Corporate Treasury Control and Performance Standards in Switzerland

Transcription

1 Corporate Treasury Control and Performance Standards in Switzerland January 2 A comprehensive treasury survey including trend comparisons Supported by: The Swiss Association of Corporate Treasurers (Swiss ACT) PricewaterhouseCoopers Global Risk Management Solutions

2 PricewaterhouseCoopers ( the world s largest professional services organisation, helps its clients build value, manage risk and improve their performance. As a leading treasury consulting firm, PricewaterhouseCoopers provides advisory services to leading global, national and local companies on how to enhance treasury s effectiveness and contribution to their business. The PricewaterhouseCoopers Treasury & Risk Management Group forms part of a 5 5 professional strong Global Risk Management Solutions, which specialises in integrated risk management, strategic risk services, financial risk management, operational/systems risk management, compliance and environmental risk management.

3 Contents Forewords 4 Executive Summary 7 Detailed survey results 11 Section 1 13 Organisation and policy standards Section 2 23 Activities and control standards Section 3 39 Measurement and review standards Section 4 49 Infrastructure and cost standards Section 5 55 New challenges for Treasuries 3

4 Forewords First of all, I would like to thank PricewaterhouseCoopers for their tremendous and valuable effort in producing this important report on Swiss treasury behaviour. I am also very grateful for and proud of the readiness of so many leading Swiss corporations to contribute in a meaningful way to this survey. It is their contribution, in combination with PricewaterhouseCoopers knowledge and assessments of treasury operations, which makes it what it is a real benchmark of and for Swiss treasury activities. The survey clarifies the role of Swiss treasurers we are not risk takers. The management of risk within controlled parameters is our objective. The highlight of a Swiss treasurer s life is not the lucky punch as many would expect, it is our ability to manage risk in these unpredictable markets in a controlled way. The avoidance of unnecessary volatility is also in the best interest of our shareholders. What is risk? Is risk as obvious as it seems? Yes, we have learned through bitter and too often, painful experience to manage currency risk. But senior management s priority on business risk still too often neglects the hidden risk, e.g. from production locations, interest rate movements and funding. Do we really know all our potential risks? Do we hedge them appropriately? The integrated risk management approach is a task of the next decade enabling corporations to distinguish unbearable risks from normal business risks and to hedge them at reasonable costs. A more sophisticated and integrated risk management approach is not the treasurer s task alone, it involves the commitment of senior management and needs their support, in order to be competitive and survive in a global economy. The role of Treasury is changing. After having satisfied the basic needs of cash management, liquidity planning and liquidity protection, the optimisation of corporate finance will enrich our activities in the future. The shareholder value philosophy in the end a real, competitive bidding process for rare capital and market valuation with the introduction of value based management principles will be one of our future topics. The optimisation of assets employed and the relevant cost of capital to achieve a true economic value added for the corporation within a controlled risk environment will be a real challenge which will require our full attention. Stephan Jud President Swiss Association of Corporate Treasurers ( Swiss ACT ) Treasurer Schindler Group 4

5 As treasurer of one of the country s largest corporations, I am pleased to write this foreword to the new treasury survey conducted by PricewaterhouseCoopers. This study will be extremely useful to assess the status of your treasury organization in relation to others, to highlight trends in treasury management and to identify areas with a need for catch-up. It provides an excellent basis for external comparisons and contributes to the establishment of so-called best practices. Discussions with many corporate treasurers show three distinctive trends: Shareholders are increasingly expecting a company to manage its financial resources and its risks in an effective manner, the number of financial losses published in the press has increased the awareness of risks involved in treasury activities and has resulted in a certain uneasiness by top management and boards of directors, the complexity of treasury management is growing fast and requires an ever higher degree of professionalism and specialization. This leads to five basic questions, which management of a company should be able to answer: (1) What are our relevant risks? (2) Should we reduce our exposures or can we accept them? (3) How can we make sure that no intolerable impact on the corporation s profit and loss arises? (4) Is it clearly defined who is authorized to decide, and on what? (5) How well is Treasury s job done? With regard to the above, treasurers should identify and assess all material risks. For this purpose they need an adequate system to capture financial transactions, to value instruments and to measure risks. Furthermore, adequate treasury policies and, last but not least, a timely reporting to management should be put in place. As things are getting more and more sophisticated, it is important that also common sense is used when handling risks, rather than simply relying on mathematical models or IT systems, which most users do not even understand properly. Fall of 1998 demonstrated that real movements can go far beyond expected movements and related mathematical probabilities. In this context, Value at Risk may be a useful tool, but it is not sufficient to answer very basic questions, such as: What is the worst possible outcome and what will it mean to our company? This latest treasury survey of PricewaterhouseCoopers shows that a great number of companies recognize these developments and start to use more professional approaches for treasury and financial risk management. Clearly, this is an ongoing and challenging task. Comparing your treasury with peers is an effective way to keep abreast of new developments. John Manser Group Treasurer Novartis 5

