Four pillars of leading practice treasury management

Treasury organisations have a critical role in maintaining funding and liquidity; developing optimised capital structures; controlling receipts, payments and cash; supporting tax and repatriation strategies; and managing interest rate risk, including hedging.

Every decade presents new challenges and opportunities for corporate treasury. These include the 2008 global financial crisis, the Asian financial crisis of 1997, the growth of China’s economy (and how companies responded to meet that growth) and G7 economic and currency policies. Today’s treasury departments must prepare for a new set of challenges, including:

• Sharply lower oil and commodity prices.
• Slowdown in China.
• Potential US Federal Reserve interest rate hikes.
• Continued negative interest rates in key economies.
• Potential political change in Brazil.
• Prospect of “Brexit” In Europe.
• Escalating fraud, cyber breaches and crime.
• Regulatory changes, including Base Erosion and Profit Shifting (BEPS), Proposition 385 and banking regulations impacting their funding practices.

Successfully anticipating, responding to and heading off these challenges will be critical to success and highly effective treasury organisations use the four pillars of leading practice treasury management to address them. A focused treasury organisation that uses these pillars will evolve to be more impactful on company operations and results, while mitigating financial risk and facilitating effective and efficient cash operations on a global scale.

Pillar 1: Developing a global treasury talent centre and organisation

Technology, talent and company structures have changed the traditional model of corporate treasury, which historically was part of the corporate headquarters and often had limited involvement in business operations. Today, the design of an effective treasury organisation must consider global capabilities and maximise use of existing structures, analytic capabilities and markets.

When developing a leading treasury department, the first step is to create updated policies and practices that identify key areas of responsibility, including funding and liquidity; financial markets risk (currency, interest rates and commodities); cash management; and bank relationship and account management. These policies create alignment with the organisation’s board, management and treasury department. This structure allows treasury leadership to develop an appropriate model to meet stated objectives and fiduciary requirements.

By evaluating and proactively developing individuals at all levels within the organisation, treasury departments can grow team members through rotations, involvement in critical projects and continuing education. Leading treasury departments review their talent pool at least semi-annually, identify strengths and gaps in the organisation, and use these forums as an enabler of talent development. Key questions to consider include:

• How many individuals are certified treasury professionals, and what are the group objectives for certification?
• How many team members have MBAs, or other advanced degrees?
• Who in the group is skilled at cash management, capital markets, investments and emerging markets?

The treasury department model has evolved from being an administrative group at corporate headquarters. Leading treasury departments are moving administrative and operational tasks to shared service centres (SSCs), which are possibly off-shored or outsourced, to lower costs and increase the effectiveness of key processes.

For example, a leading consumer products company has centralised its global payments process through a highly effective in-house service centre and payments factory in Costa Rica. Similarly, a major retailer with thousands of locations is using an outsourced service centre model in India to manage bank accounts and perform bank reconciliations. Other companies are locating key functions in international treasury centres, increasing responsiveness to multiple time zones, business requirements and operating cash pools.

Pillar 2: Creating an analytical hub and agent of change that supports business decisions

Through a focus on analytic skills and technical capabilities, today’s treasury organisations can create significant value. For example, improvements in managing financial markets risk can result in lower volatility and improve margins. Too often, companies identify financial risks in their cost structure after market volatility has exposed previously unknown risk levels – risks that could have been identified through an effective risk and impact analysis. Advanced analytic capabilities, including predictive analytics, are a leading practice to effectively manage financial risks.

Treasurers also require strong analytic capabilities for derivative pricing and valuation. Far too often, companies enter into transactions at disadvantageous pricing; the instrument used doesn’t effectively match the underlying exposure; or the company’s inability to value the instrument leads to an unanticipated loss. In addition, they may be reluctant to implement hedges, which can lead to a critical cost, competitive or business event for the company.

Economic events also have significant consequences to an organisation. Treasury departments should have key insights and information on economic events – such as recent ones in Russia, China, Venezuela and Puerto Rico – and political events in Brazil and the UK. Through preparation and scenario planning, the treasury group can be prepared for the impact of events for which it has direct responsibility, such as funding and intercompany loans. In addition, it can inform operational areas of the company about the findings, enabling them to develop contingencies in sourcing or respond to changes in prices in key inputs such as oil.

Treasury teams need strong relationship management skills to manage interactions with banks and key service providers. Companies rely on banks for funding, cash management, investments, capital markets and other services. For many companies, annual bank fees can be significant and may exceed US$10m-US$20m. A key to getting these services priced appropriately is a bank relationship strategy that incorporates fair, competitive pricing and returns, as well as sponsorship within the bank.

