper issuance etc) management
  • Credit analysis and the investment of surplus funds
  • And to ensure that a minimum amount of future necessary cash requirements are available at any given time.
  • Any foreign exchange aspects of liquidity need to be taken into account as well.

4.2. Interest Rate Management

Interest rate risk is essentially that risk of increased expenses (or reduced income) which arises from changes in interest rates.

A company’s interest rate terms (long or short, fixed or floating) are often governed by the facility provided by the lending financial institution but there are many derivative instruments available to change this profile.

Managing interest rate risk revolves around three core principals:

  • Yield curve positioning – this is whether long or short based on anticipated future yield curve movements bearing in mind that the bond/swap markets already discount future movements in interest rates. Policy should dictate a minimum ratio if a company regularly borrows.
  • The fixed - floating mix dictates as to how much chance the board wants to take on exposing itself to future interest rate moves. Again, this can be policy driven of left to the discretion of the treasury department and a minimum benchmark.
  • Implied FX rates – this can be a complicated to comprehend but basically it says (for South Africans) that if the Rand is appreciating, convert your currency ASAP or borrow currency and convert with the intention to pay the currency back at a cheaper exchange rate (less Rands required to buy the principal and interest back). If the ZAR is depreciating, keep your currency in its CFC account and borrow Rands. Yield curve positioning and the fixed floating mix (above) need to be considered in both currencies when applying implied rate theory to your interest rate risk management.

Ultimately, interest rate management boils down to ratios of fixed to floating and long or short and the relevant benchmarks.

The product/service offered is determining the extent of the company’s interest rate exposure and providing a strategy to manage on an ongoing basis. Interest rates are usually not that volatile and these ratios usually need only be addressed on a quarterly or bi-annual basis.

4.3. Foreign Exchange Risk Management

This is the glamour aspect of risk management, but also carries the most risk due to the volatility that usually characterises this market. Its basis lies in any transaction or market (direct or indirect) exposure that is not expressed in the company’s base currency (ZAR) and the risk lies in protecting (or maximising) the base currency value.

Foreign exchange risk is normally associated with a time/credit exposure as well as goods sold or bought have a time period between completion, packaging, shipping, arrival and payments. There are often initial and final payments involved in various ratios and dependant on quality controls that need to be taken into consideration. The final costing of the product is somewhere along this continuum and it is this base currency value that is required to be hedged (protected) or added to in the FX risk management process.

Foreign exchange management involves the use of benchmarks to measure performance and these can either take the form of covering the actual cost of the good or some kind of average. Measurement against the cost of a good requires careful forecasting of the costing dates (FX value) and amounts and then the future payment/receipt dates that that the actual costing (p/l) can be calculated. (Covering a cost involves an actual p/l whereby measurement against a rate when the payment is received/made is an opportunity loss or profit.) By using implied rates, the opportunity of holding a currency until later can be evaluated in terms of local funding costs.

FX management looks at either the covering of costs/payments or the analysis and taking advantage of short term market opportunities to enhance returns (or returns on costs) to add value to the main core of business.

It is important to note that many companies rely on FX valuations and profits in order to remain competitive and profitable and once again, the main core business at hand must be stressed as the driver for the business. Treasury risk management should be there to protect those values and any added revenue should be regarded as opportunistic. Treasuries aim lies in insurance: protecting the underlying value of the company.

4.4. Commodity Exposure

This is the exposure to the market (main business) that you are in and whether there are any direct or indirect methods of hedging (protecting) the value of that commodity in a base currency. This exposure is covered by futures and option markets for mining, agricultural and other markets; e.g. gold and platinum, fruits, frozen juices, beef and ‘sectorial’ via equity markets.

Most commodity exposures have an element of currency risk and that is why it is more often than not managed by the treasury department, as opposed to that of marketing. They are also mostly of an economic nature i.e. absolute value for the company as opposed to specific transactions. (For example, a gold producer may wish to sell all forward production above $ 420.00 as he can lock in good margins.)

Once again production forecasting and all other elements that affect the above exposures need to be taken into account when managing commodity exposure.