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7 Executive Summary Introduction During 1999, PricewaterhouseCoopers carried out a survey on Corporate Treasury Controls and Performance Standards in Switzerland. This treasury survey follows a first study performed in 1996 and is again supported by the Swiss Association of Corporate Treasurers ( Swiss ACT ). The success and high interest in the last treasury survey expressed by Swiss corporates encouraged PricewaterhouseCoopers to update the benchmark for corporate treasury activities established three years ago. The goal is to provide insight to trends of corporate treasury risk management approaches, controls and performance standards applied by corporate treasuries in Switzerland as well as to identify new initiatives. Information and data for the treasury survey were gathered during interviews with treasurers of 4 corporates with Group Treasury or a regional treasury centre located in Switzerland. Tailored treasury management questionnaires were completed by PricewaterhouseCoopers Treasury & Risk Management Group members during these discussions with the corporate treasurers. The survey results provide valuable insight into treasury practices of many leading corporates in Switzerland and allow participants to compare their corporate treasury activities against other peer companies. Furthermore, the survey highlights several areas where opportunity for improvement exists as well as challenges for treasurers in the future. KEY FINDINGS Treasury organisation and responsibilities Corporate management culture influences the role and responsibilities of the treasury function, which goes well beyond cash and liquidity management nowadays. Centralised financial target and policy setting and decentralised decision making characterises the management approach applied by the majority of corporates in Switzerland. Compared to 1996 an increased centralisation of key treasury tasks is observed and material financial risks are managed increasingly on a group-wide basis by dedicated specialists. Interest rate management, Foreign Exchange ( FX ) transaction management, FX economic exposure management, Group bank relationship, tax management and insurance are more often performed on Group level than three years ago. In general, participants expect the centralisation process to continue. Most corporate treasuries in Switzerland continue to be organised as service centres. For corporates in Switzerland the establishment of a treasury committee or risk committee is becoming best practice. The main purpose of such committees is to discuss treasury strategies, monitor compliance by Group Treasury with policies, procedures and risk limits and to propose amendments to policies for approval by the Board of Directors ( BOD ). Risk management approach Across all companies surveyed, most companies, i.e. 85%, continue to apply an active risk management approach. 3% of the participants take positions unrelated to the business and another 12% pursue an approach of fully hedging treasury risks. There was no corporate identified that would not hedge any exposure. There is nothing such as the one and only approach to risk management. Corporates pursue different goals and risk strategies depending on factors such as size and capital of a company, risk tolerance, industry particularities, technical know-how and systems capabilities, just to name a few. 7

8 Furthermore, consideration is given to a company s core competencies when actively managing, hedging or transferring risk. The number of corporates taking positions unrelated to the operating business has further decreased. Active FX dealing, with the aim to generate a profit contribution, is usually not part of the mission of a treasury function. This also demonstrates that the vast majority of corporates do not want to build up additional risk positions and thereby tying up economic risk capital. During the last few years, various new risk management approaches have evolved. Some companies no longer address individual risk types separately. A new trend towards integrated risk management by jointly managing financial, operational, insurance and other risks by a fully dedicated risk specialist e.g. a Chief Risk Officer, is seen more often at corporates in Switzerland. This move towards integrated risk management provides opportunities for treasurers to become the risk manager of tomorrow s corporation. Control standards The survey provides an analysis of the activities and control standards applied by treasury departments. Formal treasury policies are a key instrument for the definition of objectives, tasks, authorities and responsibilities for treasury activities. Treasury policies address the treasury organisation, core treasury functions, the risk management approach to be pursued, key treasury controls, performance measurements and reporting to Management. The survey shows that the majority of companies have formal policies in place for: debt management, FX transaction exposure, and investment management, FX translation exposure. interest rate exposure, The use of policies for interest exposure management is only applied by 55% of the participants, which is surprisingly low for this core treasury function. Across all corporates a wide range of derivative products is used to manage treasury risks. The most commonly used interest rate instruments among corporates in Switzerland are plain vanilla interest rate swaps, caps, floors and forward rate agreements. The most frequently used instruments to hedge FX transaction exposure are FX spot and forward contracts, FX swaps and currency options. Bank deposits and money market placements continue to be the instruments applied by the majority of the corporates in Switzerland for their investment management, however, investments in corporate bonds, shares and other equities products are also made, particularly by treasuries managing larger portfolios. Certain companies still do not restrict risk strategies (e.g. no uncovered short sales) or explicitly define authorised instruments in their policies. The latter is considered particularly important for structured and exotic products in view of implications on the monitoring and handling of such instruments. Among leading treasuries there is a consensus that risk controls are necessary for an effective financial risk management. The use of control parameters by corporates in Switzerland has gradually increased over the past 3 years. However, the survey shows that for a large number of corporates there still remain gaps in respect of a comprehensive risk management framework, which should comprise formal policies and procedures, effective controls as well as performance measurements. Certain control tools, which are considered to be effective for risk management, such as exposure limits, value-at risk limits or sensitivity analyses, are not widely applied. Especially in the field of interest rate exposure management, which is a technically demanding area, tailored controls are often missing. Performance measurement Is Treasury doing a good job? Performance measurements and the definition of specific benchmarks are a cornerstone for board members, senior management and the Chief 8

