Introduction and global context
The financial manager is faced with 3 major decisions, the dividend decision, investment decision and financing decision in an effort to increase shareholder value. The financing decision is the focus of treasury management.
The Subprime crisis that hit the United States of America in late 2007 to 2009, which later deteriorated into a global recession has resulted in many questions being asked and solutions being sought to come up with long term solutions to avert such a disaster in future.
In assessing the reasons for the Subprime crisis, among other factors, the failure of sound risk management practices in financial institutions[1] and modelling challenges was identified as key[2].
One of the major areas of focus lately has been on risk management and how accountants can make a contribution to risk identification and management[3].
Risk management is the identification and evaluation of actual and potential risk areas as they pertain to the company as a total entity, followed by a process of either avoidance, termination, transfer, tolerance (acceptance), exploitation, or mitigation (treatment)of each risk, or a response that is a combination or integration.
The ongoing recession has seen efforts towards recovery with liquidity injections, IFRS changes and efforts towards regulation of investment banks, hedge funds and credit rating agencies which were identified as key participants in the credit crunch.
Developing countries such as Zimbabwe have not been spared from the global recession with the liquidity crunch affecting the ongoing efforts towards recovery, recapitalisation of industry and infrastructure development.
Small organisations which previously did not have any risk management policies and procedures are being challenged by the environment to come up with their own and demystify risk management[4].
In Zimbabwe, the adoption of a multicurrency environment in early 2009 with the United States Dollars, Rands and Pula being some of the preferred currencies has resulted in companies refocusing their attention on risk, treasury management and internal controls in order to minimise loses and maximise the benefit of available working capital at the back of limited credit being offered by local banks and offshore markets.
Risk Management
Financial management principles assumes that businesses and their custodians are naturally risk averse and hence the need to minimise exposure to whatever risk as much as possible.
Enterprise Risk Management (ERM) is defined as comprehensive risk management that allows companies to identify, prioritise, and effectively manage their crucial risks. An ERM approach integrates risk solutions into all aspects of business practices and decision making processes[5].
There are essentially four key pillars of a sound risk management framework namely:
adequate board and senior management oversight;
sound risk management policies and operating procedures;
adequate management information systems;
strong risk management, monitoring and control capabilities and adequate internal controls.
Although some institutions address risk as part of their strategic plans, governance structures and project-specific business proposals, best practice in risk management in any institution requires risk to be enshrined in an Enterprise Risk Management (ERM) Policy or Framework championed by the Chief Risk Officer or risk department and approved by the board of directors.
In smaller organisations without stand alone risk functions, the CFO is responsible for monitoring and managing Enterprise Wide Risks.
Broadly considered, an ERM policy may identify the following:
responsibility of the board towards risk;
responsibility of management towards risk;
risk tolerance and appetite of an institution;
expertise required;
training needs;
management information systems (MIS) – addressing security, integrity and availability of information;
monitoring and reporting;
codes of conduct;
internal controls and segregation of duties;
exchange control regulations;
risk categories relevant to the organisation;
risk limits;
disaster recovery;
business continuity planning;
role of internal audit;
role of risk department; and
risk mitigation.
An ERM policy identifies the main risks that an institution is exposed to. Some of the major enterprise wide risks are:
strategic risk;
market risk;
operational risk;
legal risk;
reputation risk;
liquidity risk;
political risk;
technological risk;
sovereign risk;
credit risk and
compliance risk.
These risks are not cast in stone and an organisation needs to continuously assess emerging impact of other risks and lately environment risk has been a major risk given the focus on green reporting and environmentally friendly business practices.
Risks relevant to treasury management
Risk management in inextricably linked to treasury management and all organisations not only financial institutions have had to embrace sound risk management practices and in some cases revise the existing controls.
