How to be a Better Risk Manager - in Treasury and Across the Organisation
The treasury environment is changing quickly with the advent of the single euro payments area (SEPA), the banking industry’s current liquidity crisis, the introduction of regulations such as the Markets in Financial Instruments Directive (MiFID) and Basel II, and also the pace of technological developments. All this means that treasurers need to adopt a broader approach to risk mitigation. They must constantly keep up-to-date as it is increasingly seen as their role not only to mitigate financial risk but also the financial effect of risk across the organisation. They need to have an active risk management strategy and look for ways of dealing with the risk associated with new developments and regulations.
The physical and the financial supply chains are evolving rapidly due to advances in technology and the move away from documentary credits towards open account. However, this area of trade also poses several risks for treasury, one of them being the risk of non-payment. Treasurers should investigate the possibility of e-invoicing, which is becoming more common, facilitating and speeding up the payments process, thereby reducing non-payment risk to some extent. The EU Directive for e-invoicing was passed a few years ago, and the European Payments Council (EPC) is now in the process of defining e-invoicing in the context of SEPA. It is likely that this will become a global standard for e-invoicing. Companies should also look at factoring and reverse factoring, which are set to increase enormously in future because companies can benefit from the risk appetite of larger companies. Factoring and reverse factoring enables a company to outsource their collections department and free up resources. That in turn can be invested, for example, to start up new production processes in an earlier phase. Factoring and reverse factoring speed up the processes in the financial supply chain and result in a more efficient allocation of resources.
Monitoring risk in the supply chain is particularly important in the food and agricultural business. It’s important for consumers to know that their food is produced ethically and it is important for treasurers in food and agricultural companies to know that too. Any disruption to the product supply chain, for example because of workers’ pay disputes, bad harvests or delays in shipment, will have a direct effect on the company’s cash flow. Treasurers need to understand their company’s processes – and this means getting out of the office, visiting site locations and finding out what the risks involved in the production process are, including supplier credit risk. The risks need to be quantified, translated into financial terms and then mitigated appropriately.
A better understanding of the physical and financial supply chains should result in a reduction of the need for working capital and will lead to better cash flow forecasting, less interest paid on working capital and lower risk.
Read more about risk management, corporate responsibility and sustainability in the supply chain in the article Supply Chain Management: Risk Management and Sustainability by Rabobank’s Arthur Payens.
In the area of cash management, the changing products pose a challenge for the treasurer or CFO, and SEPA is one example of the increasing need for risk awareness among treasury staff. Banks will have to provide SEPA-compliant credit transfers from January 2008, and although companies are under no obligation to use these, at some point companies will have to make adjustments to their ledger system. Treasurers need to be aware that this will have to be done and that they will need to process the 18-digit international bank account numbers (IBANs). The main risk to companies, apart from the fact that eventually they will not be compliant with EU payment standards, is that they could lose out on commercial benefits, such as the faster and more efficient processing of euro payments. Treasurers can seek support and advice from their banks, accountants and software suppliers on when and how the ledger system can be modified.
Corporates should also be aware, with the introduction of SEPA-compliant payments in 2008 and under the Payment Services Directive (PSD), that the pan-European direct debit (PEDD) system means that customers are entitled to reclaim money paid into a bank account eight weeks after the payment is made. This poses a significant risk for users of PEDD, who could find that non-payment has occurred eight weeks after the transaction. There are two ways to manage this risk: one is not to use PEDD, and the other is to come to an agreement with your bank or client, whereby a contract is signed to ensure a fixed payment on a fixed date.
Treasurers need to truly understand their payments processes and, just as with the supply chain, they need to look outside the treasury department and understand the payments mechanisms. They need to talk to their banks, accountants and software suppliers to find out if there is any unjustifiable risk in the payments process.
With the credit transfer coming into effect from the 28 January 2008, international operating companies can really benefit from setting up a payment factory. By managing payments from one location, companies can help manage risk more effectively.
No corporate treasurers or CFO can afford to ignore online banking – it has increased the speed of the sales process as well as many other account management processes. It also enables round-the-clock access to accounts through laptop computers and mobile phones or hand-held devices. It is important for corporates to put in place a multi-banking facility because this facilitates access to all accounts and cash. If possible this facility should be accessible online and from mobile devices. Corporates that do not have the latest cash flow information at their fingertips are at a disadvantage, as this data can significantly speed up the sales process. For example, sales people can have access to the relevant account via their hand-held device (e.g., a BlackBerry) and they will be able to see the incoming payments immediately. The technology can filter out any non-essential data, which then mitigates any security risks. This puts CFOs and treasurers in the position of being able to demand online cash management technology by arguing that it will benefit the sales department just as much as the finance department.
Some corporates still have security concerns regarding online banking, although new technology enables companies to limit access per user and therefore make it more difficult for fraudsters to enter the system. According to the gtnews Online Banking Services poll, conducted earlier this year, many corporates’ fears regarding data security have been allayed. In fact, the use of advanced technology has made online banking as safe as traditional off-line banking. For more information about the poll, read the results article that was published on gtnews in September: Online Banking a Necessity for All.
By having online banking linked into the ledger system, companies will be able to see exactly where their idle cash is. With a good cash forecasting system, treasurers will be able to manage their working capital and their risks more effectively. With real-time information, they will be able to make decisions such as drawing money market facilities or putting idle cash into liquidity funds. They will reduce interest costs and foreign exchange risk. The key element here is that the online banking tools offer a fully integrated package for cash, trade and treasury.
Corporates can save money by having one point of contact for all of their bank account management needs. They need to have an effective transaction system in place because any transaction problems can affect relationships with suppliers or even acquisitions and this leads to an indirect risk for the company.
With bank account management, as with all systems based on several integrated systems, there is always a risk that things can go wrong. Corporates should ensure that any risk is minimised by choosing a bank with good customer support, so that if anything does go wrong, it can be rectified quickly.
For more information on bank account management, read the following article by Raboank’s Chris Sunderman and Eelco Kaan, that describes clear steps to improving the corporate’s management of its bank accounts, emphasising the importance of efficient data management:Three Steps to Good Bank Account Management.
Banks are now taking their social responsibilities seriously and they increasingly expect their corporate customers to do the same. Banks are under global pressure not to fund companies and projects that could harm the environment, do not respect human rights, fair trade and other social issues. Banks need to monitor their clients’ corporate social responsibilities (CSR) to ensure that their own risks are mitigated. For a corporate, the risk of finding out that your product is made by child labour, or that you have poisoned a natural habitat, can be extremely damaging to your company’s reputation. So, the risk of not monitoring a company’s CSR programme is significant. Automation of the financial streams in the supply chain, and automation of e-invoicing help to achieve transparency, both in terms of payments and in terms of knowing your suppliers.
Understanding and mitigating risk is very much in the domain of treasurers and CFOs and it has become increasingly clear that risk management purely within the treasury department is no longer sufficient to cover all enterprise risks. It is now necessary for treasurers to fully understand their company and to do this they need to get out of the financial environment and examine the physical supply chain, the payments processes and all areas of corporate social responsibility. Banks can assist their clients in this by offering a standard approach such as taking the enterprise risk management approach. Once they have a good understanding of company processes and all areas of company risk, they can then use their knowledge to mitigate and improve treasury processes.