9 Financial Officer ( CFO ) to assess whether treasury units are working effectively and add value to the Company. 87% of the participants stated that they consider performance measures to be either highly important or important. The measurement of treasury performance is driven by the objective to demonstrate the financial contribution of the treasury function and effectiveness of treasury strategies. Performance measurement is particularly applied at group treasury level. Six out of ten corporates measure performance for FX exposure management. Performance measurement for other core treasury activities such as interest rate exposure management, short-term liquidity and long-term debt/investments is applied by approximately a third of all companies. Among those corporates applying performance measurement, there are only few applying risk-adjusted measures. Very few corporates evaluate banking services statistically (e.g. margin and bid analyses), although there are strong views on service quality. The survey participants assessed the quality of services provided by their banking partners compared to three years ago. Management of foreign banks and cantonal banks will be pleased to note that various participants stated that their services have improved. On the other hand, corporate clients of large Swiss banks are not particularly satisfied with the level of service received. Three out of four corporate treasurers assess the quality of service to have worsened. Staff and technology For four out of ten participants, corporate treasuries in Switzerland have a size between one and four persons, including support staff. Our survey does not indicate significant changes of staffing levels compared to However, the number of professionally qualified treasury staff has increased. This may also be due to corporates employing more often sophisticated treasury management systems and therefore requiring a larger number of qualified staff. Only a small number of corporates remunerate their treasury staff based on individual performance. More companies are remunerating their treasury staff on a team performance basis than in the past. Several corporate treasuries have gone through substantial technological change during the last three years. Our survey examined the use of technology and extent of automation among corporate treasuries across the major process areas. More than half of the participants use treasury management packages to manage their core treasury processes such as deal recording, deal confirmation, operational reporting and settlement instructions. The number of treasuries applying in-house developed treasury systems has significantly decreased compared to our 1996 survey. Spreadsheets are still widely used for position recording, performance measurement and certain management reporting tasks. The use of spreadsheets continues to raise concerns from a control perspective. New challenges for treasuries Our survey also looked into new developments and challenges that treasurers may face during the next few years. New products are offered to corporate treasuries every day. New instruments include risk fusion products, credit derivatives, contingent capital solutions, multi-trigger options, weather derivatives and more. Besides the technical understanding of these complex products, the appropriate capturing of such instruments in a treasury management system undoubtedly is a challenge for corporates. Furthermore, survey participants were asked to assess how new trends and products will impact their treasury and risk management during the next five years. High impact is primarily expected from the European corporate bond market, Emerging market risks, Internet trading and the new accounting standards on financial instruments (IAS 39, FAS 133). Corporate treasurers of very large corporates envisage spending more time on interest rate risk and liquidity risk in the future, while other survey participants will increasingly focus on foreign exchange risk, interest rate risk and operational risk. 9

10 Categorisation Annual turnover Participants (in CHF) Small and medium sized companies <2bn 13 Large corporates 2 bn 12 Very large corporates >bn 15 Total 4

11 Detailed survey results Our first survey on Corporate Treasury Controls and Performance Standards in Switzerland issued in November 1996 was well received, particularly as it was the first comprehensive corporate treasury study published for Switzerland and as statistical data on corporate treasury activities is very limited. During July to October 1999, PricewaterhouseCoopers carried out a new treasury study. To facilitate comparisons as well as to allow trend analyses, our survey has been structured in the same way as in 1996 but has been enriched with a number of selected questions on new products and developments in treasury management. The key objectives of this survey were to identify: (1) Standards applied by leading corporates to the structure and operation of their treasury functions (2) Standards of control and performance measurement applied by corporates in Switzerland to their treasury activities (3) Trends and challenges for treasurers in future. The survey presents the major findings and conclusions for the following issues: Organisation and policy standards Activities and control standards Measurement and review standards Infrastructure and cost standards New challenges for treasuries 4 companies participated in the new survey, representing a broad range of industries including corporates from all parts of Switzerland. The Treasury & Risk Management Group members of PricewaterhouseCoopers personally interviewed the participants in this survey. This approach has been chosen again, to allow for discussions of individual questions and as such to immediately identify misunderstandings, should any have occurred. About the participants: Participants consist of non-banks and represent a broad range of industry sectors (including insurance). The survey includes corporates from the German, French and Italian parts of Switzerland. Of the 4 participants, 33 are quoted either in Switzerland or on a foreign exchange stock exchange. The market capitalisation of our participants, which are included in the Swiss Market Index ( SMI ) represent more than 7% of the market capitalisation of non-banks included in this index. Information on individual companies will remain confidential and will not be disclosed without prior permission of the company. The participants of our treasury study include small, medium sized, large and very large corporates. The categorisation of the respondent companies by annual turnover is shown in our table on the left side. 11

