Not so risky times ahead

Since the start of the financial crisis, a great deal of focus has been put on how companies should reorganise their internal structures in an effort to try and prevent history repeating itself. While most parts of the corporate structure have been looked at, one area that has received little attention is the treasury function.  But this is starting to change.

The financial crisis elevated the issue of risk and the ability of institutions to identify, monitor and limit their exposure to both counterparty risk and credit risk.  In the corporate world in particular, organisations are struggling to measure and mitigate these risks. 

For example, before the collapse of Lehman Brothers, counterparty limit management in corporate treasuries was usually based on the simple allocation of limits against the counterparty’s credit rating. But this method completely failed to give advance warning of the impending crisis.  Lehman Brothers carried an investment grade ‘A’ rating when the bank crashed.  So best practice counterparty risk management must reflect the credit view currently implicit in credit default swap spreads, or via similar methodologies, to offer the necessary sensitivity to enable adverse changes in creditworthiness to be swiftly detected, quantified and promptly managed. 

The reliability of the use of credit ratings alone has been called into question and, as a result, corporates have adopted conservative policies potentially limiting their opportunities for growth.  Better risk indicators could really help corporates in this regard, enabling them to expose themselves to levels of risk permitted by treasury policy – and to identify and avoid unacceptable risk exposures.  Investment opportunities may therefore be more confidently taken, given that their risk has been accurately evaluated.   

The treasury function is uniquely placed to understand and address the issue of counterparty risk, through its well established procedures for monitoring and evaluation.  As a result, treasury is moving up an organisation’s hierarchy and is now providing intelligence that guides strategic decision making at a board level.

It is my view that the treasury function is uniquely positioned to influence the solvency of an organization and also measure and manage the issue of counterparty and credit risk.  Treasurers are experts in looking forward in time and evaluating what might happen, as well as analysing and reporting what has already happened. 

Regardless of who you are, or the size of your organisation, companies need be transparent and take a back-to-basics approach when trying to anticipate and manage risk. Counterparty risk information is only really useful if it is available in real time, or, at worst, 'near real time’ as the time window in which a company can react and mitigate a problem may be very small.  

Right now, quite rightly, the priority for most corporates is controlling costs, and new investments in treasury demand close management scrutiny and cost/benefit analysis.  But in terms of managing counterparty risk, this investment could actually pay dividends for years to come and more than outweigh the initial cash outlay.  At the very least, it can enable treasurers to be confident that they are measuring counterparty risk more accurately, and are transparently complying with corporate treasury policy.  At the extreme, a catastrophic counterparty exposure might be avoided.  The necessary tools and information are available – they simply need to be deployed.   

 

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