Leadership in Treasury: How
Treasury Can Lead ERM
Nilly Essaides, Director Practitioner Content Development,
AFP
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
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
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
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
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
Stock Price Performance
Reduce Price Volatility
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
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
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
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
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
Common Traits of ERM
Champions in Treasury
•
•
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•
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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
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
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
•
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
Case study: Spectra
• To expand its purview, treasury established a process
that engages 30-35 functional leaders from across the
company, each brings his/her own business, operational
and departmental and an enterprise risk perspective to
the table
• The 30-35 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
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
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
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?
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
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
Conclusion
Questions?