12 As in 1996, for certain significant findings of the survey, a distinction was made between very large corporates and other survey participants. Very Large Corporates ( VLCs ) are defined as those companies with an annual turnover greater than CHF billion. Other Survey Participants ( OSPs ) are defined as those companies with an annual turnover equal to or below CHF billion. As a result of this distinction, 15 VLCs and 25 OSPs were identified. This definition has been applied throughout this report. All survey participants will receive a summary benchmark report showing their responses against either other VLCs or OSPs and against the Swiss standard for 1999 and 1996 each. Any company, which did not participate in the survey, but would be interested to obtain a benchmark assessment for comparison with other corporates in Switzerland, should contact their local PricewaterhouseCoopers office listed in the back of this document. The primary purpose of this report is to provide an overview of the principal findings of the survey. The report is structured as follows: Section I Section II Section III Section IV Section V Organisation and policy standards. This section of the report examines the approach by corporates to manage the treasury and financial risks in their organisations, as well as the allocation of responsibility and accountability for treasury. Activities and control standards. This section of the report deals with the activities and control standards of the treasury function. Measurement and review standards. This section of the report examines the performance measurement, management reporting and internal review standards applied by corporates to treasury management practices. Infrastructure and cost standards. This section of the report analyses the staffing and technology standards applied by corporates to support their central treasury functions and identify the cost incurred by organisations for these elements. New challenges for treasuries. This section outlines new developments and some of the challenges that treasurers will face during the next few years, respectively at the edge of the new millennium. 12

13 Section 1 Organisation and policy standards Introduction This section of the report examines the approach by corporates to manage the treasury and financial risks in their organisations, as well as the allocation of responsibility and accountability for treasury. This section comprises: Treasury organisation and responsibilities Risk management approach Treasury policies 13

14 Organisational management approach of participants 13% 7% Fully Centralised Fully Decentralised 8% Centralised policy making and decentralised decision making Day-to-day responsibilities of Group Treasury % 55% 52% 91% 78% 74% 9% 74% 7% 57% 8% 78% 83% 48% 95% 74% 2% 26% 13% 9% 25% 17% 38% 26% 93% 83% 8% 61% 13% % 75% 48% 1 Cash Management 2 Long-term funding 3 Investment Management 4 Interest rate Management 5 FX transaction exp. Mgmt 6 FX translation exp. Mgmt 7 FX economic exp. Mgmt 8 Group Bank relationship 9 Op Co Bank relationship Collection & payment cycle Management 11 Commodity risk Mgmt 12 Leasing 13 Corporate Finance 14 Taxation 15 Pension fund Management 16 Insurance 14

15 Treasury organisation and responsibilities Centralised financial target and policy setting and decentralised decision making continues to be the most common management approach of corporates in Switzerland. This applies to 8% of the survey participants and 13% are fully centralised. Only 7% of the participants have a fully decentralised corporate management culture. The percentage of companies with a centralised management style increased compared to our 1996 survey (13% vs. 4%). The corporate management culture influences the role and responsibilities of the treasury function. In general, fewer tasks are performed at Group Treasury or regional treasury level for companies with a fully decentralised management approach. The organisational structure and the assignment of treasury responsibilities to different levels are also affected by new techniques in risk management and system developments. The trend to manage material financial risks on a group-wide basis by dedicated specialists at the centre prevails. Centralisation of treasury and financial risk management functions is also facilitated by enterprise-wide systems such as SAP and Peoplesoft, allowing easier and more timely access to transaction and exposure data of individual group companies. Nowadays the role of treasury goes well beyond cash and liquidity management. The survey examines the allocation of day-to-day responsibilities for treasury activities to group treasury, regional treasury, country cash manager and operating company level. Our table highlights the most common allocation of responsibilities for different treasury tasks. Main responsibilities assigned to Group Treasuries comprise long-term funding (%), Group bank relationship (95%), Corporate finance (93%), interest rate risk management (9%), FX economic exposure management (83%), FX translation exposure management (8%), taxation (8%), investment management (78%), insurance (75%) and FX transaction exposure management (7%). Working capital management (including debtor collection and creditor payments) as well as local bank relationship management remain largely decentralised. Where applicable, commodity risks often are managed by purchase departments or, like leasing activities, by other finance functions and less frequently by Group Treasuries. In many cases the investment management for pension fund assets is outsourced to specialised banks or is managed on an operating company level. The survey results show that OSPs centralise more tasks at Group Treasury level than very large corporates. This particularly applies to those treasury activities, which require special treasury expertise or substantial technical know-how such as interest rate exposure management (% vs. 73%) or investment management (88% vs. 6%). In addition to critical mass considerations, this situation is explained by VLCs sometimes assigning such treasury tasks to regional treasury centres. Compared to our 1996 survey an increased centralisation of treasury activities has been observed. A significant move towards centralisation has taken place for the following functions: Group bank relationship (95% vs. 74%), interest rate management (9% vs. 74%), FX economic exposure management (83% vs. 48%), tax management (8% vs. 61%), insurance (78% vs. 48%) and FX transaction management (7% vs. 57%). The participants indicated that they expect the centralisation process to continue. 15

