Treasure Islands: Navigating New Opportunities and Risks in Treasury Management
As automation steps up the pace of business operations, financial and risk management capabilities must keep up. Integrating and modernising diverse treasury management competencies will augment the polarisation between leaders and laggards among financial services institutions (FSIs) and other globally minded industries.
Smarter ways of doing business, coupled with continual technology innovation, are reshaping the corporate treasury landscape. Living up to the following challenges will be decisive:
Amid continuing challenges and uncertainty, treasury leaders are tapping new opportunities in business methods and technologies to excel in these fundamental competencies. New opportunities also entail new risks, so advanced treasury management will help in elevating market risk and other key risk dimensions to a more strategic level.
Changing market realities reveal new obstacles that prevent commonly liquid financial instruments from converting into cash within a few days. When disruptive events affect sovereign governments, even cash that is held in foreign currency may turn out to be illiquid. Complex derivatives and other financial assets are more vulnerable to market distress and will no longer represent a trusted source of liquidity. The relaxation of mark-to-market rules and government intervention in stalled markets were all but ineffectual in reinstating the credibility and yields of complex instruments. Indeed, TowerGroup has found that many FSIs still have a hard time valuating complex derivatives contracts that they had stockpiled under strained market conditions. Economic woes, depressed money markets, and tightness of credit further compound the liquidity challenges.
So where will successful treasurers find creative means to improve corporate liquidity? A first step will be to understand the hidden subtleties underlying the company’s business model as well as its ecosystem of clients and suppliers. Opportunities abound to overcome structural inefficiencies in the supply chain and the flow of physical inventory, fractures between internal business units and external parties, delays and inaccuracies in decision support information, and imbalances in foreign currency positions. By improving business operations, treasurers can optimise working capital and free up cash.
Despite recession hiccups in western economies, global trade will continue its relentless growth. China alone wields a significant influence: In 2007, its merchandise exports to Europe and North America amounted to US$528bn and exports throughout Asia another US$521bn. Chinese exports will continue growing at a fast clip, around 20% annually, spurring bilateral and regional trade. To be effective in a global economy, FSIs supporting corporate treasuries must have an international footprint. Since very few institutions can attain global coverage through their own offices, most FSIs rely on an international network of business partners.
When operating multiregionally, corporate treasuries must heed a plethora of regulatory mandates and constraints. Protectionism drives some countries to impose diverse financial restrictions such as currency convertibility, repatriation of investment capital, application of notional pooling, and enforceability of netting contracts. Complexity and cross-border risk increase exponentially with the number of participants and jurisdictions. A cohesive approach to trade finance that minds local regulations and taxation rules will significantly improve the efficiency of working capital and will mitigate risk. Cash management methods such as hedge instruments, as well as foreign exchange or interest rates swaps, also drive treasury’s effectiveness. A global mindset is instrumental in meeting the demands of an interdependent business world that operates 24 hours a day, seven days a week.
Given that electronic funds flow massively, instantly, and globally, market volatility will persist. Absent structural improvements to manage systemic risk, financial imbalances and market swings will increase in frequency and intensity. Thus, corporate treasuries must articulate well-reasoned strategies based on modeling risks and turmoil scenarios that are likely to haunt them for at least a couple of years. Adequate stress testing refines and strengthens such strategies. By unveiling functional weaknesses and probable points of failure, reverse stress-testing techniques raise the level of corporate preparedness to weather virtually any market storm.
A granular and timely approach to asset and liability management is essential. Granular analysis enables corporate treasuries to track the company’s course and adjust strategy dynamically to reflect changing liquidity, maturity, and valuation conditions. The bulk of the effort involves integrating multiple data sources of financial transactions, contractual obligations, and business events. As the treasury function attains more granularity and integrates financial information in real time, advanced analytics will improve the predictability and resilience of cash flows.
The effective allocation of capital hinges on an enterprise perspective that encompasses the entire business portfolio. Although corporate treasuries may produce significant financial gains, these are no substitute for healthy and sustainable operating margins. Financial opportunities should not distract the treasury function from fulfilling its central role of lubricating business operations throughout the enterprise.
Several treasury resources will contribute to effective corporate growth and performance. For example, factoring of receivables and reverse factoring of payables remove bottlenecks and accelerate the business cycle throughout the value chain. Similarly, reliable ratings and financial data help in securing the extension of credit to suppliers and third-party providers and speeding the order-to-pay and provisioning processes. Treasury may also improve balance sheet capacity and credit management flows to enable open account trading.
Comprehensive, end-to-end process views that integrate financial functions and business operations unveil opportunities for structural change. For FSIs and companies large and small, streamlining and automating treasury processes brings quantum gains in performance. The application of smart technologies such as image scanning, electronic signature and automated payments eliminates lags in documentation workflows and data latency. Aligning internal and external workflows can greatly amplify and speed up business throughput. Straight-through processing (STP) helps in expediting business deals from confirmation to settlement and account reconciliation and eliminates discrepancies.
The adoption of secure corporate and client portals facilitates access and interoperability. Real-time transaction processing architectures, coupled with advanced visualisation and reporting tools provide greater transparency at all levels. Modular automation tools and flexible software as a service (SaaS) solutions are widely available. Banks also offer a rich array of treasury, trade and cash management services. Given the range of opportunities to improve and automate execution, corporate treasuries should champion the orchestration of an optimal combination of core treasury and support functions.