These sponsorships are critical when a company undertakes market expansion, requires liquidity or faces changes in the business and economic cycle. For example, a global consumer durable goods manufacturer is currently developing a bank relationship management strategy to promote depth and quality with its banks at a fair return.

Relationship development is also essential as treasury groups work across organisations with operations, marketing and supply chain. These internal relationships enable treasury departments to identify financial costs and risks, such as hedging foreign exchange (FX) on imported items to protect a key consumer price point.

For example, a leading food production company used outside advisors to help it restructure its risk management programme. A key element was the development of a risk committee that included the corporate treasurer, commodities group and division presidents. The change in structure created organisational alignment, improving operating plan achievement. Today, the company chief executive officer (CEO) regularly refers to the risk management dashboard that was created in planning meetings.

Pillar 3: Developing an “agile” treasury organisation that can quickly react to the changing business cycle and manage financial risks

Treasury organisations need to respond quickly to key internal and external events. Every company faces the business cycle. Current issues include the global economy post the 2008 crisis; declines in commodity prices – particularly oil; and structural changes in FX rates, including the Canadian dollar.

Sectors as divergent as steel and consumer fashion face weaknesses in demand, creating a need for treasury departments to monitor cash flow forecasting and liquidity. Other sectors, including automotive and housing, show significant growth in output. Disruptive technology companies like Amazon, Google, Uber and Facebook, are impacting entire industries, creating changes to funding plans and risks related to receivables from retail organisations. Monitoring credit risk for customers and counterparty risks for cash balances and derivatives is an essential function; particularly when economic or industry events cause rapid changes in conditions.

An example of an agile treasury organisation is a leading automotive supplier that uses current improved conditions in the industry to focus on its cash flow forecasting as part of a strategy to improve its credit rating to investment grade.

Treasury departments also need to be responsive to internally driven events. Record activity in corporate mergers, acquisitions and divestitures is being recorded. These events create significant treasury events in funding and developing an organisation that meets the requirements of the new company.

They also need to monitor and swiftly respond to financial risks such as external fraud threats, which are growing exponentially. The US Association for Financial Professionals (AFP) Payments Fraud and Control Survey found that 73% of companies reported payment fraud in 2015, against 62% in 2014. Organised crime is targeting corporate treasury organisations, using hacking and social engineering to develop fraud schemes. Major fraud losses at companies can exceed US$50m in a single scam; “smaller” losses may still be US$1m-plus.

Given these risks, company treasury departments must transform governance and controls, test risk areas, and improve systems and training for key employees. Every fraud event can be linked to weaknesses in one or more of these areas, and the credibility of the treasurer and chief financial officer (CFO) is linked to performance in the financial control area.

A final area that requires a flexible treasury organisation is ever-changing regulations. Current regulatory changes in Proposition 385, BEPS and Basel III will potentially require changes in intercompany loan documentation and processes, cash pooling, international treasury centres and bank relations. These regulatory changes create additional financial risk for companies, require close coordination with groups such as tax, and necessitate working closely with bank providers.

Pillar 4: Enabling technology through implementation of an appropriate treasury management system (TMS)

Leading treasury departments use one of the following two types of TMS: (i) a system through a major third-party TMS vendor or (ii) an enterprise resource planning (ERP) system such as SAP Treasury. The benefits of a TMS are the centralisation, standardisation and automation of treasury processes.

An additional leading practice is the use of SWIFT for secure messaging. These technology solutions streamline banking platforms, reduce reliance on bank portals, and provide security and controls of payments, bank accounts and global visibility into cash.

In lieu of these options, some treasury departments use shortcut processes often based on Excel spreadsheets. These spreadsheets create false economies, as their development time and effort may well exceed the cost of a TMS. More importantly, spreadsheets are more prone to errors and create control risks. A mistake in one cell or a training issue can lead to a missed payment or miscalculation of the company’s daily cash position. Errors in fraud and payments are often traced to email instructions and other insecure forms of communication.

A well-designed TMS selection and implementation process enables a company to have leading practices in cash management, cash flow forecasting, derivative valuation and hedge position tracking, bank account management and cash balance visibility. These enablers reduce both cost and risk for treasury organisations.

Key takeaways

Generating, maintaining and developing leading practices are both integral and essential to creating a world-class treasury organisation. Developing a strategy and assessing treasury requirements using the four pillars outlined above can help organisations build a highly qualified, agile, and efficient global treasury team and processes that can mitigate risk, reduce cost and interest expense, and have a meaningful, positive impact on their companies.

About the authors:

Paul DeCrane is the national leader of Ernst & Young LLP’s global treasury services practice in the US. Marc Monyek is senior manager – global treasury services for EY Americas Financial Accounting Advisory Services.

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