16 Location of responsibilities for treasury activities Centralised at Group Treasury Long-term funding Investment management Interest rate exposure FX translation exposure FX transaction exposure FX economic exposure Bank relations Group Corporate Finance Taxation Insurance Partially centralised / partially decentralised and other finance functions Cash management and short-term funding Leasing Responsibilities with operating companies and other finance functions Bank relations Operating Companies Working capital management Commodity risk Pension funds Role of treasury 7% 7% 73% 13% Service Centre Profit Centre Cost Centre Not formally defined 16

17 Half of the companies interviewed still perform their cash management activities and short-term funding primarily on a decentralised basis. However, when cash concentration and netting techniques or Shared Service Center structures are introduced then specific tasks performed on all levels are affected. Across all companies surveyed, 5% plan to implement or have already implemented a pan-european Euro cash pool within the next two years. For another 3% of the participants Euro cash pooling is under evaluation. Therefore it is to be expected that also banking and cash management activities will more frequently be co-ordinated through Group Treasuries in the future. Most corporate treasuries in Switzerland continue to operate as service centres (i.e. the primary objective is to support the operating business and not the generation of a profit contribution). 13% of the companies surveyed run their treasuries as profit centres. Three participants each stated that their treasury acts as a cost centre or that the approach is not formally defined. The latter is somewhat surprising and, neither undefined, nor cost centre approaches were observed in our first survey. Therefore, the percentage of service centres decreased from 87% to 73% compared to Amongst service centre treasury functions, few operate within any formally defined measurement criteria. Most of these functions do not use formalised Service Level Agreements ( SLA ) with their operating businesses, which would help evaluate the quality contributions to the overall business. Across all companies, 55% indicated that they recharge costs to the operating companies. This applies to two of the three cost centres (5%), a portion of the service centres (44%) as well as for one profit centre and one treasury function, for which the approach is not formally defined (3% each). The establishment of a treasury committee or risk committee is becoming best practise in Switzerland. Already 53% of the survey participants have set up such organisational body. Even two thirds of the very large corporates have established a treasury or risk committee. The main purpose of such a committee is to discuss treasury strategies, review treasury activities, monitor compliance by Group Treasury with policies, procedures and risk limits and to propose amendments to policies for approval by the BOD. 17

18 Risk management approach Fully hedge Actively manage risks Do not hedge = none Take positions 1999 Fully hedge Actively managing risks Do not hedge = none Take positions % 3% 85% 4% 4% 92% Dedicated Risk Officer 5 All participants 4 4% Very large corporates % 12% Other survey participants Existence of risk officer position 18

19 Risk management approach The majority of the participating companies, i.e. 85%, continue to apply an active risk management approach. 3% indicated that they take positions unrelated to their underlying business risk and another 12% pursue an approach of fully hedging their treasury risks. There was no Swiss corporate identified that would not hedge any exposure. An active risk management approach should not necessarily be seen as the execution of a high volume of derivative transactions. Main challenges for corporates primarily consist of the timely identification of risks, prompt information flows within the group and the proper aggregation of risk exposures. There is nothing such as the one and only approach to risk management. Different goals are pursued and strategies differ due to risk being perceived as: a hazard (i.e. the risk of bad things happening), an uncertainty of outcomes (e.g. not meeting expectations) or an opportunity. As a consequence of their views companies will either focus on avoiding the downside, managing volatility/variances or exploiting the upside. Furthermore, consideration is given to a company s core competencies when actively managing, hedging or transferring risk. 1 Risk management strategies and approaches pursued by corporate treasuries in Switzerland also vary due to factors other than different objectives. Discussions with the treasurers interviewed showed that other key factors comprise: company size, capital and credit standing (e.g. risk absorption capacity) a company s risk appetite, being the maximal tolerable loss length of product development cycles and planning horizons industry particularities, like price adjustment mechanisms and earnings volatility technical know-how and systems capabilities. Also new risk management approaches have evolved, which do not address individual risk types in an unconnected manner. 23% of all the participating companies, respectively 4% for VLCs, stated that they have a dedicated risk officer position, e.g. Chief Risk Officer, in their company. The new trend to integrated risk management by jointly managing financial, operational, insurance and other risks by a fully dedicated risk specialist was first observed at financial institutions and large corporates in Anglo-Saxon countries. Given the need for a comprehensive understanding of a group s business, technical risk management skills and pro-active monitoring of new developments and trends, the background of treasury professionals would be an asset for dedicated risk management units. This may provide additional opportunities for treasurers in the future. 19

