Practical Risk Management for Treasury

Published: 25 July 2024

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Practical risk management for treasury concept

Risk management is a key part of the treasurer’s job, and in times of crisis it’s fundamental. In that context, seasoned treasury colleagues advise against betting we’re not in crisis, or just about to enter one.

To support treasury students, we asked a panel of experienced treasury practitioners what they know about risk management for treasury, that would have been useful to know earlier in their careers. Key themes were the value of personal experience, the ability to step back from detail, and to think through tail risk scenarios.

Arrange personal painful experience of financial market risk

"What I would have wanted to know earlier in my career is the importance of understanding markets. I would encourage students to start learning about financial markets as soon as possible.

The best way is to start investing even very small amounts, so that there is this experience of following the news, learning what drives the markets, how portfolios fluctuate etc."

(Dimitris Papathanasiou CFA, Treasury and Risk Executive)

Doing nothing is an action with consequences

Eleanor Hill, Founder of The Treasury Storyteller, advises that a treasurer will never be praised for taking risks, even if there is some upside.

“Treasury is all about making sure the downside is protected. That is the value that good risk management brings in the treasury profession.

On that note, it is important to remember that - when it comes to hedging - not doing anything is a decision in its own right. Of course, at times, not using hedging instruments (derivatives) might be the best scenario for the business - especially if there are natural hedges to exploit internally. But be conscious in your approach to risk management and remember that inactivity - or the lack of decision-making around hedging - is in fact an action with consequences."

Hard dedicated risk management will pay off

Tim Coope FCT, Head of Treasury, Interim, St James’s Place, notes a lot of the benefits of risk management are not known until there has been an unforeseen event, sometimes years in the future. “Most of the time, it feels like a lot of hard dedicated work, updating, implementing, monitoring, and reporting various risk policies, which generally if all goes well are within tolerance and not much more is required.

But when something does happen, and they are needed, you really are glad that you put in the work and did the right thing. Much about risk management seems to be preparing for the worst but hoping for the best."

Keep an eye on tail risk

Phil Aspin FCT, FTSE100 CFO, Chair of 100 Group Pensions Committee and former Group Treasurer, advises keeping a beady eye on tail risk at all times.

"Corporates spend most of their time focused on the likely risks they face and the effectiveness of their controls to mitigate these to acceptable levels.

While this is essential, it’s also important not to lose sight of tail risk (often referred to as “black swan” risk) and to scenario plan how these risks might play out. To illustrate, I’ll summarise two notable events that come to mind from my career in treasury.

As a corporate treasurer during the Global Financial Crisis (2007/8) I recall having very significant credit exposure on the Royal Bank of Scotland (RBS)/Natwest/ABN group. The night before RBS was bailed out, I recall briefing my CFO on the position, explaining both the scale of our exposure, but also that the systemic nature of the risk meant it was highly likely to result in government intervention.

After a restless night, the UK Government announced the next day it was indeed stepping into support RBS. In contrast, there were several other smaller financial institutions - always paying good rates - that failed, with their depositors suffering total credit loss.

Later, in October 2022, I was chair of the 100 Group pensions committee during the UK gilt crisis which saw a significant increase in gilt rates following the well documented Liz Truss budget. Rates rose quickly requiring pension schemes to post significant collateral against their interest rate hedge positions, with somewhat of a self-fulfilling impact, as many needed to sell gilts (their most readily realisable asset) to post cash collateral.

After much discussion with market participants, including the 100 Group pensions committee, the Bank of England stepped in to stabilise the market and provide liquidity support as the risk became systemic. Generally, 100 Group members came through unscathed. However, many smaller schemes without robust liquidity positions had to close positions as rates headed up, and then suffered capital losses as rates came back down again when they were no longer hedged.

Afterwards, there was much debate in the pension industry about what was the right amount of liquidity, with large schemes all having a similar level (and generally better than smaller schemes) based on advisor Monte Carlo analysis of historical rates performance. My advice is to have just a little bit more liquidity than the majority of others. That way you are on the right side of the systemic risk intervention.

The most important consideration on tail risk is not crunching lots of detailed analysis, but rather to supplement this by stepping back and thinking through how things might play out."

The real lesson of black swans is robustness

The author and practitioner who popularised the black swan concept is Nassim Nicholas Taleb. He counsels against optimisation, and to focus instead on robustness. “When a company becomes more specialised with things, and it works better, the numbers look better. But your hidden risks rise and rise. And then when you are faced with a problem, you don’t know what to do about it, whereas in other cases you have more variations all the time. You have more fluctuations and, of course, you are a lot more robust.

... try not to predict the catalyst, which is the most foolish thing in the world, but to try to identify areas of vulnerability. It’s like saying a bridge is fragile. I can’t predict which truck is going to break it, so I have to look at it more in a structural form ... And then you learn not to try to predict which truck is going to break that bridge. But you just look at bridges and say, ‘Oh, this bridge doesn’t have a great foundation. This other one does. And this one needs to be reinforced.’ We can do a lot with the notion of robustness."

People risks and opportunities

As well as developing our own treasury risk management capabilities, we need strong teams around us. Fi Wallace, Associate Director, Treasury & finance recruitment, Renoir at Renovata and Company, summarises. "We’re in a turbulent time globally, including elections, wars, challenging interest rates and increased market volatility. Some of today’s treasury and finance leaders have been through periods where interest rates were similar to those in the 07/08 global finance crisis, but a lot haven’t!

This highlights the ever greater need to have the best treasury people in place, who can step back in the way Phil described and deal strategically with a rapidly evolving domestic and international political and economic environment."

Fundamental in crisis

Joanna Bonnett FCT, Group Treasurer of Straumann Group, concludes. "Risk management has always been a key part of the treasurer’s job description, but at times of crisis it becomes fundamental."

That being the case, never bet that we’re not in - or just about to enter – a crisis.

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Author: Doug Williamson, FCT