In practice, addressing risk management with relation to treasury can be done in the ERM framework of the organisation or through separate treasury management policies. The specific risks that are related to treasury include the following:
currency risk;
interest rate risk;
settlement risk;
concentration risk;
commodity risk;
equity risk;
credit risk;
fraud risk;
liquidity risks;
systematic risk;
systemic risk; and
off-balance sheet risk.
These risks can further be broken down into specific risks that are relevant to an institution for example in financial institutions; interest rate risk has the following sub-risks:
repricing risk;
basis risk;
yield curve risk; and
optionality risk.
Any sound guidelines on treasury related risks should focus not only on identifying the risks but on the following:
1. definition of risks;
2. potential impact assessment;
3. direction of risk/probability;
4. monitoring tools; and
5. mitigation/hedging strategies.
Treasury and internal control environment
The internal control environment for any treasury function needs careful consideration. An internal control environment encompasses the overall attitudes, awareness and actions of senior management towards internal controls.
Essentially the board of directors sets the tone of the internal control environment by approving and amending key policies and procedures in line with changes in the operating environment.
In a financial institution, there is need for segregation of duties with clear separation of front, middle office and back office to avoid the famous Nick Leason effect. A code of conduct guiding operations of treasury officers is key is this regard.
The Barings crisis and recently Societe Generale debacle continue to underscore the need for sound internal controls and secure Management Information Systems (MIS) which cannot be manipulated to cover losses.
Centralised treasury
The liquidity crunch being experienced by many companies because of the global recession has resulted in a key focus of centralised treasury to maximise deployment and investment of available cash resources. This is essential for holding companies with subsidiaries and plays a role in having a coordinated management to the risks associated with treasury.
Already developing countries are harnessing the advantages of establishing centralised treasury Departments. Big companies in Zimbabwe such as Delta Corporation, CFI Holdings, and African Sun have centralised treasury Departments to manage their working capital.
The key functions of centralised treasury are:
funding management;
liquidity management;
investment management; and
currency management.
Identification of the key risks associated with these functions and actively managing them is very important for any organisation and cannot be left for specialised personnel alone, accountants need to play a key role.
Risk Management and Financial Instruments Hedging
From an IFRS perspective, IAS 39: Financial Instruments: Recognition and Measurement requires institutions to make use of hedges if, among other things:
they are highly effective; and
in line with a documented hedging policy[6].
This further highlights the need for an ERM Policy/Framework to underpin any treasury activities undertaken by an organisation.
Risk management and King III
The King 3 guideline on corporate governance, developed by the Institute of Directors of Southern Africa to replace King 2 effective from March 2010 reinforces the importance of risk management and highlights:
the board’s responsibility for risk governance;
management’s responsibility for risk management;
risk assessment;
risk responses;
risk monitoring;
risk assurance; and
risk disclosure.
Conclusion
Risk management in general, and its impact on treasury in particular, has received growing attention due to the sub prime crisis and the liquidity crunch.
One key lesson emerging is that there is need for institutions irrespective of size to formalise and review their risk management structures in line with best practices.
King 3 Code of Corporate Governance actually recommends that the board of directors should review the implementation of the risk management plan at least once a year.
The benefits for organisations are immense including low insurance premiums, low exposure to risk, reduced shocks and contagion effects to systemic risk and reduced compliance costs to regulatory requirements (especially for financial institutions).
Robust risk management also ensure reduced allocations of capital for operational, credit and market risks in line with Basel II for financial institutions.
[1] ACCA Policy paper, September 2008 – Climbing Out of the Credit Crunch
[2] Bank of International Settlements (BIS) November 2008 – Supervisory guidance for assessing banks’ financial instruments fair value practices.
[3] ACCA & CFO Research Services, August 2009 – The CFO’s new environment
[4] ACCA July 2009 – The Risk Register, Basic Principles for Small Companies
[5] King Code of Governance for South Africa, 2009, Institute of Directors of Southern Africa.