20 Companies with a formal policy for treasury activities % 65% Debt Mgmt 78% 7% Investment Mgmt 55% 61% IR Mgmt 88% 83% 73% FX transaction 61% FX translation % 39% FX economic Responsibilities for treasury objectives and policies: Development % Board 73% Group CFO 3% Treas/Fin Committee 85% Group Treasurer 3% 3% % % CCM Div Fin Director OpCo Audit FD Committee Responsibilities for treasury objectives and policies: Review & approval % Board 65% Group CFO 15% 13% Treas/Fin Committee Group Treasurer % % CCM Div Fin Director 3% 3% OpCo Audit FD Committee Responsibilities for treasury objectives and policies: Monitor compliance % Board 55% Group CFO 38% Treas/Fin Committee 83% Group Treasurer 8% CCM 15% Div Fin Director 35% 23% OpCo Audit FD Committee Responsibilities for treasury objectives and policies: Reporting compliance % Board 23% Group CFO Treas/Fin Committee 68% 23% 13% 13% 13% 5% Group Treasurer CCM Div Fin Director OpCo Audit FD Committee 2

21 Treasury policies The coverage of treasury activities by formal policies has increased in Switzerland compared to However, it should be noted that content and level of detail of policies vary a lot in practice. There are still significant gaps to a comprehensive treasury and financial risk management at various treasuries in Switzerland, particularly as effective control parameters and performance measurements are still missing at many companies. The latter indicates that the effectiveness of the treasury framework, where established and implemented, may sometimes be limited. This corporate treasury framework comprises treasury objectives (e.g. a mission statement), treasury policies and treasury procedures. Treasury policies are a key instrument for the definition of objectives, tasks, authorities and responsibilities for treasury activities. Furthermore, treasury policies often address the treasury organisation, core treasury functions, the risk management approach to be pursued, key treasury controls, performance measurements and reporting to Management. The majority of companies have formal policies in place for debt management, investment management, interest rate exposure, FX transaction exposure and FX translation exposure. Only one out of four participants has established policies for FX economic risk, which focus on long-term and competitive exposures. The use of policies for interest exposure management by only 55% of the participants is surprisingly low for this core treasury function. With regard to company size, VLCs more frequently apply formal treasury policies than OSPs. Investment management policies are applied by 87% of VLCs compared to 72% of OSPs. This might also be due to large corporates frequently managing sizeable liquid funds. The majority of the companies in Switzerland assign the responsibility for developing treasury objectives and policies primarily to the CFO or the Group Treasurer. Group Treasurers have more often been involved in the development of treasury policies compared to the results of our first survey. The treasury objectives and policies are reviewed and approved by the BOD or the CFO for most participants. However, given the significance of financial risks and importance of treasury strategies for many corporates, it is surprising that 22% of the companies interviewed still do not require an approval of treasury policies by the BOD. Responsibility for monitoring policy compliance and reporting treasury compliance (e.g. also for subsidiaries) has shifted to some extent from local finance directors to the Group CFO and Group Treasurer, which may be a result of increased centralisation of treasury tasks in many groups. The role of Audit Committees is limited, as many companies in Switzerland have not yet established such an organisational body. An annual review of treasury policies is less frequently applied than in the past (35% vs. 57%), which may also reflect pressures experienced by many Group Treasurers. Companies predominantly review policies on an ad-hoc basis (73%) or when significant events arise (e.g. mergers and acquisitions). However, a periodic review (e.g. at least a review on a bi-annual basis) is important due to the fast changing nature of business, new technical developments and additional tasks having to be assigned. 21

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23 Section 2 Activities and control standards Introduction This section of the report deals with the activities and control standards of the treasury function in Swiss corporates. The survey looks at the different types of financial instruments used by the surveyed participants within each risk management program and the methods used to identify and control risks for major risk types. This section is divided into the following chapters: Interest rate exposure management Foreign exchange exposure management Transaction exposure Translation exposure Economic exposure Debt management Investment management 23

24 Interest rate risk monitoring and management 8% 11% 5% Not monitored For special events Transaction basis 54% 22% Portfolio basis Net overall approach Interest rate exposure management approach 13% 8% Fully hedge = none Partially hedge Take positions 79% Do not hedge Instruments used to manage interest rate exposures % 61% 52% 43% 45% 43% 4%35% 43% 35% 33 28% 33% 26% 26% 18% 2% 17 Plain vanilla IRS FRA Caps Floors Collars Options Swaptions Derivative based swaps IR Futures Control parameters applied to interest rate management activities % Authorised Instruments 48% 38% 38% 3% Counterparty limits IR sensitivityprofit % fixed/ floating Aggregate portfolio limits 15% 13% % Dealing limits Instrument exposure limits Stop-loss limits 8% Delegated authorities 24

