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Leadership in Treasury: How Treasury Can Lead ERM Nilly Essaides, Director Practitioner Content Development, AFP.

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Presentation on theme: "Leadership in Treasury: How Treasury Can Lead ERM Nilly Essaides, Director Practitioner Content Development, AFP."— Presentation transcript:

1 Leadership in Treasury: How Treasury Can Lead ERM Nilly Essaides, Director Practitioner Content Development, AFP

2 Introduction AFP Research shows more companies are turning to their treasurers to run their ERM programs, as the treasurers assume a more strategic role in their organizations Treasurers are naturally inclined to manage risk – ERM is a natural extension of their skills Treasurers are adept at quantifying risk and are able to apply these skills on a more holistic basis to broader risk types

3 What’s Driving ERM Focus Companies face internal and external factors that are driving advancements in ERM focus: Regulators and rating agencies are seeking more information on companies’ risk management frameworks Increased fiduciary responsibilities are driving pressure on the board to take additional responsibility for risk oversight A more volatile and fast moving business environment places pressure risk managers

4 What’s Driving ERM Focus 2014 Aon and the Wharton School of the University of Risk Maturity Index Insight showed demand for more information, more risk oversight, and greater understanding of how the executive management is executing the risk management plan The survey found that in more mature organization the board collectively takes responsibility and has more reports on a more frequent basis, which enables them to dialogue risk more and use risk more in making key strategic decisions

5 What’s Driving ERM Focus Treasurers need to consider their role before the Board For example, what is their role in recommending concepts such as risk appetite and risk tolerance to the board Has Treasury aided in building consensus around what the key risks are? For many organizations, the key to more sophisticated risk execution is the use of what Aon and Wharton researchers refer to as risk-based forecasting and planning, i.e., integrating risk concepts and enhanced quantitative risk modeling techniques into core planning, capital allocation and strategic planning processes

6 Link between ERM and Performance “Firms with stronger risk management practices exhibit reductions in cash and earnings volatility and do a much better job at forecasting. They exhibit reductions in forecast error, bias and width Mature risk management translates into better financial performance, i.e., a strong relationship in metrics such as return on investment and return on assets, which are key indicators of how effective companies are at allocating their risk capital the survey found a correlation between high risk management maturity and volatility—the higher the maturity level the lower the stock and EPS volatility

7 Stock Price Performance

8 Reduce Price Volatility

9 Voice of Treasury “Treasurers inherently think about risk. Although the preponderance within treasury is financial, it’s bringing that mindset to the table, focusing on risk and volatility across the business. Having that risk mindset helps when you’re aggregating, analyzing and presenting ERM programs to management. In fact, if I had a key takeaway around ERM it is that what’s important to ERM is a leader who truly knows the company and who can get his or her arms around the risk in the company rather than bringing in a risk expert from the outside.” -- John Gallagher, Vice President, Business Planning & Analysis and Treasurer at Becton, Dickinson and Company

10 3 Reasons Treasurers are Taking a more Active Role Treasurers are in a position to map actual capital, and therefore the company’s ability to take risk. Risk appetite comes down to available capital that is defined by treasury activity More treasurers have taken on a new set of analytical skills, tools and models Finally, treasurers have great visibility into the executive suite and boardroom

11 Toward a Broader Risk Management Role 1.Core requirements: liquidity and capital risk, foreign exchange and IR exposure, compliance and operational risk [including fraud] 2.Managing financial counterparty risk 3.Managing commodity risk, working closely with procurement and other departments 4.Managing supply chain risk, a natural extension of the more traditional engagement with analyzing the counterparty risk of financial counterparties, working closely with A/P and A/R Evaluating geopolitical and economic risk of entering new markets

12 The Basic Risk Cycle Exposure gathering. Identify the exposure and gather the data Exposure analytics Risk mitigation coverage/risk appetite. Define the risk mitigation strategy that fits the company’s risk appetite. Deploy proper risk mitigation measures On-going monitoring/reporting. There needs to be an ongoing exercise to ensure new risks are constantly identified and managed Finally, adjust and manage, to allow treasury to adjust course as things move outside the accepted risk parameters

13 Increasing ERM Acumen Broaden the risk view. Identify secondary types of risk — those that are very high-impact with a low probability of occurring. Boil it down to dollars and cents. The extension of that is taking data with more sophisticated analytical methods and tying it to cash flow and its impact on capital structure, by extension related to impact on risk on equity market value. This makes it easier to see which risks are the most significant Introduce the portfolio effect. Finally, treasurers could introduce risk correla­tions, conceivably bundling risk into a portfolio and applying the theory of value at risk. Companies can use an economic capital model and develop a risk-adjusted distribution of potential outcomes, maybe by individual busi­ness lines, moving into risk adjusted performance management in the non-financial sector

