Five Good Reasons Why Treasury and Procurement Need to Work Together

Transcription

1 Five Good Reasons Why Treasury and Procurement Need to Work Together By Sharon Petrey, Treasury & Risk Management, Reval and Peter Seward, Vice President Product Strategy, Reval September, 2014

2 Executive summary About Reval In 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133: Accounting for Derivative Instruments and Hedging. This rule required all derivative instruments to be recorded on balance sheets, including those used by non-financial companies to offset fluctuations in foreign exchange, interest rates and commodity prices. Companies marking to market the value of their derivatives, rather than applying new and complex hedge accounting rules, didn t quite know what they were in for until volatile markets wreaked havoc on P&L statements. If history is to teach us anything, we only need to look back at this time when new derivative rules sent companies on the hunt for embedded derivatives, such as those in purchase contracts, to remember how critical it is for treasury and procurement to work together. Introduction Reval is a leading, global Software-as-a-Service (SaaS) provider of comprehensive and integrated Treasury and Risk Management (TRM) solutions. Our cloud-based software and related offerings enable enterprises to better manage cash, liquidity and financial risk, and includes specialized capabilities to account for and report on complex financial instruments and hedging activities. The scope and timeliness of the data and analytics we provide allow chief financial officers, treasurers and finance managers to operate more confidently in an increasingly complex and volatile global business environment. Today, the financial reform measures of Dodd-Frank, EMIR and Basel III have created new requirements for corporate end-users of derivatives and their counterparties. And again companies are reviewing their operational structures, workflows and controls to ensure they comply with regulatory mandates. This is a great reason to reassess how groups work together and how they can best be supported by technology. But beyond regulatory concerns, there are good business reasons why treasury and procurement need to work together. Because procurement manages pricing for commodities and treasury manages all financial risk, it is the contract that binds the two together, regardless of who is doing the hedging, or if hedging is done at all. Without aligning treasury and procurement around a common business strategy, and providing them with a common technology environment for visibility, collaboration and control, companies can watch their best laid plans go awry. Using Reval, companies can optimize treasury and risk management activities across the enterprise for greater operational efficiency, security, control and compliance. Founded in 1999, Reval is headquartered in New York with regional centers across North America, EMEA and Asia Pacific. For more information, visit or info@reval.com Reval.com, Inc. All Rights Reserved 2

3 You may have reasons of your own, but here are five that demonstrate why collaboration between treasury and procurement is critical to the bottom line. 1. Contract terms matter Commodity purchase contracts contain language that both legal and treasury recognize as red flags for procurement, best exemplified by the hunt for embedded derivatives in the early days of hedge accounting. Procurement may wish to hedge by order placed or by region, though treasury may know the best markets and times to enter into derivative contracts. While procurement has the best supplier contacts and may be able to find a fixed price supplier, treasury can advise on the best terms of those contracts. By working together, treasury, procurement and legal can combine their expertise to minimize commodity risk and, where necessary, hedge it in the most efficient way. 2. You only think you are seeing all of your risk Not all exposures are the same, and managing them in isolation can cost you. Some commodity exposures: cannot be hedged because no active derivative markets exist, can be hedged, but don t qualify for hedge accounting (creating P&L volatility), or can be hedged and qualify for hedge accounting. Procurement sees only commodity risk, but treasury needs to see all financial risk. If treasury sees only the commodity risks that can be hedged, it can miss the impacts that un-hedgable risks can have on the total picture. This can result in overhedging or hedging with inappropriate derivatives. However, companies now have access to advanced technology that can be used to analyze all exposures, hedgable or not. With advanced analytics, groups can identify the effects of correlation between commodity exposures and determine which exposures carry the most risk. It is well known that not all commodities have the same risk, and that some commodity prices often move in opposite directions of each other, or in the opposite direction of the exposure of other asset classes, such as currency or interest rates. Advanced analytics like Cash Flow at Risk (CFaR) allow treasury and procurement to be more precise in implementing hedging programs, which often results in less hedging. These tools also provide simple metrics and graphs to help treasury communicate and promote an understanding of risk to non-technical stakeholders. Advanced analytics help provide an understanding of these correlation effects across asset classes and can help create hedge policies that take these effects into account. Often, the hedging of individual risks can be eliminated because of natural offsets, and other risks only hedged for disaster insurance, leaving positive upside for gains Reval.com, Inc. All Rights Reserved 3

4 3. Budgets could reflect disconnects between treasury and procurement You are growing globally and need to make sure you are forecasting your budgets properly, both locally and centrally. Because you want to fix pricing in local currencies where you can for the commodities you purchase, you need to be able to take into consideration the FX component of your commodity hedges. Regional production centers often settle U.S. dollar-denominated commodity derivatives in the local entity s functional currency, creating FX risk to the parent. And, if they settle in U.S. dollars, there is a functional currency/usd risk to the local entity. In either of these scenarios, it is usually treasury that identifies these risks and hedges on behalf of the parent or production center. Therefore, treasury and procurement both need to be aware of the translational and transactional risk to commodity activities. 4. Trading in a vacuum affects Share of Wallet Procurement may have a piece of risk management, but again, treasury has responsibility for all financial risks, including liquidity risk and counterparty risk. Neither can afford to be running up exposures without the other being aware. Procurement departments that are trading over-the-counter (OTC) contracts, for example, may be giving business to banks that aren t even a credit provider to the company. It is one thing to manage excessive exposure to banks, but it is another to manage the pairing off of company and bank for future business. Treasury counts on knowing all of the ancillary business the company is giving each bank so that it can ensure adherence to counterparty limits while striving to fairly compensate the bank group. If treasury and procurement are working in the same, multi-asset class TRM system, and can transact and enter trades in that system as well, then the company has the ability to track, analyze and make decisions, not only about risk mangement, but also about how to leverage the bank group. 5. You must be sure the liquidity is there to cover margin It s not uncommon that commodity risk management consists of fixed pricing through supplier contracts, exchange traded derivatives and even dealing OTC with market makers. While posting margin is a given for exchange traded activity, it could also be a requirement for OTC trades, depending on the Credit Support Annex (CSA) of your master ISDA agreement. Either way, treasury and procurement need to work together to properly forecast cash flow and ensure they have enough liquidity to cover margin. With a handle on the holistic effects on liquidity, you may have more choices available to you to trade in the futures market or OTC, and you can feel more confident in the choices you do make. Working in the same treasury and risk management system will provide you with the real-time, global visibility you need into your daily cash position inclusive of margin obligations and the liquidity you have available to meet daily funding requirements Reval.com, Inc. All Rights Reserved 4

5 Today, treasury and procurement are experiencing another whole partnering to identify risks and comply with new regulations. Just as you once searched for embedded derivatives, you are now searching for swaps. But now you have technology that enables you to comply with the rules governing derivatives and collaborate on cash and risk strategies to improve corporate performance. For more information on technology that enables treasury and procurement teams to work together, visit com Reval.com, Inc. All Rights Reserved 5