Treasury Risk Management Implications of M&A
As companies consider mergers and acquisitions (M&As) as viable growth strategies, success lies with those that put in place a solid foundation upon which they can build a new, more efficient treasury organisation. In addition to cash and liquidity management considerations, risk management processes and technology pose overwhelming challenges for corporate treasurers post-merger or acquisition. The good news is that companies have an opportunity to ‘future-proof’ and ensure that their treasury organisation is structured for more efficient, globalised operations and continued future growth.
To lay the groundwork for a comprehensive financial risk management process, companies can put in place a best practice control framework. This control framework is a formula for how to assess a company’s financial risk management practices and how they will integrate with that of the acquiring company. The areas of risk management will vary, from hedging commodity risk, for example, to exposure gathering. However, the control framework ensures that no matter what the risk that needs to be assessed, it is done using a consistent and thorough methodology. This control framework must define responsibilities, policies and procedures, and it will dictate how the combined companies will operate together with regards to who, what, when, and how.
Consider the following:
Treasurers should work to put this risk management process in place now, while companies consider M&A targets. By implementing it prior to M&A activity, it will ensure that the process runs more smoothly during and after the acquisition. Companies that do not have a risk management process in place can be vulnerable to missteps. When companies do stumble, it typically happens in two areas:
The best-run treasury organisations allow for a constant flow of this information from treasury to all stakeholders, both internal and external and across all levels of the enterprise. The appropriate benchmarks will vary by organisation. However, it is critical to establish the right ones for your organisation and to appropriately report on them in a timely manner. Some common examples include weighted average hedge rate as well as the effective rate of un-hedged and hedged exposures in a given portfolio.
It is also important to consider that M&A activity may push treasury into hedging asset classes or products that they have not in the past. If this is the case, treasurers must plan for this as part of the control framework. In addition, in situations where commodity risk management is handled elsewhere in the organisation, and not by treasury, treasurers may view restructuring of the organisation as an opportunity to bring this process into the realm of the treasury department.
Historically, commodity risk management has been the responsibility of the procurement function. However, in recent years, and especially post global financial crisis, this function is being managed more and more in treasury departments. One large benefit of this shift to treasury has included a richer understanding of dealing with financial counterparties in the context of the entire relationship (lending, syndication, bank fees, and derivative activity).
When it comes to exposure gathering, most companies typically have fairly manual processes for collecting this data, which usually involves some combination of Excel and email from subsidiaries to central treasury. Bringing together all these manual processes can create some of the biggest headaches immediately following a merger or acquisition.
Most treasurers don’t need to experience a post-M&A quagmire to realise that the process of manually gathering exposure data is not tenable for an organisation looking at M&A growth. The logic is fairly straightforward: if an organisation uses a manual exposure gathering process today, and then if you multiply the number of subsidiaries that need to be ‘serviced’ post-M&A growth, the process will eventually reach a breaking point. Mistakes and inaccuracies start to creep in and treasury personnel become even more overworked. No organisation can afford to have a process as integral to the risk management framework as exposure gathering reach a breaking point. By running this stress test, prepared treasury organisations are usually able to secure budget to automate these processes prior to any merger or acquisition.
Preparing for a merger or acquisition is a great way to see if improvements are possible for existing risk management processes, which requires a comprehensive exposure analysis process. For example, an auto manufacturer we work with looked at their currency exposure using a current forward curve approach. By looking at each currency discretely it found that by using a portfolio approach, and taking correlations between currencies in their portfolios into account, it was possible to reduce derivative usage by close to 50% due to natural offsets in their portfolio.
However, another organisation, which quantified exposures using the current forward curve (dollar equivalents), was able to gain even more insight into its exposure profile by using cash flow at risk (CFaR) to get worst-case scenarios. This analysis essentially allowed the company to concentrate hedging activities around those currencies that were the most volatile as they had the greatest contribution to the worst-case scenario.
As with global cash and liquidity management, preparing the risk management process in advance of M&A activity will make the integration of two treasury risk management systems much smoother, not to mention less time-intensive. In addition, by preparing now, treasurers will be able to simulate and forecast various scenarios, which will help prove the need for greater resources for the treasury department before a merger or acquisition takes place. By being ahead of the curve and not being forced to play catch up, treasurers can ensure that the opportunities presented by the new combined entity are maximised, while the risks are minimised.
To read the first article in this series, please see Facing M&A? Eight Steps Treasurers Need to Consider.