14 Common Traits of ERM Champions in Treasury They got their traditional mandate under control They liaison effectively with business leaders The view risk on a holistic basis They don’t own the risk – they own the process They facilitate communication with senior management They interview and collect cross company risk data They handle reporting to the CFO and the Board

15 Risk Quantification For ERM to make a real difference in the business there needs to be much more risk quantification: When companies assess catastrophic risk, it’s important to get those items identified and quantified in terms of dollars. This changes the way and companies view and prioritize risk It’s important to make management and the board aware that using dollars is not intended to be numerically precise. Instead, it will act as a guideline in prioritizing risks much more accurately

16 Risk Quantification Treasurers are the ones most involved in understanding statistics and portfolio effect in the organization, hence best suited for this exercise If companies are going to quantify what might be over the horizon, they also have to measure how risk has affected them to date. That can be expressed in terms of cost of risk versus cost of doing business. To be able to measure the cost of risk, the leader of the program has to have the ability to understand the financial statement and how changes in one area affect others and how those relate to the performance goals of the organization. Very often that individual is the treasurer

17 Case Study: Spectra Energy Spectra Energy separated from Duke Energy 10 years ago to become an independent, publicly traded, pure play natural gas business. As Spectra Energy reorganized for the future, it looked for a central location where risk excellence would reside. There was agreement that the function should report to the CFO, and the treasury department was ultimately selected to lead the effort The decision reflected the fact that treasury already had a management cross-enterprise view of financial risk. There was a sense that treasury has a cross-enterprise risk profile, including financing and planning including volatility around EBITA and credit metrics for both internal and external reporting

18 Case study: Spectra To expand its purview, treasury established a process that engages functional leaders from across the company, each brings his/her own business, operational and departmental and an enterprise risk perspective to the table The participants convene each fall for a one-day, in person ERM workshop. Treasury works with everyone in advance to prepare them for the meeting, a deep dive on existing, ongoing new or emerging risks. After the meeting, treasury meets with executive leadership to discuss the results. Ultimately, the results are presented to the full board

19 Case Study: Spectra Examples could be an unexpected move in the U.S. dollar vs. Canadian dollar (40 percent of Spectra’s assets are in Canada). Or in another emerging case, it may be the risk of shifting environmental regulations in a particular state or on a federal level Some of the risks that bubble up in between board meetings are not easily quantifiable. However, if they keep rising the company can begin to assess their impact which may be a high dollar value in the years to come. They have a tool and a structure to allow an appropriate level of communication

20 Case Study: Spectra The entire board looks at ERM and the risk mapping done through treasury’s leadership also as a way to help fashion the board’s discussion agenda. The leading risks are translated into standalone conversations either for the full board or for a board committee The same is true for executive leadership. The top identified risks are designated as road signs and become issues top management must stop and examine over the course of the year. ERM shapes the conversation

21 Conclusion: How to Get to the CRO Role Step 1: Transparency. To get the process going, the first step is to create transparency about the impact of risk you know about on the cash flow and earnings of the corporation. Treasurers should prove how doing effective ERM on those risks in particular will bring good risk management across the entire organization and treasury specifically. One entre is using FX to start the conversation and ask the right questions, e.g., what are the underlying economic exposures?

22 Conclusion: Getting to that CRO Role Step 2: Clear Answers. Next, treasurers must make it clear why the organization needs answers. If there’s pricing flexibility in the contract, the company may be wasting valuable resources by hedging unnecessarily Step 3: Open that discussion Treasurers can foster the dialogue about broader issues. Important insight is not just a number. It’s looking at pricing and volume, not just financial risk. “They’re really well positioned to drive those questions

23 3 Challenges Treasurers Face in Leading ERM “Stick to your knitting.” Treasurers often face resistance from people who feel that they are already effectively managing their own frontline risks Develop a clear line of sight. The second challenge is that some treasurers may not necessarily have a direct line to the C-suite or the board. That’s critical for making ERM a strategic vs. compliance exercise Know what’s happening in the business. Finally, critical to effective ERM leadership is line of sight to the business. ERM is not about gathering numbers. It’s about being engaged and understanding what’s happening in the business

24 Conclusion Questions?


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