25 Interest rate exposure management Interest rate risk is neither monitored, nor managed by only 8% of the responding companies, whereas another 11% manage the risk occasionally for special events (e.g. acquisition of a new subsidiary). Only 5% of the companies focus on interest rate risk on a transaction by transaction basis. The majority of respondents, i.e. 54%, state that they manage interest rate risk on a net overall basis. The remaining 22% primarily manage interest rate exposures on a portfolio basis, e.g. for a debt or a securities portfolio. This indicates that interest rate risk is predominantly managed on an aggregated level. However in practise, a clear definition of a risk-free position or target risk profile (including a specific benchmark), as a prerequisite for an effective risk management, is often missing. It is also evidenced by 45% of the survey participants not having formal policy for interest rate risk management. 79% of all participating companies partially hedge their interest rate exposure. 8% of the surveyed corporates take positions unrelated to their underlying business exposure and 13% do not hedge at all. In terms of companies not hedging interest rate exposure (13% vs. 29% in 1996), a distinction must be made between those which consciously choose not to do so and those, which do not possess sufficient technical know-how to pro-actively manage interest rate exposures. Discussions with treasurers showed that unlike to banks, corporates frequently focus on cash flow and net interest income implications when managing interest risks, and not primarily on market value movements. A wide range of derivative instruments is applied to manage interest risk. The most commonly used interest rate hedging instruments among Swiss corporates are plain vanilla interest rate swaps (7%), caps (45%), floors (4%) and forward rate agreements (FRAs, 43%). Compared to our 1996 results, interest rate swaps are employed by more participants (7% vs. 61%) and fewer participants make use of FRAs (43% vs. 52%). In addition to gaps in respect of formal policies also effective controls for interest rate exposure are still limited and performance measurements are missing at most corporates. For example, sensitivity analyses of interest rate volatility on profit and aggregate portfolio limits are in place for 48% only, and 3% respectively of the participating companies. It should be taken into account that interest rate risk management is a technically demanding area and controls need tailoring to support defined objectives and to reflect particularities of individual companies. A number of treasurers stated that they are in the process of developing a formal framework for an interest rate risk management. 25

26 Foreign exchange exposure management approach: Transaction Foreign exchange exposure management approach: Translation 5% % Fully hedge Partially hedge 38% Fully hedge = none Partially hedge Take positions Do not hedge 85% Do not hedge = none 62% Foreign exchange exposure management approach: Economic 84% 16% Fully hedge = none Partially hedge Take positions = none Do not hedge Annual value of external FX transactions % 76% 27% 25% 27% 24% All participants Very large corporates Other survey participants 17% 46% % CHF 2bn CHF 2 bn more than CHF bn Impact of the introduction of the Euro: Overall risk profile % 8% Time spent to manage FX risk following to the introduction of the Euro: 3% 25% 2% Increased Unchanged Decreased <25% Decreased >25% Increased = none Unchanged Decreased <25% Decreased >25% 62% 72% Transaction and hedging costs related to FX risk following to the introduction of the Euro: 8% 3% Increased = none Unchanged Decreased <25% Decreased >25% 62% 26

27 Foreign exchange exposure management Our survey examines approaches pursued by corporate treasuries in Switzerland for FX transaction, FX translation and FX economic exposure management. FX transaction exposures arise out of the operating business from actual conversion or exchange of one currency for another, resulting in cash gains or losses, which directly impacts profit and loss. FX translation exposures relate to investments in subsidiaries with a different functional currency than the Group s base currency. Translation differences do not result in actual cash flows. FX economic exposure management deals with the potential of suffering a gain or loss through fluctuations in market prices due to changes in business and economic circumstances within a country of operation in the longer term. Among all surveyed corporates, 85% stated that they partially hedge their foreign exchange transaction exposure. 5% of the participants take positions, which are unrelated to underlying exposures and % fully hedge their foreign exchange transaction exposure. FX translation and FX economic exposures are addressed differently. 62% of the participating corporates do not hedge their FX translation exposure and 84% do not hedge their FX economic exposure. Comments received showed that corporates in Switzerland, both VLCs and OSPs, focus their FX risk management on transaction exposure. For the 95% of corporates, which either fully or partially hedge their FX transaction exposure, it should be noted that individual hedging strategies vary substantially, e.g. with regard to period covered or hedge ratios. The percentage of participants taking positions unrelated to the operating business further decreased to 5% (vs. 13% in 1996). This also demonstrates that the vast majority of corporates does not want to build up additional risk positions (tying up economic risk capital) and that active FX dealing, with the aim to generate a profit contribution, is increasingly not part of the mission of the treasury function. A decrease of the annual external FX transaction volume is observed for treasuries in Switzerland. In 1996, 86% of the VLCs reported a transaction volume of more than CHF 2 billion per annum. This number decreased to 73%. The corresponding figures also decreased for OSPs (76% vs. 6%), indicating lower transaction volumes as well. The decrease in transaction volume is not surprising. Given increased centralisation of treasury activities and improved group-wide information flows, Group Treasuries can more easily reduce foreign exchange volumes transacted with external counterparties by netting the group s foreign exchange flows (which also helps to reduce credit/counterparty exposures). Another key reason is the introduction of the Euro, reducing or eliminating exposures in participating EMU currencies on different levels (Group and subsidiary). Three of four survey participants stated that the introduction of the Euro helped to reduce their group s FX exposure. 63% of the companies assess the overall risk profile having reduced up to 25% and % of the participants (3 VLCs and 1 OSP) estimate the reduction to even exceed this range. The time spent on managing FX risk reduced for 76% of the participants, but only one OSP expects to save more than 25%. The results with regard to transaction and hedging costs are similar: 71 % experience cost reductions, including those 7% (2 VLCs and 1 OSP), which expect the effect to exceed 25%. 27