[6] IAS39, Financial Instruments: Recognition & Measurement, paragraph 88
The financial manager is faced with 3 major decisions, the dividend decision, investment decision and financing decision in an effort to increase shareholder value. The financing decision is the focus of treasury management.
The Subprime crisis that hit the United States of America in late 2007 to 2009, which later deteriorated into a global recession has resulted in many questions being asked and solutions being sought to come up with long term solutions to avert such a disaster in future.
In assessing the reasons for the Subprime crisis, among other factors, the failure of sound risk management practices in financial institutions[1] and modelling challenges was identified as key[2].
One of the major areas of focus lately has been on risk management and how accountants can make a contribution to risk identification and management[3].
Risk management is the identification and evaluation of actual and potential risk areas as they pertain to the company as a total entity, followed by a process of either avoidance, termination, transfer, tolerance (acceptance), exploitation, or mitigation (treatment)of each risk, or a response that is a combination or integration.
The ongoing recession has seen efforts towards recovery with liquidity injections, IFRS changes and efforts towards regulation of investment banks, hedge funds and credit rating agencies which were identified as key participants in the credit crunch.
Developing countries such as Zimbabwe have not been spared from the global recession with the liquidity crunch affecting the ongoing efforts towards recovery, recapitalisation of industry and infrastructure development.
Small organisations which previously did not have any risk management policies and procedures are being challenged by the environment to come up with their own and demystify risk management[4].
In Zimbabwe, the adoption of a multicurrency environment in early 2009 with the United States Dollars, Rands and Pula being some of the preferred currencies has resulted in companies refocusing their attention on risk, treasury management and internal controls in order to minimise loses and maximise the benefit of available working capital at the back of limited credit being offered by local banks and offshore markets.
Risk Management
Financial management principles assumes that businesses and their custodians are naturally risk averse and hence the need to minimise exposure to whatever risk as much as possible.
Enterprise Risk Management (ERM) is defined as comprehensive risk management that allows companies to identify, prioritise, and effectively manage their crucial risks. An ERM approach integrates risk solutions into all aspects of business practices and decision making processes[5].
There are essentially four key pillars of a sound risk management framework namely:
adequate board and senior management oversight;
sound risk management policies and operating procedures;
adequate management information systems;
strong risk management, monitoring and control capabilities and adequate internal controls.
Although some institutions address risk as part of their strategic plans, governance structures and project-specific business proposals, best practice in risk management in any institution requires risk to be enshrined in an Enterprise Risk Management (ERM) Policy or Framework championed by the Chief Risk Officer or risk department and approved by the board of directors.
In smaller organisations without stand alone risk functions, the CFO is responsible for monitoring and managing Enterprise Wide Risks.
Broadly considered, an ERM policy may identify the following:
responsibility of the board towards risk;
responsibility of management towards risk;
risk tolerance and appetite of an institution;
expertise required;
training needs;
management information systems (MIS) – addressing security, integrity and availability of information;
monitoring and reporting;
codes of conduct;
internal controls and segregation of duties;
exchange control regulations;
risk categories relevant to the organisation;
risk limits;
disaster recovery;
business continuity planning;
role of internal audit;
role of risk department; and
risk mitigation.
An ERM policy identifies the main risks that an institution is exposed to. Some of the major enterprise wide risks are:
strategic risk;
market risk;
operational risk;
legal risk;
reputation risk;
liquidity risk;
political risk;
technological risk;
sovereign risk;
credit risk and
compliance risk.
These risks are not cast in stone and an organisation needs to continuously assess emerging impact of other risks and lately environment risk has been a major risk given the focus on green reporting and environmentally friendly business practices.
Risks relevant to treasury management
Risk management in inextricably linked to treasury management and all organisations not only financial institutions have had to embrace sound risk management practices and in some cases revise the existing controls.
In practice, addressing risk management with relation to treasury can be done in the ERM framework of the organisation or through separate treasury management policies. The specific risks that are related to treasury include the following:
currency risk;
interest rate risk;
settlement risk;
concentration risk;
commodity risk;
equity risk;
credit risk;
fraud risk;
liquidity risks;
systematic risk;
systemic risk; and
off-balance sheet risk.