A Centralised Treasury:

A structure within the front office theme is the centralised treasury with the aim to streamline policy, procedure, systems and through the use of economies of scale, reduce costs by not duplicating functions and processes for company’s that have multiple independent subsidiaries, departments or even loose holding relationships. Once again, progress and growth within a company dictates the necessity for a central treasury’s existence and the need for a specialist operation to cover all the risks and financial requirements

Through Ilizwe’s expertise and systems the following functions will be achievable through a centralised treasury with Ilizwe:

  • All surplus cash can be centrally managed and the best rates achieved through the power of volume
  • Centralised CFC (currency other than Rands) account management – interest, 180 days, etc
  • A central pooling system - one business unit can fund another, general cash management
  • Functional currency management where applicable – maintain/enhance the Dollar value of any company from a Rand asset base and a Dollar product.
  • All banking facilities are centrally negotiated – multiple facilities to spread risk and maintain competitiveness in pricing and cost reduction
  • Efficient cash management controls – Cash on call rather than in current account etc.
  • All FX deals are centrally managed - imports, exports (netting) dividend man. from policy
  • Interest rate management – consistency and risk aversion and the use of natural hedges
  • Central commodity hedging – against a centralised policy
  • Centralized benchmarking of individual entity’s/mines/divisions performance through cash forecasting accuracy and data capture.
  • Centralized expertise and risk management of the entire company’s flows.
  • Centralized credit management
  • Dividend management
  • Asset and liability management – e.g. matching maturity profiles etc
  • Centralized bank recons
  • Central payment factory – debtor management and control of accounts

Through a centralised treasury, the following operational solutions present themselves.

  • Centralized systems, controls and duties
  • Through process, standardization, and automation to reduce human error
  • Centralized policy and procedures
  • Centralized accounting
  • Centralized settlements

One of the most efficient results of a centralised treasury is that the management reporting function is not duplicated, but central and controlled. Management need only make one call for any report on any entity, or may even have access to the Ilizwe’s system for live exposure/reporting functionality/capability in the near future.

5. Back-Office Administration

Back office administration is very systems dependent where policy and procedure play the main drivers to install an environment of ultimate control. It includes:

  • Confirmation of trades
  • The cash settlement of all trades or transactions – (payment)
  • All account reconciliations
  • Ensures that all the check and balances are met – the main focus from an audit point of view.

6. Compliance

Compliance falls into middle office management (operational risk) and ultimately has to ensure that good corporate governance is taking place in the form of controls, accounting and reporting. Operational risk can be defined as the risk of loss that results from inadequate or failed internal processes, people and systems or other external events. While it is often difficult to create a separate department or position for this and it noften falls within the ‘back-office’/accounts environment, it is important to recognise its importance from the control aspect:

  • All accounting (GAAP, AC133 etc)
  • Valuations
  • That policy and procedure as authorised by the board is adhered to and that
  • All exceptions are reported.
  • Systems are compliant and adequate to meet the companies minimum requirements
  • Counterparty risk (debtor) management falls in here as the credit risk of counterparty’s (chance of financial failure) are evaluated and managed into trading limits in terms of size or duration.
  • Creditor management in terms of investment limits
  • Dealing (front office) trade, hedging and product limit monitoring and reporting
  • Ensuring that all regulatory requirement are met – SARB, FSB etc
  • Documentation
  • All management reporting should emanate from here as there is no direct risk management, deal or reporting contamination to affect what is reported. Reports should also be system generated so as to avoid personal interference where possible. This must be auditable and timeously delivered.

Summary:

All of the above falls into an iterative process that is specific, skilled, controlled and has defined delegated authority, responsibility and targets (benchmarks) such that accountability is covered at all times.

1. Numerical timeline analysis of all exposures from identification and definition to cash flow forecasting etc. (compliance)

2. Market research and policy are used to create a strategy to manage the above quantified exposures (compliance)

3. Risk management – with stakeholders/management and other authorized parties. Make a dealing decision unless policy otherwise dictates. (Compliance)

4. Deal pricing and execution (Compliance)

5. Confirm, settle and report (full compliance)

A client automatically receives best practice policy from Ilizwe as a result of its exposure to many clients and banks while transparency is an overriding philosophy when dealing with banks and clients. Ilizwe’s treasury value chain marries all processes and controls with a defined risk objective in order to create an obtainable objective or ‘key performance indicator’ that has the buy-in of all individual clients in order to achieve a win-win objective in managing all the above risks. The ultimate control will always remain with the client

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