28 Instruments used to manage FX transaction exposure % % 91% 88% 87% 78% 74% 55% 7% FX spots FX forward FX swaps CY options CY CY futures borrowings 5% % Control parameters applied to FX transaction exposure management activities % Agreed basis 55% 6% Exposure limits Min/ Max % hedge 25% Dealing limits 65% Authorised Instruments 4% 35% 38% Sens - base Stop loss Sens - reporting CY 18% Deleg authorities 28

29 Foreign exchange transaction exposure management The most commonly used instruments to hedge FX transaction exposure are FX spot contracts and FX forward contracts (both used by all participants), FX swaps (88%) and currency options (78%). Borrowings in foreign currency (55% vs. 7%) and currency futures (5% vs. 17%) are less frequently used than in Currency futures are still not popular with corporate treasuries due to administrative efforts related to the maintenance and handling of margin accounts. A clear and unambiguous definition of transaction exposure is a cornerstone for an effective FX exposure management. Technical exposure definitions for example should outline how tender offers or other contingent flows are to be treated and how individual instruments are to be aggregated (e.g. use of underlying or delta values for currency options). Nine out of ten participants state that they have an agreed basis for identifying the transaction exposure. The use of other control parameters has increased to some extent compared to our last survey. The most frequently applied control parameters to manage FX transaction exposure include authorised instruments 65% (vs. 43% in 1996) and a minimum/maximum percentage of exposure to be hedged 6% (vs. 48%). Other control tools, which may be more effective from a risk management point of view, such as exposure limits (55%) and sensitivity analysis of exchange rate volatility on base currency value (4%) are not as wide-spread. Stop loss limits are used by 35% of participants (unchanged) and dealing limits are less frequently used (25% vs. 48%), which may relate to FX dealing activities being pursued by few corporates only. 29

30 Instruments used to manage FX translation exposure % 39% 23% 39% 3% 26% 13% 13% 15% 26% 26% 35% 13% 13% % % CY FX forwards FX spots Cross None CY borrowings currency futures CY options FX swaps swaps Control parameters applied to FX translation exposure management activities 23% 18% 15% Sens - net assets 6 5% Agreed basis for Identification Sensprofit Authorised Instruments 8% % 5% 3% 5% % Min/Max % hedge Delegated authorities Sens of fx rate vol on cons gear Stop-loss limits Exposure limits Dealing limits 3

31 Foreign exchange translation exposure management Our survey shows that most companies in Switzerland are not hedging their translation exposure. 38% of the surveyed corporates partially hedge their foreign exchange translation exposure. Very large corporates more often hedge this exposure than other survey participants. Translation exposures do not lead to immediate cash flows. Translation exposure arises when profits and losses, assets and liabilities are denominated in a foreign currency but are expressed in terms of a base currency for financial reporting without an actual conversion taking place. The revaluation differences resulting from the translation of net assets and net income of subsidiaries into a group s functional currency are included in translation adjustments, a component of consolidated equity. With regard to instruments for translation management, currency borrowings and FX forward contracts are primarily used. These instruments are applied by 23% of the survey participants, respectively by 61% of the companies, which partially hedge translation exposures. Several treasurers pointed out that they are more concerned about effects of currency fluctuations on transaction risk than on translation risks. Therefore translation exposures are less actively monitored and controlled and less frequently reported to senior management than transaction exposures. Translation risk, however, is not always well understood by Management members in all respects. Disregarding translation exposures as accounting exposures and focusing solely on cash flows or transaction exposures could be dangerous. For example, adverse translation movements may result in a significant decrease of total consolidated equity and in turn, a higher debt/ equity ratio could trigger convenants included in financing agreements (with severe implications on liquidity). 5 % of the participants identify translation exposures (vs. 35% in 1996). Other control parameters include sensitivity of FX rate volatility on consolidated net assets (23%) and sensitivity of FX rate volatility on consolidated profits (18%). It is surprising that only few companies make use of sensitivity analyses to assess and control effects of exchange rate fluctuations on profits or consolidated equity, despite Value at Risk or similar tools being more frequently available (e.g. integrated functionality in various treasury management systems). 31