Treasury plays an essential role in managing companies’ cash flows, foreign exchange, debt and other critical financial matters that affect profitability and solvency. Yet in many businesses – especially mid-sized and high-growth organisations – the relationship between treasury and the board can be neglected or poorly articulated in policies and procedures.
With this in mind, HSBC Australia and Rochford Group recently convened the following panel of experts to discuss the topic. Their insights are distilled in the advice below.
Today’s treasurers must be able to manage and meet stakeholder expectations and maintain an effective partnership with the board. But how can they achieve this if the board doesn’t fully understand what treasury does?
As a first step, companies should get the board to focus on treasury and educate members about what the unit does and its importance to the organisation. According to Mike Christensen, this could include having conversations with the board about:
Christensen established DEXUS Property Group’s treasury function and ran it for more than 12 years. He now sits on a number of boards. In his experience, it helps to identify champions on the board and in management, particularly individuals who have been exposed to value-adding treasury functions at other organisations.
“Another tip is to find and provide ‘lighthouses’ for what best practice or value-add looks like, such as using peer or industry benchmarks,” he said. “These lighthouses could be further validated by someone, such as an independent consultant, who is known and respected by the directors.”
It is difficult to educate or engage the board if a company doesn’t have a clear definition of its treasury’s scope and mandate. Does treasury focus primarily on keeping money safe and ensuring the business has sufficient liquidity? Or does it hold a strategic role by actively managing enterprise risk and the effective allocation of capital?
Addressing this issue should come down to appreciating the value treasury brings – for example, how its use of capital markets to access funds during difficult times can enable acquisitions, or how its management of hedging costs and liquidity can benefit the company’s bottom line. However, the higher the expectation to deliver value, the more the business will need to invest in its treasury function – and the potential opportunity cost.
“Show the board the choices for what the treasury function could be, ranging from low value, low cost, right through to high value. Outline the investment required, compared to the benefits derived from each option,” said Christensen. “Maybe a compromise is required. Or maybe the function matures over time as the business grows.”
Treasurers’ board-level accountability and responsibility for financial risks require them to understand potential threats to their companies. They must be clear about the level of risk their organisations can take without leaving their businesses vulnerable.
By understanding potential risks, companies can plan for all eventualities. Their treasurers can monitor and effectively manage individual risk components, such as changes in foreign exchange and interest rates. As a result, they can ensure their companies adhere to their risk profiles and values, which is of primary concern for any board.
“If you understand how sensitive your business is to various risks and know how to manage them, it will give the board comfort that you’re doing the right thing,” said Thomas Averill.
Exposures vary depending on the size of the business. For example, small- to medium-sized enterprises (SMEs) often have only one market and business, and as a result, can be sensitive to concentration risk. “This influences how they should hedge their risk and protect their margins,” commented Peter Parry during the discussion.
Boards should clearly define an organisations’ risk appetite then ensure it becomes a core part of its corporate treasury policies and capital plans. To guide this process, the panel said companies may find it helpful to refer to established standards for setting risk management frameworks – in particular the guidance for large companies and financial institutions from the Australian Stock Exchange and Australian Prudential Regulation Authority.
According to Jann Skinner, a well-defined risk appetite statement gives treasury a clear sense of where the board wants it to go.
“It’s so powerful from a treasury management perspective to have the message of ‘this is the risk tolerance that our stakeholders are allowing us to manage’,” Christensen agreed.
Christensen added that many SMEs were starting to embrace the idea of defining their risk appetite. “The concept applies to all businesses – it’s just a case of purpose-fitting it,” he said. “So, the risk framework and the risk appetite statement need not be as comprehensive or complex for smaller organisations, but the concept still applies.”
Companies also need policies and plans to enable them to proactively manage risks.
A treasury policy is particularly important. It defines how an organisation should respond to its financial risks based on an understanding of what is acceptable risk in the eyes of key stakeholders such as investors and the board. It should also provide protocols for managing those risks and reporting them to the board. By having a process to report risks, management and the board can agree on what responsibilities must be delegated and how.