These risks can further be broken down into specific risks that are relevant to an institution for example in financial institutions; interest rate risk has the following sub-risks:
repricing risk;
basis risk;
yield curve risk; and
optionality risk.
Any sound guidelines on treasury related risks should focus not only on identifying the risks but on the following:
1. definition of risks;
2. potential impact assessment;
3. direction of risk/probability;
4. monitoring tools; and
5. mitigation/hedging strategies.
Treasury and internal control environment
The internal control environment for any treasury function needs careful consideration. An internal control environment encompasses the overall attitudes, awareness and actions of senior management towards internal controls.
Essentially the board of directors sets the tone of the internal control environment by approving and amending key policies and procedures in line with changes in the operating environment.
In a financial institution, there is need for segregation of duties with clear separation of front, middle office and back office to avoid the famous Nick Leason effect. A code of conduct guiding operations of treasury officers is key is this regard.
The Barings crisis and recently Societe Generale debacle continue to underscore the need for sound internal controls and secure Management Information Systems (MIS) which cannot be manipulated to cover losses.
Centralised treasury
The liquidity crunch being experienced by many companies because of the global recession has resulted in a key focus of centralised treasury to maximise deployment and investment of available cash resources. This is essential for holding companies with subsidiaries and plays a role in having a coordinated management to the risks associated with treasury.
Already developing countries are harnessing the advantages of establishing centralised treasury Departments. Big companies in Zimbabwe such as Delta Corporation, CFI Holdings, and African Sun have centralised treasury Departments to manage their working capital.
The key functions of centralised treasury are:
funding management;
liquidity management;
investment management; and
currency management.
Identification of the key risks associated with these functions and actively managing them is very important for any organisation and cannot be left for specialised personnel alone, accountants need to play a key role.
Risk Management and Financial Instruments Hedging
From an IFRS perspective, IAS 39: Financial Instruments: Recognition and Measurement requires institutions to make use of hedges if, among other things:
they are highly effective; and
in line with a documented hedging policy[6].
This further highlights the need for an ERM Policy/Framework to underpin any treasury activities undertaken by an organisation.
Risk management and King III
The King 3 guideline on corporate governance, developed by the Institute of Directors of Southern Africa to replace King 2 effective from March 2010 reinforces the importance of risk management and highlights:
the board’s responsibility for risk governance;
management’s responsibility for risk management;
risk assessment;
risk responses;
risk monitoring;
risk assurance; and
risk disclosure.
Conclusion
Risk management in general, and its impact on treasury in particular, has received growing attention due to the sub prime crisis and the liquidity crunch.
One key lesson emerging is that there is need for institutions irrespective of size to formalise and review their risk management structures in line with best practices.
King 3 Code of Corporate Governance actually recommends that the board of directors should review the implementation of the risk management plan at least once a year.
The benefits for organisations are immense including low insurance premiums, low exposure to risk, reduced shocks and contagion effects to systemic risk and reduced compliance costs to regulatory requirements (especially for financial institutions).
Robust risk management also ensure reduced allocations of capital for operational, credit and market risks in line with Basel II for financial institutions.
[1] ACCA Policy paper, September 2008 – Climbing Out of the Credit Crunch
[2] Bank of International Settlements (BIS) November 2008 – Supervisory guidance for assessing banks’ financial instruments fair value practices.
[3] ACCA & CFO Research Services, August 2009 – The CFO’s new environment
[4] ACCA July 2009 – The Risk Register, Basic Principles for Small Companies
[5] King Code of Governance for South Africa, 2009, Institute of Directors of Southern Africa.
[6] IAS39, Financial Instruments: Recognition & Measurement, paragraph 88
Dony Mazingaizo, ACCA has an interest in Financial Management and IFRS