“If the board is reactive, that’s when you often see knee-jerk decision making based on fear and emotion,” said Averill. “It’s better to stop yourself from falling in the hole as opposed to trying to get yourself out of the hole.”
Another piece of advice was for treasury teams to avoid overloading their boards with information.
“On several of my boards, we’ve introduced policies that board papers should be five pages,” said Jann Skinner. “Maybe you can have some appendices, but if you can’t distil the message into five pages, you’re not actually thinking about how to best articulate the topic.”
To help treasurers condense their message, Skinner suggested asking:
“The sort of information the board really needs is feedback on monitoring of risk appetite,” she added. “Have there been any breaches and are you within tolerance? Are you looking at getting close? And if that’s the case, what are the action plans?”
When reporting about a risk, a treasurer must simplify their message so the board knows exactly what it needs to protect. Parry added that in a former role as chief financial officer, he and his team often had to cut stories down to key points for the board.
“We had to simplify the story and exposures and explain what the overall net risk amount was relative to the balance sheet,” he noted. “The focus was on the impact of hedging on profit, cash flow and margin, using simple sensitivity analysis with reference to historical volatility ranges.”
It’s also wise to present the board with a range of fully costed scenarios. This requires analysing risks in different scenarios and assessing their possible impact on the company’s profit and balance sheet.
According to Christensen, having a few ‘game plans’ tells the board the treasury team is prepared for different scenarios. Even if some of these options are suboptimal, often they’re better than not having any options at all – particularly in extreme cases.
“You can go to the board and say: ‘Look if these things happen, this would be game plan A, this would be game plan B, this would be game plan C’,” he said.
As a central player in managing risk and optimising liquidity, it is critical that treasury works closely with other business units. For example, treasury teams should discuss the potential treatment of approaches such as hedging with the company’s financial reporting team.
When seeking board approval for a recommendation, it pays to check in with other functions. According to Skinner, boards typically want to know if a treasury recommendation has been reviewed by the company’s legal, accounting and investor relations units, for example.
“Communication and making sure that you get appropriate sign-offs prior to entering into a transaction is critical,” she said.
Financial risk management is not set and forget. Treasury teams need to constantly monitor the environment and update the board. They must, for example, keep track of movements in exchange rates and how they are affecting the company’s liquidity and overall risk profile.
“Risk management is a dynamic process and changes with the business environment,” said Parry. “You really need to understand the business environment and monitor it very closely and be ready to adapt to changes in the business.”
According to Averill, treasury must regularly give the board information about the nature of a risk, how the company is hedging it, the effectiveness of the strategy and the expected outcomes. The quality of information is also crucial to enabling the board to empower management and treasury to manage risk proactively on a day-to-day basis.
“A lack of information can make for decision-making paralysis,” said Averill. “If you’re generating a two-way flow of information and acting on it, then you’re going to be in business for a long time.”
Finally, managing financial risks effectively requires using the right tools, such as foreign exchange solutions and hedging products like derivatives.
According to Parry, such solutions are particularly important for Australian companies due to the extreme fluctuations of the Australian dollar. “You have to be proactive to manage your margins and protect your margins by using a diversity of available products that have different characteristics and payoffs in different market situations and are more suitable at certain times in a market cycle,” he said.
Innovative foreign exchange solutions, for example, can reduce currency risks and costs by facilitating greater pricing transparency and operational efficiency. By managing foreign exchange conversions precisely, a business can maintain competitive pricing.
Hedging foreign currency risks can also boost a company’s earnings, as Parry’s experience at Centennial Coal shows. “We’ve always managed our risks using hedging instruments,” he said. “This has paid off by contributing significantly to our bottom line over the long term despite fluctuations year to year.”
To know more about how you can manage your company’s treasury risks, visit https://www.business.hsbc.com.au/en-au/navigating-treasury-risk.